Nicolet Bankshares - 10-Q quarterly report FY2018 Q3

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_________________________

FORM 10-Q

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

For the quarterly period ended September 30, 2018

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

For the transition period from to

Commission file number: 001-37700

NICOLET BANKSHARES, INC.

(Exact Name of Registrant as Specified in its Charter)



WISCONSIN (State or Other Jurisdiction of Incorporation or Organization)	47-0871001 (I.R.S. Employer Identification No.)

111 North Washington Street Green Bay, Wisconsin (Address of Principal Executive Offices)	54301 (Zip Code)

(920) 430-1400 (Registrant’s Telephone Number, Including Area Code)

N/A (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 ý 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 preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý 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 x

Non-accelerated filer ¨	Smaller reporting company ¨

Emerging Growth Company x

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

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

As of October 31, 2018 there were 9,525,855 shares of $0.01 par value common stock outstanding.

Nicolet Bankshares, Inc.

TABLE OF CONTENTS



			PAGE
PART I	FINANCIAL INFORMATION

	Item 1.	Financial Statements:

		Consolidated Balance Sheets September 30, 2018 (unaudited) and December 31, 2017	3

		Consolidated Statements of Income Three and Nine Months Ended September 30, 2018 and 2017 (unaudited)	4

		Consolidated Statements of Comprehensive Income Three and Nine Months Ended September 30, 2018 and 2017 (unaudited)	5

		Consolidated Statement of Stockholders’ Equity Nine Months Ended September 30, 2018 (unaudited)	6

		Consolidated Statements of Cash Flows Nine Months Ended September 30, 2018 and 2017 (unaudited)	7

		Notes to Unaudited Consolidated Financial Statements	8

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	45

	Item 4.	Controls and Procedures	45

PART II	OTHER INFORMATION

	Item 1.	Legal Proceedings	46

	Item 1A.	Risk Factors	46

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

	Item 3.	Defaults Upon Senior Securities	46

	Item 4.	Mine Safety Disclosures	46

	Item 5.	Other Information	46

	Item 6.	Exhibits	47

		Signatures	48

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS:

NICOLET BANKSHARES, INC.

Consolidated Balance Sheets

(In thousands, except share and per share data)



	September 30, 2018			December 31, 2017
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	60,346		$	86,191
Interest-earning deposits	100,066			68,008
Federal funds sold	743			734
Cash and cash equivalents	161,155			154,933
Certificates of deposit in other banks	995			1,746
Securities available for sale (“AFS”), at fair value	410,911			405,153
Other investments	17,479			14,837
Loans held for sale	2,593			4,666
Loans	2,143,457			2,087,925
Allowance for loan losses	(12,992		)	(12,653		)
Loans, net	2,130,465			2,075,272
Premises and equipment, net	47,305			47,151
Bank owned life insurance (“BOLI”)	65,820			64,453
Goodwill and other intangibles, net	125,360			128,406
Accrued interest receivable and other assets	38,819			35,816
Total assets	$	3,000,902		$	2,932,433

Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing demand deposits	$	664,788		$	631,831
Interest-bearing deposits	1,857,368			1,839,233
Total deposits	2,522,156			2,471,064
Short-term borrowings	—			—
Long-term borrowings	77,241			78,046
Accrued interest payable and other liabilities	23,602			18,444
Total liabilities	2,622,999			2,567,554

Stockholders’ Equity:
Common stock	96			98
Additional paid-in capital	251,631			263,835
Retained earnings	133,501			102,391
Accumulated other comprehensive loss	(8,057		)	(2,146		)
Total Nicolet Bankshares, Inc. stockholders’ equity	377,171			364,178
Noncontrolling interest	732			701
Total stockholders’ equity and noncontrolling interest	377,903			364,879
Total liabilities, noncontrolling interest and stockholders’ equity	$	3,000,902		$	2,932,433

Preferred shares authorized (no par value)	10,000,000			10,000,000
Preferred shares issued and outstanding	—			—
Common shares authorized (par value $0.01 per share)	30,000,000			30,000,000
Common shares outstanding	9,576,644			9,818,247
Common shares issued	9,604,160			9,849,167

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Income

(In thousands, except share and per share data) (Unaudited)



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Interest income:
Loans, including loan fees	$	28,997	$	27,329	$	84,644	$	73,098
Investment securities:
Taxable	1,564		1,114		4,503		3,422
Tax-exempt	572		604		1,737		1,761
Other interest income	747		407		2,326		1,136
Total interest income	31,880		29,454		93,210		79,417
Interest expense:
Deposits	4,055		2,364		11,012		5,216
Short-term borrowings	—		—		8		72
Long-term borrowings	883		699		2,571		1,894
Total interest expense	4,938		3,063		13,591		7,182
Net interest income	26,942		26,391		79,619		72,235
Provision for loan losses	340		975		1,360		1,875
Net interest income after provision for loan losses	26,602		25,416		78,259		70,360
Noninterest income:
Trust services fee income	1,638		1,479		4,915		4,431
Brokerage fee income	1,732		1,500		5,074		4,192
Mortgage income, net	1,902		1,774		4,510		4,022
Service charges on deposit accounts	1,247		1,238		3,637		3,367
Card interchange income	1,481		1,225		4,082		3,378
BOLI income	1,019		459		1,929		1,314
Rent income	303		285		951		852
Asset gains (losses), net	146		1,305		1,322		2,071
Other income	1,181		899		3,292		2,391
Total noninterest income	10,649		10,164		29,712		26,018
Noninterest expense:
Personnel	12,983		11,488		38,149		32,404
Occupancy, equipment and office	3,660		3,559		10,901		9,613
Business development and marketing	1,334		1,113		4,139		3,359
Data processing	2,375		2,238		7,094		6,428
FDIC expense	245		205		800		582
Intangibles amortization	1,054		1,173		3,336		3,514
Other expense	1,393		1,086		3,718		3,598
Total noninterest expense	23,044		20,862		68,137		59,498
Income before income tax expense	14,207		14,718		39,834		36,880
Income tax expense	3,268		5,133		9,431		12,605
Net income	10,939		9,585		30,403		24,275
Less: Net income attributable to noncontrolling interest	80		74		230		228
Net income attributable to Nicolet Bankshares, Inc.	$	10,859	$	9,511	$	30,173	$	24,047

Earnings per common share:
Basic	$	1.13	$	0.97	$	3.12	$	2.58
Diluted	$	1.09	$	0.91	$	3.02	$	2.45

Weighted average common shares outstanding:
Basic	9,633,158		9,836,646		9,678,726		9,316,814
Diluted	9,949,295		10,408,683		10,004,316		9,820,724

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	10,939		$	9,585		$	30,403		$	24,275
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities AFS:
Net unrealized holding gains (losses) arising during the period	(1,836		)	834			(6,814		)	5,685
Reclassification adjustment for net gains included in income	—			(1,222		)	—			(1,220		)
Income tax (expense) benefit	497			125			1,840			(1,741		)
Total other comprehensive income (loss)	(1,339		)	(263		)	(4,974		)	2,724
Comprehensive income	$	9,600		$	9,322		$	25,429		$	26,999

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statement of Stockholders’ Equity

(In thousands) (Unaudited)



	Nicolet Bankshares, Inc. Stockholders’ Equity
	Common Stock			Additional Paid-In Capital			Retained Earnings		Accumulated Other Comprehensive Loss			Noncontrolling Interest			Total
Balance December 31, 2017	$	98		$	263,835		$	102,391	$	(2,146	)	$	701		$	364,879
Comprehensive income:
Net income	—			—			30,173		—			230			30,403
Other comprehensive loss	—			—			—		(4,974		)	—			(4,974		)
Stock-based compensation expense	—			3,613			—		—			—			3,613
Exercise of stock options	1			1,223			—		—			—			1,224
Issuance of common stock	—			167			—		—			—			167
Purchase and retirement of common stock	(3		)	(17,207		)	—		—			—			(17,210		)
Distribution to noncontrolling interest	—			—			—		—			(199		)	(199		)
Adoption of ASU 2016-01 (See Notes 1 and 5)	—			—			937		(937		)	—			—
Balance, September 30, 2018	$	96		$	251,631		$	133,501	$	(8,057	)	$	732		$	377,903

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Cash Flows (Unaudited)



(In thousands)	Nine Months Ended September 30,
	2018			2017
Cash Flows From Operating Activities:
Net income	$	30,403		$	24,275
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion	4,643			7,038
Provision for loan losses	1,360			1,875
Increase in cash surrender value of life insurance	(1,367		)	(1,314		)
Stock-based compensation expense	3,613			1,871
Asset (gains) losses, net	(1,322		)	(2,071		)
Gain on sale of loans held for sale, net	(4,026		)	(3,614		)
Proceeds from sale of loans held for sale	184,314			164,726
Origination of loans held for sale	(178,911		)	(164,806		)
Net change in:
Accrued interest receivable and other assets	(4,952		)	239
Accrued interest payable and other liabilities	6,798			1,733
Net cash provided by operating activities	40,553			29,952
Cash Flows From Investing Activities:
Net increase in loans	(50,703		)	(126,499		)
Net decrease in certificates of deposit in other banks	751			1,490
Purchases of securities AFS	(57,891		)	(49,119		)
Proceeds from sales of securities AFS	—			10,798
Proceeds from calls and maturities of securities AFS	40,302			34,426
Purchases of other investments	(634		)	(3,256		)
Proceeds from sales of other investments	807			6,519
Proceeds from redemption of BOLI	561			—
Net increase in premises and equipment	(2,974		)	(2,958		)
Net decrease in other real estate and other assets	1,486			2,470
Net cash received in business combination	—			9,119
Net cash used by investing activities	(68,295		)	(117,010		)
Cash Flows From Financing Activities:
Net increase in deposits	51,171			22,054
Net increase in short-term borrowings	—			12,900
Proceeds from long-term borrowings	—			30,000
Repayments of long-term borrowings	(1,189		)	(4,487		)
Purchase and retirement of common stock	(17,210		)	(7,462		)
Capitalized issuance costs, net	—			(186		)
Proceeds from issuance of common stock	167			175
Proceeds from exercise of stock options	1,224			1,064
Distribution to noncontrolling interest	(199		)	—
Net cash provided by financing activities	33,964			54,058
Net increase (decrease) in cash and cash equivalents	6,222			(33,000		)
Cash and cash equivalents:
Beginning	154,933			129,103
Ending *	$	161,155		$	96,103
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	13,294		$	7,117
Cash paid for taxes	9,325			8,805
Transfer of loans and bank premises to other real estate owned	587			828
Capitalized mortgage servicing rights	696			679
Transfer of loans from held for sale to held for investment	—			3,236
Acquisitions:
Fair value of assets acquired	$	—		$	439,000
Fair value of liabilities assumed	—			398,000
Net assets acquired	—			41,000

* Cash and cash equivalents include restricted cash of $7.4 million and $2.4 million at September 30, 2018 and 2017, respectively, for the reserve balance required with the Federal Reserve Bank.

See accompanying notes to unaudited consolidated financial statements.

NICOLET BANKSHARES, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

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

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Critical Accounting Policies and Estimates

Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, valuation of loans in acquisition transactions, useful lives for depreciation and amortization, fair value of financial instruments, other-than-temporary impairment calculations, valuation of deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the determination and assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisition transactions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking or tax regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.

There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Recent Accounting Developments Adopted

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, Compensation – Stock Compensation (Topic 718). ASU 2017-09 applies to entities that change the terms or conditions of a share-based payment award to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718 to the modification to the terms and conditions of a share-based payment award. The updated guidance was effective for interim and annual reporting periods beginning after December 15, 2017. The Company adopted the updated guidance effective January 1, 2018 with no material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, to clarify the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets versus businesses. The update narrows the definition of a business by adding three principal clarifications: (1) if substantially all the fair value of the gross assets in the asset group is concentrated in either a single identifiable asset or group of similar identifiable assets the transaction does not involve a business, (2) if the asset group does not include a minimum of an input and a substantive process, it does not represent a business, and (3) if the integrated set of activities (including its inputs and processes) does not create, or have the ability to create, goods or services to customers, investment income (e.g., dividends or interest) or other revenue, it is not a business. The overall intention is to provide consistency in applying the guidance and make the definition of a business more operable. This update was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and should be applied prospectively. The Company adopted the updated guidance effective January 1, 2018 with no material impact on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash to provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows to reduce diversity in practice. The amendment requires that a statement of cash flow explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash or restricted cash equivalents should be included in cash and cash equivalents when reconciling the beginning and end of period total amounts shown on the statement of cash flow. This amendment was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and should be applied retrospectively to each period presented. The Company adopted the updated guidance effective January 1, 2018 with no material impact on its consolidated financial statements. See the consolidated statements of cash flows for additional disclosures related to this ASU.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on specific cash flow issues, including: debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies, and distributions received from equity method investees. The amendments were effective for public business entities for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. The Company adopted the updated guidance effective January 1, 2018 with no material impact on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This amendment supersedes the guidance to classify equity securities with readily determinable fair values into different categories, requires equity securities to be measured at fair value with changes in the fair value recognized through net income, and simplifies the impairment assessment of equity investments without readily determinable fair values. The amendment also requires public business entities that are required to disclose the fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price notion. The amendment requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. This amendment was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities were required to apply the amendment by means of a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, with the exception of the amendment related to equity securities without readily determinable fair values, which should be applied prospectively to equity investments that exist as of the date of adoption. The Company adopted the updated guidance effective January 1, 2018 and recognized a cumulative-effect adjustment at adoption of approximately $0.9 million for the after tax impact of the unrealized gain on equity securities. See the consolidated statement of stockholders’ equity and Note 5 for additional disclosures related to this ASU.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), with several subsequent updates. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Topic 606 provides a five-step model to apply to revenue recognition, consisting of the following: (1) identify the contract; (2) identify the performance obligation in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations; and (5) recognize revenue when or as the performance obligation is satisfied. The guidance was effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company adopted the updated guidance using the modified retrospective approach effective January 1, 2018, with no material impact on its consolidated financial statements. See Note 10 for the new disclosures related to Topic 606.

Operating Segment

While the chief-operating decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.

Reclassifications

Certain amounts in the 2017 consolidated financial statements have been reclassified to conform to the 2018 presentation.

Note 2 – Acquisitions

During the third quarter of 2018, Nicolet purchased a small brokerage book of business from a retiring financial advisor in support of the Company's initiative to expand its wealth management business. As a result of this purchase, the Company recorded a customer list intangible of $290,000 which will be amortized on a straight-line basis.

On April 28, 2017, the Company consummated its merger with First Menasha Bancshares, Inc. (“First Menasha”) pursuant to the Agreement and Plan of Merger by and between the Company and First Menasha dated November 3, 2016, (the “Merger Agreement”), whereby First Menasha was merged with and into the Company, and The First National Bank-Fox Valley, the wholly

owned commercial bank subsidiary of First Menasha serving the Fox Valley area of Wisconsin, was merged with and into Nicolet National Bank (the “Bank”). The system integration was completed, and five branches of First Menasha opened on May 1, 2017, as Nicolet National Bank branches, expanding its presence in Calumet and Winnebago Counties, Wisconsin. The Company closed one of its Calumet County locations concurrently with the First Menasha merger.

The purpose of the merger was to continue Nicolet’s interest in strategic growth, consistent with its plan to improve profitability through efficiency, leverage the strengths of each bank across the combined customer base, and add shareholder value. With the merger, Nicolet became the leading community bank to serve the Fox Valley area of Wisconsin.

Pursuant to the Merger Agreement, the final purchase price consisted of issuing 1,309,885 shares of the Company’s common stock (given the final stock-for-stock exchange ratio of 3.126 except for First Menasha shares owned by the Company immediately prior to the time of the merger), for common stock consideration of $62.2 million (based on $47.52 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period) plus cash consideration of $19.3 million. Approximately $0.2 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital.

Upon consummation, the Company added $480 million in assets, $351 million in loans, $375 million in deposits, $4 million in core deposit intangible, and $41 million of goodwill. The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of First Menasha prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective estimated fair values at the date of acquisition.

Note 3 – Earnings per Common Share

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



	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands, except per share data)	2018		2017		2018		2017
Net income attributable to Nicolet Bankshares, Inc.	$	10,859	$	9,511	$	30,173	$	24,047

Weighted average common shares outstanding	9,633		9,837		9,679		9,317
Effect of dilutive common stock awards	316		572		325		504
Diluted weighted average common shares outstanding	9,949		10,409		10,004		9,821

Basic earnings per common share*	$	1.13	$	0.97	$	3.12	$	2.58
Diluted earnings per common share*	$	1.09	$	0.91	$	3.02	$	2.45

*Cumulative quarterly per share performance may not equal annual per share totals due to the effects of the amount and timing of capital increases. When computing earnings per share for an interim period, the denominator is based on the weighted average shares outstanding during the interim period, and not on an annualized weighted average basis. Accordingly, the sum of the earnings per share data for the quarters will not necessarily equal the year to date earnings per share data.

For the three and nine months ended September 30, 2018, options to purchase approximately 0.1 million shares are excluded from the calculation of diluted earnings per common share as the effect of their exercise would have been anti-dilutive. There was no anti-dilutive effect of options outstanding for the three and nine months ended September 30, 2017.

Note 4 – Stock-Based Compensation

The Company may grant stock options and restricted stock under its stock-based compensation plans to certain officers, employees and directors. At September 30, 2018, approximately 144,000 shares were available for grant under these stock-based compensation plans.

A Black-Scholes model is utilized to estimate the fair value of stock option grants, while the market price of the Company’s stock at the date of grant is used to estimate the fair value of restricted stock awards. The weighted average assumptions used in the Black-Scholes model for valuing stock option grants were as follows.



	Nine Months Ended September 30,
	2018			2017
Dividend yield	—		%	—		%
Expected volatility	25		%	25		%
Risk-free interest rate	2.48		%	2.13		%
Expected average life	7 years			7 years
Weighted average per share fair value of options	$	17.60		$	15.44

Activity in the Company’s Stock Incentive Plans is summarized in the following tables.



Stock Options	Option Shares Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value (in thousands)
Outstanding - December 31, 2017	1,643,255		$	39.82
Granted	10,000		54.06
Exercise of stock options *	(56,881	)	21.53
Forfeited	(6,500	)	39.43
Outstanding - September 30, 2018	1,589,874		$	40.57	7.6	$	22,429
Exercisable - September 30, 2018	543,886		$	32.00	6.4	$	12,243

* The terms of the stock option agreements permit having a number of shares of stock withheld, the fair market value of which as of the date of exercise is sufficient to satisfy the exercise price and/or tax withholding requirements; accordingly, 2,194 such shares were surrendered to the Company during the nine months ended September 30, 2018.

Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The intrinsic value of options exercised for both the nine months ended September 30, 2018 and 2017 was approximately $1.8 million.



Restricted Stock	Weighted Average Grant Date Fair Value		Restricted Shares Outstanding
Outstanding - December 31, 2017	$	34.26	30,920
Granted	55.64		7,510
Vested *	37.44		(10,911	)
Forfeited	16.50		(3	)
Outstanding - September 30, 2018	$	38.84	27,516

* The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly, 1,615 shares were surrendered during the nine months ended September 30, 2018.

The Company recognized approximately $3.4 million and $1.9 million of stock-based compensation expense (included in personnel on the consolidated statements of income) during the nine months ended September 30, 2018 and 2017, respectively, associated with its common stock awards granted to officers and employees. In addition, during the third quarter of 2018, the Company recognized approximately $0.2 million of director expense (included in other expense on the consolidated statements of income) for a total restricted stock grant of 3,510 shares with immediate vesting to directors. As of September 30, 2018, there was approximately $13.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the remaining vesting period of approximately three years. The Company recognized a tax benefit of approximately $0.2 million for both the nine months ended September 30, 2018 and 2017, respectively, for the tax impact of stock option exercises and vesting of restricted stock.

Note 5 – Securities Available for Sale

Amortized cost and fair value of securities available for sale are summarized as follows.



	September 30, 2018
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government agency securities	$	27,133	$	—	$	879	$	26,254
State, county and municipals	169,431		38		4,647		164,822
Mortgage-backed securities	140,427		85		4,667		135,845
Corporate debt securities	84,957		165		1,132		83,990
Total	$	421,948	$	288	$	11,325	$	410,911



	December 31, 2017
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government agency securities	$	26,586	$	—	$	377	$	26,209
State, county and municipals	186,128		180		2,264		184,044
Mortgage-backed securities	157,705		160		2,333		155,532
Corporate debt securities	36,387		449		39		36,797
Equity securities *	1,287		1,284		—		2,571
Total	$	408,093	$	2,073	$	5,013	$	405,153

* Effective January 1, 2018, the Company adopted ASU 2016-01, which requires equity securities with readily determinable fair values to be measured at fair value with changes in the fair value recognized through net income. Such securities are no longer reflected as securities AFS. As a result of this accounting change, the Company recognized a cumulative-effect adjustment at adoption from accumulated other comprehensive income to retained earnings of approximately $0.9 million in the consolidated statement of stockholders’ equity for the net of tax impact of the unrealized gain on equity securities as of the date of adoption and recognized a gain of approximately $475,000 for the nine months ended September 30, 2018, in the consolidated statements of income for the change in fair value on equity securities since adoption. In addition, the approximately $2.8 million current fair value of equity securities is now reflected within other investments on the consolidated balance sheets rather than as securities AFS. Prior periods have not been restated for the impact of this accounting change. See Note 1 for additional information on this new accounting standard.

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



	September 30, 2018
	Less than 12 months				12 months or more				Total
($ in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Number of Securities
U.S. government agency securities	$	—	$	—	$	26,254	$	879	$	26,254	$	879	2
State, county and municipals	71,359		1,168		81,418		3,479		152,777		4,647		453
Mortgage-backed securities	32,929		727		93,312		3,940		126,241		4,667		212
Corporate debt securities	69,816		1,132		—		—		69,816		1,132		37
Total	$	174,104	$	3,027	$	200,984	$	8,298	$	375,088	$	11,325	704



	December 31, 2017
	Less than 12 months				12 months or more				Total
($ in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Number of Securities
U.S. government agency securities	$	26,209	$	377	$	—	$	—	$	26,209	$	377	2
State, county and municipals	110,157		1,097		49,326		1,167		159,483		2,264		465
Mortgage-backed securities	72,210		735		65,537		1,598		137,747		2,333		215
Corporate debt securities	10,172		39		—		—		10,172		39		5
Total	$	218,748	$	2,248	$	114,863	$	2,765	$	333,611	$	5,013	687

As of September 30, 2018, the Company does not consider its securities AFS with unrealized losses to be other-than-temporarily impaired, as the unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the nine months ended September 30, 2018 or 2017.

The amortized cost and fair value of securities AFS by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties; as this is particularly inherent in mortgage-backed securities, these securities are not included in the maturity categories below.



	September 30, 2018
(in thousands)	Amortized Cost		Fair Value
Due in less than one year	$	21,592	$	21,559
Due in one year through five years	157,636		154,294
Due after five years through ten years	95,324		92,078
Due after ten years	6,969		7,135
	281,521		275,066
Mortgage-backed securities	140,427		135,845
Securities available for sale	$	421,948	$	410,911

Proceeds from the sale of securities AFS were as follows.



	Nine Months Ended September 30,
(in thousands)	2018		2017
Gross gains	$	—	$	1,227
Gross losses	—		(7		)
Gains (losses) on sales of securities AFS, net	$	—	$	1,220
Proceeds from sales of securities AFS	$	—	$	10,798

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

The loan composition is summarized as follows.



	September 30, 2018					December 31, 2017
(in thousands)	Amount			% of Total		Amount			% of Total
Commercial & industrial	$	665,754		31.1	%	$	637,337		30.5	%
Owner-occupied commercial real estate (“CRE”)	449,151			21.0		430,043			20.6
Agricultural (“AG”) production	35,727			1.7		35,455			1.7
AG real estate	52,378			2.4		51,778			2.5
CRE investment	331,312			15.5		314,463			15.1
Construction & land development	86,533			4.0		89,660			4.3
Residential construction	30,295			1.4		36,995			1.8
Residential first mortgage	357,163			16.6		363,352			17.4
Residential junior mortgage	109,692			5.1		106,027			5.1
Retail & other	25,452			1.2		22,815			1.0
Loans	2,143,457			100.0	%	2,087,925			100.0	%
Less allowance for loan losses (“ALLL”)	12,992					12,653
Loans, net	$	2,130,465				$	2,075,272
Allowance for loan losses to loans	0.61		%			0.61		%

As a further breakdown, loans are summarized by originated and acquired as follows.



	September 30, 2018										December 31, 2017
(in thousands)	Originated Amount			% of Total		Acquired Amount			% of Total		Originated Amount			% of Total		Acquired Amount			% of Total
Commercial & industrial	$	551,395		38.9	%	$	114,359		15.8	%	$	488,600		39.3	%	$	148,737		17.6	%
Owner-occupied CRE	274,036			19.3		175,115			24.2		237,548			19.1		192,495			22.8
AG production	10,821			0.8		24,906			3.4		11,102			0.9		24,353			2.9
AG real estate	29,685			2.1		22,693			3.1		27,831			2.2		23,947			2.8
CRE investment	151,335			10.7		179,977			24.8		113,862			9.2		200,601			23.8
Construction & land development	63,106			4.4		23,427			3.2		56,061			4.5		33,599			4.0
Residential construction	30,245			2.1		50			0.1		33,615			2.7		3,380			0.4
Residential first mortgage	211,474			14.9		145,689			20.1		191,186			15.4		172,166			20.4
Residential junior mortgage	74,366			5.2		35,326			4.9		65,643			5.3		40,384			4.8
Retail & other	22,464			1.6		2,988			0.4		18,254			1.4		4,561			0.5
Loans	1,418,927			100.0	%	724,530			100.0	%	1,243,702			100.0	%	844,223			100.0	%
Less ALLL	11,118					1,874					10,542					2,111
Loans, net	$	1,407,809				$	722,656				$	1,233,160				$	842,112
ALLL to loans	0.78		%			0.26		%			0.85		%			0.25		%

A roll forward of the allowance for loan losses is summarized as follows.



	Nine Months Ended						Year Ended
(in thousands)	September 30, 2018			September 30, 2017			December 31, 2017
Beginning balance	$	12,653		$	11,820		$	11,820
Provision for loan losses	1,360			1,875			2,325
Charge-offs	(1,110		)	(1,156		)	(1,604		)
Recoveries	89			71			112
Net charge-offs	(1,021		)	(1,085		)	(1,492		)
Ending balance	$	12,992		$	12,610		$	12,653

Practically all of the Company’s loans, commitments, and letters of credit have been granted to customers in the Company’s market area. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment.



	TOTAL – Nine Months Ended September 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	4,934		$	2,607		$	129		$	296		$	1,388		$	726		$	251		$	1,609		$	488		$	225		$	12,653
Provision	1,043			293			(8		)	(2		)	(8		)	(230		)	(41		)	119			(55		)	249			1,360
Charge-offs	(743		)	(64		)	—			—			(37		)	—			—			(85		)	—			(181		)	(1,110		)
Recoveries	30			12			—			—			—			—			—			3			31			13			89
Net charge-offs	(713		)	(52		)	—			—			(37		)	—			—			(82		)	31			(168		)	(1,021		)
Ending balance	$	5,264		$	2,848		$	121		$	294		$	1,343		$	496		$	210		$	1,646		$	464		$	306		$	12,992
As percent of ALLL	40.5		%	21.9		%	0.9		%	2.3		%	10.3		%	3.8		%	1.6		%	12.7		%	3.6		%	2.4		%	100.0		%

ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	5,264			2,848			121			294			1,343			496			210			1,646			464			306			12,992
Ending balance	$	5,264		$	2,848		$	121		$	294		$	1,343		$	496		$	210		$	1,646		$	464		$	306		$	12,992

Loans:
Individually evaluated	$	5,858		$	1,548		$	—		$	234		$	2,876		$	603		$	—		$	2,663		$	57		$	12		$	13,851
Collectively evaluated	659,896			447,603			35,727			52,144			328,436			85,930			30,295			354,500			109,635			25,440			2,129,606
Total loans	$	665,754		$	449,151		$	35,727		$	52,378		$	331,312		$	86,533		$	30,295		$	357,163		$	109,692		$	25,452		$	2,143,457

Less ALLL	5,264			2,848			121			294			1,343			496			210			1,646			464			306			12,992
Net loans	$	660,490		$	446,303		$	35,606		$	52,084		$	329,969		$	86,037		$	30,085		$	355,517		$	109,228		$	25,146		$	2,130,465

As a further breakdown, the ALLL is summarized by originated and acquired as follows.



	Originated – Nine Months Ended September 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	4,192		$	2,115		$	112		$	235		$	1,154		$	628		$	200		$	1,297		$	409		$	200		$	10,542
Provision	1,143			349			(4		)	9			(13		)	(217		)	(25		)	165			(43		)	247			1,611
Charge-offs	(743		)	(64		)	—			—			(37		)	—			—			(85		)	—			(178		)	(1,107		)
Recoveries	29			1			—			—			—			—			—			—			29			13			72
Net charge-offs	(714		)	(63		)	—			—			(37		)	—			—			(85		)	29			(165		)	(1,035		)
Ending balance	$	4,621		$	2,401		$	108		$	244		$	1,104		$	411		$	175		$	1,377		$	395		$	282		$	11,118
As percent of ALLL	41.6		%	21.6		%	1.0		%	2.2		%	9.9		%	3.7		%	1.6		%	12.4		%	3.5		%	2.5		%	100.0		%

Loans:
Individually evaluated	$	2,553		$	328		$	—		$	—		$	918		$	—		$	—		$	251		$	—		$	—		$	4,050
Collectively evaluated	548,842			273,708			10,821			29,685			150,417			63,106			30,245			211,223			74,366			22,464			1,414,877
Total loans	$	551,395		$	274,036		$	10,821		$	29,685		$	151,335		$	63,106		$	30,245		$	211,474		$	74,366		$	22,464		$	1,418,927

Less ALLL	4,621			2,401			108			244			1,104			411			175			1,377			395			282			11,118
Net loans	$	546,774		$	271,635		$	10,713		$	29,441		$	150,231		$	62,695		$	30,070		$	210,097		$	73,971		$	22,182		$	1,407,809



	Acquired – Nine Months Ended September 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	742		$	492		$	17		$	61		$	234		$	98		$	51		$	312		$	79		$	25		$	2,111
Provision	(100		)	(56		)	(4		)	(11		)	5			(13		)	(16		)	(46		)	(12		)	2			(251		)
Charge-offs	—			—			—			—			—			—			—			—			—			(3		)	(3		)
Recoveries	1			11			—			—			—			—			—			3			2			—			17
Net charge-offs	1			11			—			—			—			—			—			3			2			(3		)	14
Ending balance	$	643		$	447		$	13		$	50		$	239		$	85		$	35		$	269		$	69		$	24		$	1,874
As percent of ALLL	34.3		%	23.9		%	0.7		%	2.7		%	12.7		%	4.5		%	1.9		%	14.3		%	3.7		%	1.3		%	100.0		%

Loans:
Individually evaluated	$	3,305		$	1,220		$	—		$	234		$	1,958		$	603		$	—		$	2,412		$	57		$	12		$	9,801
Collectively evaluated	111,054			173,895			24,906			22,459			178,019			22,824			50			143,277			35,269			2,976			714,729
Total loans	$	114,359		$	175,115		$	24,906		$	22,693		$	179,977		$	23,427		$	50		$	145,689		$	35,326		$	2,988		$	724,530

Less ALLL	643			447			13			50			239			85			35			269			69			24			1,874
Net loans	$	113,716		$	174,668		$	24,893		$	22,643		$	179,738		$	23,342		$	15		$	145,420		$	35,257		$	2,964		$	722,656

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment.



	TOTAL – Year Ended December 31, 2017
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	3,919		$	2,867		$	150		$	285		$	1,124		$	774		$	304		$	1,784		$	461		$	152		$	11,820
Provision	2,419			(290		)	(21		)	11			263			(35		)	(53		)	(192		)	96			127			2,325
Charge-offs	(1,442		)	—			—			—			—			(13		)	—			(8		)	(72		)	(69		)	(1,604		)
Recoveries	38			30			—			—			1			—			—			25			3			15			112
Net charge-offs	(1,404		)	30			—			—			1			(13		)	—			17			(69		)	(54		)	(1,492		)
Ending balance	$	4,934		$	2,607		$	129		$	296		$	1,388		$	726		$	251		$	1,609		$	488		$	225		$	12,653
As percent of ALLL	39.0		%	20.6		%	1.0		%	2.3		%	11.0		%	5.7		%	2.0		%	12.7		%	3.9		%	1.8		%	100.0		%

ALLL:
Individually evaluated	$	163		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	163
Collectively evaluated	4,771			2,607			129			296			1,388			726			251			1,609			488			225			12,490
Ending balance	$	4,934		$	2,607		$	129		$	296		$	1,388		$	726		$	251		$	1,609		$	488		$	225		$	12,653

Loans:
Individually evaluated	$	5,870		$	1,689		$	—		$	248		$	5,290		$	1,053		$	80		$	2,801		$	178		$	12		$	17,221
Collectively evaluated	631,467			428,354			35,455			51,530			309,173			88,607			36,915			360,551			105,849			22,803			2,070,704
Total loans	$	637,337		$	430,043		$	35,455		$	51,778		$	314,463		$	89,660		$	36,995		$	363,352		$	106,027		$	22,815		$	2,087,925

Less ALLL	4,934			2,607			129			296			1,388			726			251			1,609			488			225			12,653
Net loans	$	632,403		$	427,436		$	35,326		$	51,482		$	313,075		$	88,934		$	36,744		$	361,743		$	105,539		$	22,590		$	2,075,272

As a further breakdown, the ALLL is summarized by originated and acquired as follows.



	Originated – Year Ended December 31, 2017
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	3,150		$	2,263		$	122		$	222		$	893		$	656		$	266		$	1,372		$	373		$	132		$	9,449
Provision	2,429			(172		)	(10		)	13			261			(28		)	(66		)	(69		)	105			122			2,585
Charge-offs	(1,388		)	—			—			—			—			—			—			(8		)	(72		)	(69		)	(1,537		)
Recoveries	1			24			—			—			—			—			—			2			3			15			45
Net charge-offs	(1,387		)	24			—			—			—			—			—			(6		)	(69		)	(54		)	(1,492		)
Ending balance	$	4,192		$	2,115		$	112		$	235		$	1,154		$	628		$	200		$	1,297		$	409		$	200		$	10,542
As percent of ALLL	39.8		%	20.1		%	1.1		%	2.2		%	10.9		%	6.0		%	1.9		%	12.3		%	3.9		%	1.8		%	100.0		%

ALLL:
Individually evaluated	$	163		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	163
Collectively evaluated	4,029			2,115			112			235			1,154			628			200			1,297			409			200			10,379
Ending balance	$	4,192		$	2,115		$	112		$	235		$	1,154		$	628		$	200		$	1,297		$	409		$	200		$	10,542

Loans:
Individually evaluated	$	2,189		$	—		$	—		$	—		$	549		$	—		$	—		$	253		$	12		$	—		$	3,003
Collectively evaluated	486,411			237,548			11,102			27,831			113,313			56,061			33,615			190,933			65,631			18,254			1,240,699
Total loans	$	488,600		$	237,548		$	11,102		$	27,831		$	113,862		$	56,061		$	33,615		$	191,186		$	65,643		$	18,254		$	1,243,702

Less ALLL	4,192			2,115			112			235			1,154			628			200			1,297			409			200			10,542
Net loans	$	484,408		$	235,433		$	10,990		$	27,596		$	112,708		$	55,433		$	33,415		$	189,889		$	65,234		$	18,054		$	1,233,160



	Acquired – Year Ended December 31, 2017
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	769		$	604		$	28		$	63		$	231		$	118		$	38		$	412		$	88		$	20		$	2,371
Provision	(10		)	(118		)	(11		)	(2		)	2			(7		)	13			(123		)	(9		)	5			(260		)
Charge-offs	(54		)	—			—			—			—			(13		)	—			—			—			—			(67		)
Recoveries	37			6			—			—			1			—			—			23			—			—			67
Net charge-offs	(17		)	6			—			—			1			(13		)	—			23			—			—			—
Ending balance	$	742		$	492		$	17		$	61		$	234		$	98		$	51		$	312		$	79		$	25		$	2,111
As percent of ALLL	35.1		%	23.3		%	0.8		%	2.9		%	11.1		%	4.6		%	2.4		%	14.8		%	3.7		%	1.3		%	100.0		%

ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	742			492			17			61			234			98			51			312			79			25			2,111
Ending balance	$	742		$	492		$	17		$	61		$	234		$	98		$	51		$	312		$	79		$	25		$	2,111

Loans:
Individually evaluated	$	3,681		$	1,689		$	—		$	248		$	4,741		$	1,053		$	80		$	2,548		$	166		$	12		$	14,218
Collectively evaluated	145,056			190,806			24,353			23,699			195,860			32,546			3,300			169,618			40,218			4,549			830,005
Total loans	$	148,737		$	192,495		$	24,353		$	23,947		$	200,601		$	33,599		$	3,380		$	172,166		$	40,384		$	4,561		$	844,223

Less ALLL	742			492			17			61			234			98			51			312			79			25			2,111
Net loans	$	147,995		$	192,003		$	24,336		$	23,886		$	200,367		$	33,501		$	3,329		$	171,854		$	40,305		$	4,536		$	842,112

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired.



	Total Nonaccrual Loans
(in thousands)	September 30, 2018			% of Total		December 31, 2017			% of Total
Commercial & industrial	$	5,803		57.0	%	$	6,016		46.0	%
Owner-occupied CRE	474			4.6		533			4.1
AG production	—			—		—			—
AG real estate	175			1.7		186			1.4
CRE investment	1,381			13.6		4,531			34.6
Construction & land development	80			0.8		—			—
Residential construction	28			0.3		80			0.6
Residential first mortgage	1,973			19.4		1,587			12.1
Residential junior mortgage	268			2.6		158			1.2
Retail & other	—			—		4			—
Nonaccrual loans	$	10,182		100.0	%	$	13,095		100.0	%
Percent of total loans	0.5		%			0.6		%



	September 30, 2018										December 31, 2017
(in thousands)	Originated Amount			% of Total		Acquired Amount			% of Total		Originated Amount			% of Total		Acquired Amount			% of Total
Commercial & industrial	$	2,729		55.9	%	$	3,074		58.0	%	$	2,296		70.0	%	$	3,720		37.9	%
Owner-occupied CRE	360			7.4		114			2.2		86			2.6		447			4.6
AG production	—			—		—			—		—			—		—			—
AG real estate	—			—		175			3.3		—			—		186			1.9
CRE investment	918			18.8		463			8.7		549			16.8		3,982			40.6
Construction & land development	—			—		80			1.5		—			—		—			—
Residential construction	28			0.6		—			—		—			—		80			0.8
Residential first mortgage	777			15.9		1,196			22.5		331			10.1		1,256			12.8
Residential junior mortgage	66			1.4		202			3.8		12			0.4		146			1.4
Retail & other	—			—		—			—		4			0.1		—			—
Nonaccrual loans	$	4,878		100.0	%	$	5,304		100.0	%	$	3,278		100.0	%	$	9,817		100.0	%
Percent of nonaccrual loans	47.9		%			52.1		%			25.0		%			75.0		%

The following tables present past due loans by portfolio segment.



	September 30, 2018
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	30		$	5,803		$	659,921		$	665,754
Owner-occupied CRE	—			474			448,677			449,151
AG production	—			—			35,727			35,727
AG real estate	48			175			52,155			52,378
CRE investment	—			1,381			329,931			331,312
Construction & land development	104			80			86,349			86,533
Residential construction	212			28			30,055			30,295
Residential first mortgage	638			1,973			354,552			357,163
Residential junior mortgage	31			268			109,393			109,692
Retail & other	61			—			25,391			25,452
Total loans	$	1,124		$	10,182		$	2,132,151		$	2,143,457
Percent of total loans	0.1		%	0.4		%	99.5		%	100.0		%



	December 31, 2017
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	211		$	6,016		$	631,110		$	637,337
Owner-occupied CRE	671			533			428,839			430,043
AG production	30			—			35,425			35,455
AG real estate	—			186			51,592			51,778
CRE investment	—			4,531			309,932			314,463
Construction & land development	76			—			89,584			89,660
Residential construction	587			80			36,328			36,995
Residential first mortgage	1,039			1,587			360,726			363,352
Residential junior mortgage	14			158			105,855			106,027
Retail & other	4			4			22,807			22,815
Total loans	$	2,632		$	13,095		$	2,072,198		$	2,087,925
Percent of total loans	0.1		%	0.6		%	99.3		%	100.0		%

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

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

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

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

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

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

Grade 9, Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.

The following tables present total loans by risk categories.



	September 30, 2018
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	630,681		$	20,123		$	2,725		$	12,225		$	—	$	—	$	665,754
Owner-occupied CRE	412,146			28,643			2,234			6,128			—		—		449,151
AG production	30,195			2,892			2,342			298			—		—		35,727
AG real estate	45,288			3,483			3,026			581			—		—		52,378
CRE investment	321,138			7,086			1,006			2,082			—		—		331,312
Construction & land development	81,296			5,141			16			80			—		—		86,533
Residential construction	30,267			—			—			28			—		—		30,295
Residential first mortgage	352,778			1,388			520			2,477			—		—		357,163
Residential junior mortgage	109,394			17			—			281			—		—		109,692
Retail & other	25,452			—			—			—			—		—		25,452
Total loans	$	2,038,635		$	68,773		$	11,869		$	24,180		$	—	$	—	$	2,143,457
Percent of total	95.1		%	3.2		%	0.6		%	1.1		%	—		—		100.0		%



	December 31, 2017
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	597,854		$	12,999		$	16,129		$	10,355		$	—	$	—	$	637,337
Owner-occupied CRE	397,357			23,340			6,442			2,904			—		—		430,043
AG production	30,431			4,000			—			1,024			—		—		35,455
AG real estate	44,321			4,873			—			2,584			—		—		51,778
CRE investment	299,926			8,399			190			5,948			—		—		314,463
Construction & land development	86,011			2,758			17			874			—		—		89,660
Residential construction	36,915			—			—			80			—		—		36,995
Residential first mortgage	358,067			1,868			683			2,734			—		—		363,352
Residential junior mortgage	105,736			117			—			174			—		—		106,027
Retail & other	22,811			—			—			4			—		—		22,815
Total loans	$	1,979,429		$	58,354		$	23,461		$	26,681		$	—	$	—	$	2,087,925
Percent of total	94.8		%	2.8		%	1.1		%	1.3		%	—		—		100.0		%

The following tables present impaired loans.



	Total Impaired Loans – September 30, 2018
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	5,858	$	9,737	$	—	$	6,389	$	534
Owner-occupied CRE	1,548		2,010		—		1,614		113
AG production	—		6		—		—		1
AG real estate	234		293		—		238		14
CRE investment	2,876		3,792		—		2,988		294
Construction & land development	603		1,506		—		603		16
Residential construction	—		—		—		—		—
Residential first mortgage	2,663		3,122		—		2,734		159
Residential junior mortgage	57		360		—		62		19
Retail & other	12		13		—		12		1
Total	$	13,851	$	20,839	$	—	$	14,640	$	1,151

Originated impaired loans	$	4,050	$	4,050	$	—	$	4,453	$	213
Acquired impaired loans	9,801		16,789		—		10,187		938
Total	$	13,851	$	20,839	$	—	$	14,640	$	1,151



	Total Impaired Loans – December 31, 2017
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	5,870	$	10,063	$	163	$	6,586	$	718
Owner-occupied CRE	1,689		2,256		—		1,333		132
AG production	—		10		—		—		—
AG real estate	248		307		—		233		26
CRE investment	5,290		8,102		—		5,411		465
Construction & land development	1,053		1,053		—		813		57
Residential construction	80		983		—		91		27
Residential first mortgage	2,801		3,653		—		2,177		180
Residential junior mortgage	178		507		—		154		17
Retail & other	12		14		—		12		1
Total	$	17,221	$	26,948	$	163	$	16,810	$	1,623

Originated impaired loans	$	3,003	$	3,003	$	163	$	2,964	$	241
Acquired impaired loans	14,218		23,945		—		13,846		1,382
Total	$	17,221	$	26,948	$	163	$	16,810	$	1,623

Total purchased credit impaired loans (in aggregate since the Company’s 2013 acquisitions) were initially recorded at a fair value of $43.6 million on their respective acquisition dates, net of an initial $34.4 million non-accretable mark and a zero accretable mark. At September 30, 2018, $9.8 million of the $43.6 million remain in impaired loans.

Non-accretable discount on purchased credit impaired (“PCI”) loans:



	Nine Months Ended						Year Ended
(in thousands)	September 30, 2018			September 30, 2017			December 31, 2017
Balance at beginning of period	$	9,471		$	14,327		$	14,327
Acquired balance, net	—			8,352			8,352
Accretion to loan interest income	(1,872		)	(5,925		)	(7,995		)
Transferred to accretable	(513		)	—			(1,936		)
Disposals of loans	(97		)	(1,121		)	(3,277		)
Balance at end of period	$	6,989		$	15,633		$	9,471

Troubled Debt Restructurings

At September 30, 2018, there were five loans classified as troubled debt restructurings with a current outstanding balance of $0.7 million and pre-modification balance of $2.7 million. In comparison, at December 31, 2017, there were eight loans classified as troubled debt restructurings with an outstanding balance of $5.6 million and pre-modification balance of $6.9 million. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the nine months ended September 30, 2018. As of September 30, 2018, there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructurings.

Note 7 – Goodwill and Other Intangibles and Mortgage Servicing Rights

Management periodically reviews the carrying value of its intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. The Company’s quarterly assessment indicated no impairment charge on goodwill, core deposit intangibles or customer list intangibles was required for the year ended December 31, 2017 or the nine months ended September 30, 2018.



	Nine Months Ended		Year Ended
(in thousands)	September 30, 2018		December 31, 2017
Goodwill	$	107,366	$	107,366
Core deposit intangibles	13,488		16,477
Customer list intangibles	4,506		4,563
Other intangibles	17,994		21,040
Goodwill and other intangibles, net	$	125,360	$	128,406

Goodwill: Goodwill was $107.4 million at both September 30, 2018 and December 31, 2017. During 2017, goodwill increased due to the First Menasha acquisition. See Note 2 for additional information on the First Menasha acquisition.

Other intangible assets: Other intangible assets, consisting of core deposit intangibles and customer list intangibles, are amortized over their estimated finite lives. During 2018, customer list intangibles increased due to the purchase of a brokerage book of business, while during 2017, core deposit intangibles increased due to the First Menasha acquisition and customer list intangibles increased due to a modification to the contingent earn-out payment on the financial advisor business acquired in 2016, fixing the previously variable earn-out payment on a portion of the purchase price. See Note 2 for additional information on Nicolet's acquisitions.



	Nine Months Ended			Year Ended
(in thousands)	September 30, 2018			December 31, 2017
Core deposit intangibles:
Gross carrying amount	$	29,015		$	29,015
Accumulated amortization	(15,527		)	(12,538		)
Net book value	$	13,488		$	16,477
Additions during the period	$	—		$	3,670
Amortization during the period	$	2,989		$	4,294

Customer list intangibles:
Gross carrying amount	$	5,523		$	5,233
Accumulated amortization	(1,017		)	(670		)
Net book value	$	4,506		$	4,563
Additions during the period	$	290		$	870
Amortization during the period	$	347		$	401

Mortgage servicing rights: Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date, with the amortization recorded in mortgage income, net, in the consolidated statements of income. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets. Activity in the mortgage servicing rights asset was as follows.



	Nine Months Ended			Year Ended
(in thousands)	September 30, 2018			December 31, 2017
Mortgage servicing rights (MSR) asset:
MSR asset at beginning of year	$	3,187		$	1,922
Capitalized MSR	696			876
MSR asset acquired	—			874
Amortization during the period	(464		)	(485		)
MSR asset at end of period	$	3,419		$	3,187
Fair value of MSR asset at end of period	$	4,304		$	4,097
Residential mortgage loans serviced for others	$	560,607		$	518,419
Net book value of MSR asset to loans serviced for others	0.61		%	0.61		%

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on an estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans serviced (predominantly loan type and note interest rate). No valuation allowance or impairment charge was recorded for the year ended December 31, 2017 or the nine months ended September 30, 2018. See Note 9 for additional information on the fair value of the MSR asset.

The following table shows the estimated future amortization expense for amortizing intangible assets and the MSR asset. The projections are based on existing asset balances, the current interest rate environment and prepayment speeds as of the September 30, 2018. The actual amortization expense the Company recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements and events or circumstances that indicate the carrying amount of an asset may not be recoverable.



(in thousands)	Core deposit intangibles		Customer list intangibles		MSR asset
Year ending December 31,
2018 (remaining three months)	$	926	$	127	$	161
2019	3,337		507		643
2020	2,657		507		814
2021	2,167		507		381
2022	1,735		507		381
Thereafter	2,666		2,351		1,039
Total	$	13,488	$	4,506	$	3,419

Note 8 – Short and Long-Term Borrowings

Short-Term Borrowings:

The Company did not have any short-term borrowings (borrowing with an original maturity of one year or less) outstanding at September 30, 2018 or December 31, 2017.

Long-Term Borrowings:

The components of long-term borrowings (borrowing with an original maturity greater than one year) were as follows.



(in thousands)	September 30, 2018		December 31, 2017
FHLB advances	$	35,317	$	36,509
Junior subordinated debentures	29,976		29,616
Subordinated notes	11,948		11,921
Total long-term borrowings	$	77,241	$	78,046

FHLB Advances: The FHLB advances bear fixed rates, require interest-only monthly payments, and have maturity dates through 2022. The weighted average rate of the FHLB advances was 1.72% and 1.71% at September 30, 2018 and December 31, 2017, respectively.

Junior Subordinated Debentures: The following table shows the breakdown of junior subordinated debentures. Interest on all debentures is current. Any applicable discounts (initially recorded to carry an acquired debenture at its then estimated fair market value) are being accreted to interest expense over the remaining life of the debentures. All the debentures below are currently callable and may be redeemed in part or in full at par plus any accrued but unpaid interest. At September 30, 2018 and December 31, 2017, $28.8 million and $28.5 million, respectively, qualify as Tier 1 capital.



		Junior Subordinated Debentures
(in thousands)	Maturity Date	Par		9/30/2018 Unamortized Discount			9/30/2018 Carrying Value		12/31/2017 Carrying Value
2004 Nicolet Bankshares Statutory Trust(1)	7/15/2034	$	6,186	$	—		$	6,186	$	6,186
2005 Mid-Wisconsin Financial Services, Inc.(2)	12/15/2035	10,310		(3,421		)	6,889		6,739
2006 Baylake Corp.(3)	9/30/2036	16,598		(4,179		)	12,419		12,242
2004 First Menasha Bancshares, Inc.(4)	3/17/2034	5,155		(673		)	4,482		4,449
Total		$	38,249	$	(8,273	)	$	29,976	$	29,616


(1)	The interest rate is 8.00% fixed.


(2)	The debentures, assumed in April 2013 as the result of an acquisition, have a floating rate of the three-month LIBOR plus 1.43%, adjusted quarterly. The interest rates were 3.76% and 3.02% as of September 30, 2018 and December 31, 2017, respectively.


(3)	The debentures, assumed in April 2016 as a result of an acquisition, have a floating rate of the three-month LIBOR plus 1.35%, adjusted quarterly. The interest rates were 3.75% and 3.04% as of September 30, 2018 and December 31, 2017, respectively.


(4)	The debentures, assumed in April 2017 as the result of an acquisition, have a floating rate of the three-month LIBOR plus 2.79%, adjusted quarterly. The interest rates were 5.12% and 4.39% as of September 30, 2018 and December 31, 2017, respectively.

Subordinated Notes: In 2015, the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes. The carrying value of these subordinated Notes was $11.9 million at both September 30, 2018 and December 31, 2017.

Note 9 – Fair Value Measurements

Fair value represents the estimated price at which an orderly transaction to sell an asset or transfer a liability would take place between market participants at the measurement date under current market conditions (i.e., an exit price concept), and is a market-based measurement versus an entity-specific measurement.

The Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are:


•	Level 1 – quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date


•	Level 2 – inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly


•	Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity

In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. This assessment of the significance of an input requires management judgment.

Recurring basis fair value measurements:

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented.



(in thousands)			Fair Value Measurements Using
Measured at Fair Value on a Recurring Basis:	Total		Level 1		Level 2		Level 3
September 30, 2018
U.S. government agency securities	$	26,254	$	—	$	26,254	$	—
State, county and municipals	164,822		—		164,756		66
Mortgage-backed securities	135,845		—		135,845		—
Corporate debt securities	83,990		—		75,552		8,438
Securities AFS	$	410,911	$	—	$	402,407	$	8,504
Other investments (equity securities) *	$	2,778	$	2,778	$	—	$	—

December 31, 2017
U.S. government agency securities	$	26,209	$	—	$	26,209	$	—
State, county and municipals	184,044		—		183,386		658
Mortgage-backed securities	155,532		—		155,529		3
Corporate debt securities	36,797		—		28,307		8,490
Equity securities *	2,571		2,571		—		—
Securities AFS	$	405,153	$	2,571	$	393,431	$	9,151

* Effective January 1, 2018, the Company adopted ASU 2016-01, which requires equity securities with readily determinable fair values to be measured at fair value with changes in the fair value recognized through net income. As a result, the approximately $2.8 million current fair value of equity securities is now reflected within other investments on the consolidated balance sheets instead of in securities AFS at December 31, 2017. Prior periods have not been restated for the impact of this accounting change. See Note 1 for additional information on this new accounting standard and see Note 5 for additional information on the impact to securities AFS.

The following is a description of the valuation methodologies used by the Company for the securities AFS and equity securities measured at fair value on a recurring basis, as noted in the tables above. Where quoted market prices on securities exchanges are available, the investments are classified as Level 1. Level 1 investments primarily include exchange-traded equity securities. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include U.S. government agency securities, mortgage-backed securities, obligations of state, county and municipals, and certain corporate debt securities. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include private municipal bonds and corporate debt securities, which include trust preferred security investments. At September 30, 2018 and December 31, 2017, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on the internal analysis on these securities.

The following table presents the changes in the Level 3 securities AFS measured at fair value on a recurring basis.



(in thousands)	Nine Months Ended			Year Ended
Level 3 Fair Value Measurements:	September 30, 2018			December 31, 2017
Balance at beginning of year	$	9,151		$	9,108
Acquired balance	—			189
Paydowns/Sales/Settlements	(647		)	(146		)
Balance at end of period	$	8,504		$	9,151

Nonrecurring basis fair value measurements:

The following table presents the Company’s assets measured at fair value on a nonrecurring basis for the periods presented, aggregated by level in the fair value hierarchy within which those measurements fall.



(in thousands)			Fair Value Measurements Using
Measured at Fair Value on a Nonrecurring Basis:	Total		Level 1		Level 2		Level 3
September 30, 2018
Impaired loans	$	13,851	$	—	$	—	$	13,851
Other real estate owned (“OREO”)	1,281		—		—		1,281
MSR asset	4,304		—		—		4,304

December 31, 2017
Impaired loans	$	17,058	$	—	$	—	$	17,058
OREO	1,294		—		—		1,294
MSR asset	4,097		—		—		4,097

The following is a description of the valuation methodologies used by the Company for the items noted in the table above. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell. To estimate the fair value of the MSR asset, the underlying serviced loan pools are stratified by interest rate tranche and term of the loan, and a valuation model is used to calculate the present value of the expected future cash flows for each stratum. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value.

Financial instruments:

The carrying amounts and estimated fair values of the Company’s financial instruments are shown below.



September 30, 2018
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	161,155	$	161,155	$	161,155	$	—	$	—
Certificates of deposit in other banks	995		995		—		995		—
Securities AFS	410,911		410,911		—		402,407		8,504
Other investments, including equity securities	17,479		17,479		2,778		13,117		1,584
Loans held for sale	2,593		2,643		—		2,643		—
Loans, net	2,130,465		2,103,456		—		—		2,103,456
BOLI	65,820		65,820		65,820		—		—
MSR asset	3,419		4,304		—		—		4,304

Financial liabilities:
Deposits	$	2,522,156	$	2,523,832	$	—	$	—	$	2,523,832
Long-term borrowings	77,241		76,198		—		35,300		40,898



December 31, 2017
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	154,933	$	154,933	$	154,933	$	—	$	—
Certificates of deposit in other banks	1,746		1,746		—		1,746		—
Securities AFS	405,153		405,153		2,571		393,431		9,151
Other investments	14,837		14,837		—		13,142		1,695
Loans held for sale	4,666		4,750		—		4,750		—
Loans, net	2,075,272		2,068,382		—		—		2,068,382
BOLI	64,453		64,453		64,453		—		—
MSR asset	3,187		4,097		—		—		4,097

Financial liabilities:
Deposits	$	2,471,064	$	2,469,456	$	—	$	—	$	2,469,456
Long-term borrowings	78,046		77,029		—		36,510		40,519

The carrying value of certain assets and liabilities such as cash and cash equivalents, bank owned life insurance, short-term borrowings, and nonmaturing deposits, approximate their estimated fair value. For those financial instruments not previously disclosed, the following is a description of the valuation methodologies used.

Certificates of deposits in other banks: Fair values are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a Level 2 measurement.

Other investments: The valuation methodologies utilized for exchange-traded equity securities are discussed under “Recurring basis fair value measurements” above. The carrying amount of Federal Reserve Bank, Bankers Bank, Federal Agricultural Mortgage Corporation, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.

Loans held for sale: The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics and represents a Level 2 measurement.

Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk or other optionality, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates, which reflect the credit and interest rate risk inherent in the loan. Collateral-dependent impaired loans are included in loans, net. The fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.

Deposits: The fair value of deposits with no stated maturity (such as demand deposits, savings, interest and non-interest checking, and money market accounts) is, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market place on certificates of similar remaining maturities. Use of internal discounted cash flows provides a Level 3 fair value measurement.

Long-term borrowings: The fair value of the FHLB advances is obtained from the FHLB which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of the junior subordinated debentures and subordinated notes utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.

Lending-related commitments: At September 30, 2018 and December 31, 2017, the estimated fair value of letters of credit and outstanding mandatory commitments to sell residential mortgage loans into the secondary market was insignificant.

Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.

Note 10 – Revenue Recognition

As of January 1, 2018, the Company adopted ASU 2014-09 (Topic 606) using the modified retrospective approach. The adoption of the guidance had no material impact on the measurement, timing, or recognition of revenue; however, additional disclosures have been added in accordance with the ASU. See Note 1 for additional information on this new accounting standard.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income categories such as gains or losses associated with mortgage servicing rights, derivatives, and income from bank owned life insurance are not within the scope of the new guidance. The main types of revenue contracts within the scope of Topic 606 include trust services income, brokerage fee income, service charges on deposit accounts, card interchange income, and certain other noninterest income. These contracts are discussed in detail below:

Trust services and brokerage fee income: A contract between the Company and its customers to provide fiduciary and / or investment administration services on trust accounts and brokerage accounts in exchange for a fee. Trust services and brokerage fee income is based upon the month-end market value of the assets under management and the applicable fee rate, which is recognized over the period the underlying trust or brokerage account is serviced (generally on a monthly basis). Such contracts are generally cancellable at any time, with the customer subject to a pro-rated fee in the month of termination.

Service charges on deposit accounts: The deposit contract obligates the Company to serve as a custodian of the customer’s deposited funds and is generally terminable at will by either party. This contract permits the customer to access the funds on deposit and request additional services related to the deposit account. Service charges on deposit accounts consist of account analysis fees (net fees earned on analyzed business and public checking accounts), monthly service charges, nonsufficient fund (“NSF”) charges, and other deposit account related charges. The Company’s performance obligation for account analysis fees and monthly service charges is generally satisfied, and the related revenue recognized, over the period in which the service is provided (typically on a monthly basis); while NSF charges and other deposit account related charges are largely transactional based and the related revenue is recognized at the time the service is provided.

Card interchange income: A contract between the Company, as a card-issuing bank, and its customers whereby the Company receives a transaction fee from the merchant’s bank whenever a customer uses a debit or credit card to make a purchase. The performance obligation is completed and the fees are recognized as the service is provided (i.e., when the customer uses a debit or credit card).

Other noninterest income: Other noninterest income includes several items, such as wire transfer income, check cashing fees, check printing fees, safe deposit box rental fees, management fee income, and consulting fees. These fees are generally recognized at the time the service is provided.

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

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

Forward-Looking Statements

Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:


•	operating, legal and regulatory risks, including the effects of legislative or regulatory developments affecting the financial industry generally or Nicolet specifically;


•	economic, 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 integrating the operations of Nicolet with those of acquired entities, if any;


•	compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement; and


•	the risk that Nicolet’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

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

Overview

The following discussion is management’s analysis of the consolidated financial condition as of September 30, 2018 and December 31, 2017 and results of operations for the three and nine-month periods ended September 30, 2018 and 2017. It should be read in conjunction with Nicolet’s audited consolidated financial statements included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2017.

The timing of Nicolet’s April 2017 acquisition of First Menasha Bancshares, Inc. (“First Menasha”), at approximately 20% of pre-merger assets at the time of acquisition, impacts financial comparisons to 2017 periods. Certain income statement results, average balances and related ratios for 2018 include the full contribution of First Menasha operations, versus five months of contribution of First Menasha in the comparable nine-month period of 2017 . The first half of 2017 also included non-recurring other direct merger and integration pre-tax expenses of $0.5 million. See Note 2, “Acquisitions,” in the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional information on this acquisition.

Performance Summary

Table 1: Earnings Summary and Selected Financial Data



	At or for the Three Months Ended															At or for the Nine Months Ended
(In thousands, except per share data)	9/30/2018			6/30/2018			3/31/2018			12/31/2017			9/30/2017			9/30/2018			9/30/2017
Results of operations:
Interest income	$	31,880		$	30,545		$	30,785		$	29,836		$	29,454		$	93,210		$	79,417
Interest expense	4,938			4,742			3,911			3,329			3,063			13,591			7,182
Net interest income	26,942			25,803			26,874			26,507			26,391			79,619			72,235
Provision for loan losses	340			510			510			450			975			1,360			1,875
Net interest income after provision for loan losses	26,602			25,293			26,364			26,057			25,416			78,259			70,360
Noninterest income	10,649			10,239			8,824			8,621			10,164			29,712			26,018
Noninterest expense	23,044			22,451			22,642			21,858			20,862			68,137			59,498
Income before income tax expense	14,207			13,081			12,546			12,820			14,718			39,834			36,880
Income tax expense	3,268			3,255			2,908			3,662			5,133			9,431			12,605
Net income	10,939			9,826			9,638			9,158			9,585			30,403			24,275
Net income attributable to noncontrolling interest	80			89			61			55			74			230			228
Net income attributable to Nicolet Bankshares, Inc.	$	10,859		$	9,737		$	9,577		$	9,103		$	9,511		$	30,173		$	24,047
Earnings per common share:
Basic	$	1.13		$	1.01		$	0.98		$	0.93		$	0.97		$	3.12		$	2.58
Diluted	$	1.09		$	0.98		$	0.94		$	0.88		$	0.91		$	3.02		$	2.45
Common Shares:
Basic weighted average	9,633			9,639			9,765			9,805			9,837			9,679			9,317
Diluted weighted average	9,949			9,970			10,225			10,368			10,409			10,004			9,821
Outstanding (period end)	9,577			9,643			9,699			9,818			9,799			9,577			9,799
Period-End Balances:
Loans	$	2,143,457		$	2,128,624		$	2,100,597		$	2,087,925		$	2,051,122		$	2,143,457		$	2,051,122
Allowance for loan losses	12,992			12,875			12,765			12,653			12,610			12,992			12,610
Securities available-for-sale, at fair value	410,911			401,975			401,130			405,153			408,217			410,911			408,217
Goodwill and other intangibles, net	125,360			126,124			127,224			128,406			129,588			125,360			129,588
Total assets	3,000,902			2,922,151			3,223,935			2,932,433			2,845,730			3,000,902			2,845,730
Deposits	2,522,156			2,455,536			2,765,090			2,471,064			2,366,951			2,522,156			2,366,951
Stockholders’ equity	377,171			370,584			363,988			364,178			360,426			377,171			360,426
Book value per common share	39.38			38.43			37.53			37.09			36.78			39.38			36.78
Tangible book value per common share	26.29			25.35			24.41			24.01			23.56			26.29			23.56
Average Balances:
Loans	$	2,134,448		$	2,117,828		$	2,114,345		$	2,066,974		$	2,035,277		$	2,122,280		$	1,842,695
Interest-earning assets	2,664,316			2,742,976			2,584,070			2,531,066			2,505,073			2,664,081			2,291,588
Total assets	2,971,247			3,044,466			2,896,533			2,852,400			2,825,542			2,971,022			2,580,126
Deposits	2,497,439			2,583,112			2,436,103			2,385,821			2,377,229			2,505,776			2,175,360
Interest-bearing liabilities	1,931,119			2,084,361			1,925,443			1,835,375			1,854,339			1,980,329			1,721,362
Goodwill and other intangibles, net	125,798			126,646			127,801			128,980			129,158			126,741			110,886
Stockholders’ equity	375,507			364,988			366,002			361,455			358,228			368,867			323,273
Financial Ratios*:
Return on average assets	1.45		%	1.28		%	1.34		%	1.27		%	1.34		%	1.36		%	1.25		%
Return on average common equity	11.47			10.70			10.61			9.99			10.53			10.94			9.95
Return on average tangible common equity	17.25			16.39			16.31			15.53			16.47			16.66			15.14
Average equity to average assets	12.64			11.99			12.64			12.67			12.68			12.42			12.53
Stockholders' equity to assets	12.57			12.68			11.29			12.42			12.67			12.57			12.67
Tangible equity to tangible assets	8.76			8.74			7.65			8.41			8.50			8.76			8.50
Net interest margin	4.02			3.77			4.20			4.21			4.24			3.99			4.27
Net loan charge-offs to average loans	0.04			0.08			0.08			0.08			0.19			0.06			0.08
Nonperforming loans to total loans	0.48			0.51			0.56			0.63			0.70			0.48			0.70
Nonperforming assets to total assets	0.38			0.41			0.40			0.49			0.55			0.38			0.55
Effective tax rate	23.00			24.88			23.18			28.56			34.88			23.68			34.18
Selected Items:
Interest income from resolving PCI loans (rounded)	$	300		$	100		$	1,500		$	2,100		$	2,100		$	1,900		$	5,900
Tax-equivalent adjustment on net interest income	285			289			298			584			594			872			1,785
Tax expense (benefit) on stock-based compensation	—			—			(159		)	(1,678		)	(15		)	(159		)	(176		)
Tax expense of tax reform items	—			—			—			896			—			—			—

*Income statement-related ratios for partial-year periods are annualized.

Net income was $30.2 million for the nine months ended September 30, 2018, an increase of $6.1 million or 25% over $24.0 million for the nine months ended September 30, 2017. Earnings per diluted common share was $3.02 for the first nine months of 2018, 23% higher than $2.45 for the first nine months of 2017. Annualized return on average assets for the first nine months of 2018 and 2017 was 1.36% and 1.25%, respectively.


•	At September 30, 2018, assets were $3.0 billion, an increase of $68 million (2%) from December 31, 2017 and an increase of $155 million (5%) from September 30, 2017.


•	At September 30, 2018, loans were $2.1 billion, 3% higher than December 31, 2017 and 5% higher than September 30, 2017. On an average basis, loans grew $280 million or 15% over the first nine months of 2017, largely attributable to the timing of the 2017 acquisition (which added $351 million in April 2017). For additional information regarding loans, see “Balance Sheet Analysis — Loans.”

•

Total deposits were $2.5 billion at September 30, 2018, 2% higher than December 31, 2017 and 7% higher than September 30, 2017. On an average basis, deposits grew $330 million or 15% over the first nine months of 2017, largely attributable to the timing of the 2017 acquisition (which added $375 million in April 2017) and a $0.3 billion short-term transaction deposit of a long-standing commercial customer held in 2018 from late March to mid-June. For additional information regarding deposits, see “Balance Sheet Analysis – Deposits.”

•

Net interest income increased $7.4 million or 10% over the first nine months of 2017. Interest income grew $13.8 million (despite $4.0 million lower discount income on resolved purchased credit impaired loans), aided by a 16% increase in average interest-earning assets and the elevated rate environment on new, renewed and variable rate loans. Interest expense increased $6.4 million primarily due to rising rates on a larger deposit base. Net interest margin was 3.99% for the nine months ended September 30, 2018, compared to 4.27% last year. For additional information regarding net interest income, see “Income Statement Analysis — Net Interest Income.”


•	Noninterest income grew $3.7 million or 14% over the first nine months of 2017, with all categories except net asset gains up year-over-year. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”


•	Noninterest expense increased $8.6 million or 15% over the first nine months of 2017, mostly due to the expanded workforce and larger operating base. For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

•

Income tax expense for the first nine months of 2018 benefited from the lower corporate tax rate effective in 2018, due to the passage of the Tax Cuts and Jobs Act in December 2017. Income tax expense included a $0.2 million tax benefit for the tax impact of stock option exercises for both nine-month periods. As a result, the effective tax rate was 23.7% for the first nine months of 2018 and 34.2% for the first nine months of 2017.


•	Asset quality remains sound. Nonperforming assets declined to $11.5 million, representing 0.38% of total assets at September 30, 2018, down favorably from 0.49% at December 31, 2017 and 0.55% at September 30, 2017. For additional information regarding nonperforming assets, see “Balance Sheet Analysis – Nonperforming Assets.”

INCOME STATEMENT ANALYSIS

Net Interest Income

Tax-equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources. The tax-equivalent adjustments bring tax-exempt interest to a level that would yield the same after-tax income by applying the effective Federal corporate tax rates to the underlying assets. 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.

Table 2: Average Balance Sheet and Net Interest Income Analysis – Tax-Equivalent Basis



	For the Nine Months Ended September 30,
	2018						2017
(in thousands)	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,122,280	$	84,786	5.28	%	$	1,842,695	$	73,377	5.26	%
Investment securities:
Taxable	255,763		4,503		2.35	%	236,275		3,422		1.93	%
Tax-exempt (2)	151,643		2,467		2.17	%	160,815		3,267		2.71	%
Other interest-earning assets	134,395		2,326		2.29	%	51,803		1,136		2.92	%
Total non-loan earning assets	541,801		9,296		2.28	%	448,893		7,825		2.32	%
Total interest-earning assets	2,664,081		$	94,082	4.67	%	2,291,588		$	81,202	4.69	%
Other assets, net	306,941						288,538
Total assets	$	2,971,022					$	2,580,126
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	282,606	$	818	0.39	%	$	249,099	$	271	0.15	%
Interest-bearing demand	545,980		3,361		0.82	%	419,266		1,590		0.51	%
Money market (“MMA”)	650,485		2,897		0.60	%	581,277		1,165		0.27	%
Core time deposits	323,570		3,481		1.44	%	288,524		1,568		0.73	%
Brokered deposits	99,818		455		0.61	%	120,782		622		0.69	%
Total interest-bearing deposits	1,902,459		11,012		0.77	%	1,658,948		5,216		0.42	%
Other interest-bearing liabilities	77,870		2,579		4.38	%	62,414		1,966		4.17	%
Total interest-bearing liabilities	1,980,329		13,591		0.92	%	1,721,362		7,182		0.56	%
Noninterest-bearing demand	603,317						516,412
Other liabilities	18,509						19,079
Stockholders’ equity	368,867						323,273
Total liabilities and stockholders’ equity	$	2,971,022					$	2,580,126
Net interest income and rate spread			$	80,491	3.75	%			$	74,020	4.13	%
Tax-equivalent adjustment			$	872					$	1,785
Net interest margin					3.99	%					4.27	%


(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% for 2018 periods and 34% for 2017 periods and adjusted for the disallowance of interest expense.

Table 2: Average Balance Sheet and Net Interest Income Analysis – Tax-Equivalent Basis (Continued)



	For the Three Months Ended September 30,
	2018						2017
(in thousands)	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,134,448	$	29,045	5.35	%	$	2,035,277	$	27,420	5.29	%
Investment securities:
Taxable	264,733		1,564		2.36	%	248,579		1,114		1.79	%
Tax-exempt (2)	147,547		809		2.19	%	160,965		1,107		2.75	%
Other interest-earning assets	117,588		747		2.51	%	60,252		407		2.69	%
Total non-loan earning assets	529,868		3,120		2.35	%	469,796		2,628		2.23	%
Total interest-earning assets	2,664,316		$	32,165	4.75	%	2,505,073		$	30,048	4.72	%
Other assets, net	306,931						320,469
Total assets	$	2,971,247					$	2,825,542
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	291,811	$	313	0.43	%	$	268,552	$	129	0.19	%
Interest-bearing demand	536,830		1,191		0.88	%	441,409		758		0.68	%
MMA	594,937		979		0.65	%	606,737		622		0.41	%
Core time deposits	348,899		1,472		1.67	%	297,318		595		0.79	%
Brokered deposits	81,441		100		0.49	%	172,200		260		0.60	%
Total interest-bearing deposits	1,853,918		4,055		0.87	%	1,786,216		2,364		0.53	%
Other interest-bearing liabilities	77,201		883		4.49	%	68,123		699		4.04	%
Total interest-bearing liabilities	1,931,119		4,938		1.01	%	1,854,339		3,063		0.65	%
Noninterest-bearing demand	643,521						591,013
Other liabilities	21,100						21,962
Stockholders’ equity	375,507						358,228
Total liabilities and stockholders’ equity	$	2,971,247					$	2,825,542
Net interest income and rate spread			$	27,227	3.74	%			$	26,985	4.07	%
Tax-equivalent adjustment			$	285					$	594
Net interest margin					4.02	%					4.24	%


(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% for 2018 periods and 34% for 2017 periods and adjusted for the disallowance of interest expense.

Table 3: Volume/Rate Variance – Tax-Equivalent Basis



	For the Three Months Ended September 30, 2018 Compared to September 30, 2017:									For the Nine Months Ended September 30, 2018 Compared to September 30, 2017:
	Increase (Decrease) Due to Changes in									Increase (Decrease) Due to Changes in
(in thousands)	Volume			Rate			Net (1)			Volume			Rate			Net (1)
Interest-earning assets
Loans (2)	$	1,452		$	173		$	1,625		$	11,431		$	(22	)	$	11,409
Investment securities:
Taxable	220			230			450			626			455			1,081
Tax-exempt (2)	(88		)	(210		)	(298		)	(179		)	(621		)	(800		)
Other interest-earning assets	301			39			340			1,121			69			1,190
Total non-loan earning assets	433			59			492			1,568			(97		)	1,471
Total interest-earning assets	$	1,885		$	232		$	2,117		$	12,999		$	(119	)	$	12,880

Interest-bearing liabilities
Savings	$	12		$	172		$	184		$	41		$	506		$	547
Interest-bearing demand	185			248			433			578			1,193			1,771
MMA	(13		)	370			357			154			1,578			1,732
Core time deposits	119			758			877			211			1,702			1,913
Brokered deposits	(118		)	(42		)	(160		)	(100		)	(67		)	(167		)
Total interest-bearing deposits	185			1,506			1,691			884			4,912			5,796
Other interest-bearing liabilities	64			120			184			332			281			613
Total interest-bearing liabilities	249			1,626			1,875			1,216			5,193			6,409
Net interest income	$	1,636		$	(1,394	)	$	242		$	11,783		$	(5,312	)	$	6,471


(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)	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% for 2018 periods and 34% for 2017 periods and adjusted for the disallowance of interest expense.

Tax-equivalent net interest income was $80 million for the first nine months of 2018, $6.5 million or 9% higher than $74 million for the first nine months of 2017. Between the comparative nine-month periods, the interest rate spread decreased 38 bps due to a higher cost of funds (up 36 bps) and a decrease in the interest-earning asset yield (down 2 bps). The contribution from net free funds increased 10 bps, due mostly to the increase in average noninterest-bearing demand deposits (up 17%) and their increased value in the higher rate environment. As a result, the tax-equivalent net interest margin was 3.99% for the first nine months of 2018, down 28 bps compared to 4.27% for the comparable 2017 period.

Between the comparable nine-month periods, average interest-earning assets increased $372 million or 16% to $2.7 billion, primarily due to a $280 million or 15% increase in loans (attributable to acquired balances as well as organic growth) and a $93 million increase in all other interest-earning assets (mainly low earning cash which included the 2018 large short-term deposit previously noted). The mix of average interest-earning assets was 80% loans, 15% investments, and 5% other interest-earning assets (mostly cash), compared to 80%, 18% and 2%, respectively, for the nine months of 2017.

Tax-equivalent interest income increased $12.9 million or 16% to $94 million for the first nine months of 2018, while the related interest-earning asset yield decreased 2 bps to 4.67%. Interest income on loans increased $11 million over the first nine months of 2017, while the related yield was up 2 bps to 5.28% despite $4 million lower discount accretion income on favorably resolved purchased credit impaired loans between the periods (which, if excluding the PCI interest from both nine month periods, the loan yield would have increased 32 bps), as the higher yield on new, renewed and variable rate loans in the rising rate environment more than offset the lower aggregate discount income. Interest income on non-loan earning assets combined increased $1 million or 19% over the first nine months of 2017, while the related yield decreased 4 bps due mostly to the lower corporate effective tax rate for 2018 reducing the benefit (and thus yields) of tax-exempt investment securities and the higher volume of lower interest-earning cash, offset partly by higher yields on new investments added in the higher rate environment.

Average interest-bearing liabilities were $2.0 billion, an increase of $259 million or 15% compared to the first nine months of 2017, primarily due to a $244 million or 15% increase in interest-bearing deposits (attributable to acquired balances and organic growth, including the large customer deposit previously noted). The mix of average interest-bearing liabilities was 91% core deposits, 5% brokered deposits and 4% other funding, compared to 89%, 7% and 4%, respectively, for the nine months of 2017.

Interest expense was $14 million for the first nine months of 2018, up $6 million over the first nine months of 2017, and the related cost of funds increased 36 bps to 0.92%, driven predominantly by the cost and volume of deposits. Interest expense on deposits increased nearly $6 million from the first nine months of 2017 and the average cost of interest-bearing deposits increased 35 bps to 0.77%, influenced by increases in select deposit rates from general rate pressures of the federal funds rate changes since the start of 2017. The Federal Reserve raised short-term interest rates by 150 bps since January 1, 2017.

Of note for 2018, the large customer deposit previously noted as accepted in late March and fully distributed by mid-June was a positive contributor to net interest income, though at a very low net spread, compressing the related margin components for 2018. The inclusion of the large deposit lowered the 2018 earning asset yield by approximately 8 bps and net interest margin by 8 bps, with no material impact on the cost of funds.

Provision for Loan Losses

The provision for loan losses was $1.4 million for the nine months ended September 30, 2018, exceeding net charge-offs of $1.0 million. In comparison, the provision for loan losses for the nine months ended September 30, 2017, was $1.9 million, exceeding net charge-offs of $1.1 million. Asset quality trends remained strong with continued resolutions of problem loans. The ALLL was $13.0 million (0.61% of loans) at September 30, 2018, compared to $12.7 million (0.61% of loans) at December 31, 2017 and $12.6 million (0.61% of loans) at September 30, 2017.

The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the appropriateness of the ALLL. The appropriateness of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” “— Allowance for Loan Losses,” and “— Nonperforming Assets.”

Noninterest Income

Table 4: Noninterest Income



	Three Months Ended September 30,									Nine Months Ended September 30,
(in thousands)	2018		2017		$ Change			% Change		2018		2017		$ Change			% Change
Trust services fee income	$	1,638	$	1,479	$	159		10.8	%	$	4,915	$	4,431	$	484		10.9	%
Brokerage fee income	1,732		1,500		232			15.5		5,074		4,192		882			21.0
Mortgage income, net	1,902		1,774		128			7.2		4,510		4,022		488			12.1
Service charges on deposit accounts	1,247		1,238		9			0.7		3,637		3,367		270			8.0
Card interchange income	1,481		1,225		256			20.9		4,082		3,378		704			20.8
BOLI income	1,019		459		560			122.0		1,929		1,314		615			46.8
Rent income	303		285		18			6.3		951		852		99			11.6
Other income	1,181		899		282			31.4		3,292		2,391		901			37.7
Noninterest income without net gains	10,503		8,859		1,644			18.6		28,390		23,947		4,443			18.6
Asset gains (losses), net	146		1,305		(1,159		)	(88.8	)	1,322		2,071		(749		)	(36.2	)
Total noninterest income	$	10,649	$	10,164	$	485		4.8	%	$	29,712	$	26,018	$	3,694		14.2	%

Noninterest income grew $3.7 million or 14% over the first nine months of 2017, with all categories increasing except net asset gains.

Trust service fees were up $0.5 million or 11% between the comparable nine-month periods due to higher assets under management. Between the first nine months, brokerage fees were up $0.9 million or 21%, attributable to growth within the financial advisor business.

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, offsetting MSR amortization, valuation changes, if any, and to a smaller degree some related income. Net mortgage income increased $0.5 million or 12% between the comparable nine-month periods, commensurate with higher sales volume and increased net servicing fees on the growing portfolio of mortgage loans serviced for others.

Service charges on deposit accounts increased $0.3 million or 8% over the first nine months of 2017, resulting from a higher number of accounts and an increase to the fee charged on overdrafts implemented during mid-2017. Card interchange income grew $0.7 million or 21% due to higher volume and activity.

BOLI income was up $0.6 million or 47% over the first nine months of 2017, with the majority attributable to a BOLI death benefit. Other income was $3.3 million, up $0.9 million or 38% over the first nine months of 2017, mostly attributable to an increase of $0.3 million in income from the equity interest in UFS (a data processing company interest acquired with a 2016 bank merger) and $0.3 million of annual card contract incentives received in first quarter 2018.

The $1.3 million net asset gains in 2018 were primarily attributable to $0.6 million of net gains on the sale of OREO and fixed assets and a $0.7 million favorable fair value mark on equity securities. The $2.1 million net asset gains in 2017 were primarily attributable to a $1.2 million gain to record the fair value of Nicolet's pre-acquisition interest in First Menasha, a $0.3 million net gain on the sale of OREO, and a $0.7 million net gain on the sale or disposition of assets (mostly from the sale of two vacated bank branches).

Noninterest Expense

Table 5: Noninterest Expense



	Three Months Ended September 30,									Nine Months Ended September 30,
($ in thousands)	2018		2017		Change			% Change		2018		2017		Change			% Change
Personnel	$	12,983	$	11,488	$	1,495		13.0	%	$	38,149	$	32,404	$	5,745		17.7	%
Occupancy, equipment and office	3,660		3,559		101			2.8		10,901		9,613		1,288			13.4
Business development and marketing	1,334		1,113		221			19.9		4,139		3,359		780			23.2
Data processing	2,375		2,238		137			6.1		7,094		6,428		666			10.4
FDIC expense	245		205		40			19.5		800		582		218			37.5
Intangibles amortization	1,054		1,173		(119		)	(10.1	)	3,336		3,514		(178		)	(5.1	)
Other expense	1,393		1,086		307			28.3		3,718		3,598		120			3.3
Total noninterest expense	$	23,044	$	20,862	$	2,182		10.5	%	$	68,137	$	59,498	$	8,639		14.5	%

Non-personnel expenses	$	10,061	$	9,374	$	687		7.3	%	$	29,988	$	27,094	$	2,894		10.7	%
Average full-time equivalent employees	567		547		20			3.7	%	554		519		35			6.7	%

Noninterest expense increased $8.6 million or 15% over the first nine months of 2017, mostly due to the expanded workforce and larger operating base. Excluding the $0.5 million of non-recurring merger-related costs included in 2017, noninterest expense increased $9.1 million or 15%.

Personnel expense was $38.1 million for the first nine months of 2018, up $5.7 million or 18% compared to the first nine months of 2017, partly due to the expanded workforce resulting from the 2017 acquisition, with average full-time equivalent employees up 7% between the comparable nine-month periods. Additionally, the increase results from merit increases between the periods, additional competitive market-based wage increases made more broadly across staff positions after tax reform was passed, cash and equity incentives timing, and higher health and other benefits costs.

Occupancy, equipment and office expense was $10.9 million for the first nine months of 2018, up $1.3 million or 13% compared to 2017, primarily the result of the larger operating base and higher software and technology costs as the Company invests in solutions that will drive operational efficiency and product or service enhancements. In addition, 2018 includes approximately $0.4 million of accelerated depreciation on old buildings related to two branches, one extensively renovated and the other a new location under construction.

Business development and marketing expense was $4.1 million, up $0.8 million, or 23%, between the comparable nine-month periods, largely due to $0.7 million higher charitable giving and the timing and extent of marketing campaigns, promotions, and media.

Data processing, which is primarily volume-based, rose $0.7 million or 10% between the comparable nine-month periods; however, excluding the $0.2 million of merger-related expenses incurred in 2017, data processing costs rose 14%, in line with the higher volume of accounts and activity.

Intangible amortization decreased between the nine-month periods as higher expense from intangibles added in April 2017 was more than offset by declining amortization on the aging intangibles of previous acquisitions. Other expense was up $0.1 million

or 3% between the comparable nine-month periods; however, excluding the $0.3 million of merger-related expenses incurred in 2017, other expenses rose 11%, in line with the larger operating base offset by certain economies of scale.

Income Taxes

Income tax expense was $9.4 million (effective tax rate of 23.7%) for the first nine months of 2018, compared to $12.6 million (effective tax rate of 34.2%) for the comparable period of 2017. The underlying Federal corporate tax rate declined to 21% (beginning in 2018) from 35% (for 2017) as a result of the Tax Cuts and Jobs Act passed in December 2017, impacting the effective tax rates between the years. Additionally, the BOLI death benefit recognized in third quarter 2018 was non-taxable, and a tax benefit of $159,000 and $176,000 was recorded against income tax expense for the nine months ended September 30, 2018 and 2017, respectively, related to the tax impact of stock option exercises and vesting of restricted stock.

Income Statement Analysis – Three Months Ended September 30, 2018 versus Three Months Ended September 30, 2017

Net income was $10.9 million for the three months ended September 30, 2018, an increase of $1.3 million or 14% over $9.5 million for the three months ended September 30, 2017. Earnings per diluted common share was $1.09 for third quarter 2018, 20% higher than $0.91 for third quarter 2017. Annualized return on average assets for third quarter 2018 and 2017 was 1.45% and 1.34%, respectively.

•

Tax-equivalent net interest income was $27.2 million for third quarter 2018, comprised of net interest income of $26.9 million ($0.6 million or 2% over third quarter 2017, despite $1.8 million lower aggregate discount accretion on purchased loans), and tax-equivalent adjustment of $0.3 million (down $0.3 million, due to lower tax-exempt municipal securities held and the lower corporate tax rate between the years). Tax-equivalent interest income increased $2.1 million between the third quarter periods, with $1.9 million from stronger earning asset volumes (led by loans and lower earning cash) and $0.2 million from improved yields (with a 3 bps increase in the interest-earning asset yield, despite lower discount accretion income from favorably resolved purchased credit impaired loans, and the lower taxable equivalent adjustment). Excluding the PCI interest from both third quarter periods, the loan yield would have increased 38 bps, compared to the reported 6 bps increase reflected in Table 2. Interest expense increased $1.9 million over third quarter 2017, with $1.6 million from rising rates (with a 36 bps increase in the cost of funds) and the remainder from higher volumes, both led by deposits. For additional information regarding net interest income, see “Income Statement Analysis — Net Interest Income.”


•	For third quarter 2018, provision for loan losses was $0.3 million and net charge-offs were $0.2 million, on continually improving asset quality. Provision for loan losses for third quarter 2017 was $1.0 million, with net charge-offs of $1.0 million due to the charge-off of a large commercial loan.

•

Noninterest income was $10.6 million for third quarter 2018, an increase of $0.5 million or 5% over third quarter 2017. Excluding net asset gains, noninterest income increased $1.6 million or 19%, largely due to trust and brokerage fees (up $0.4 million or 13% combined), card interchange income (up $0.3 million or 21% on higher volume and activity), mortgage income (up $0.1 million or 7% on higher sales volume and a larger servicing portfolio), and BOLI income (up $0.6 million from a death benefit). Net asset gains of $0.1 million for third quarter 2018 were attributable to fair value marks on equity securities. Net asset gains of $1.3 million for third quarter 2017 were primarily attributable to the gain to record the fair value of Nicolet's pre-acquisition interest in First Menasha. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”

•

Noninterest expense was $23.0 million for third quarter 2018, an increase of $2.2 million or 10% over third quarter 2017. Personnel expense increased $1.5 million or 13% from third quarter 2017 partly due to the expanded workforce (average FTEs increased 4%), as well as merit and competitive wage increases between the periods, higher equity incentives, and higher health and other benefit costs. Non-personnel expenses combined increased $0.7 million or 7%, largely due to business development and marketing (up $0.2 million or 20%, on higher charitable giving) and other expense (up $0.3 million or 28% for an annual equity retainer granted to the Board). For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

•

Income tax expense for third quarter 2018 benefited from the lower corporate tax rate effective in 2018, due to the passage of the Tax Cuts and Jobs Act in December 2017, as well as the tax treatment on the BOLI death benefit in 2018. Income tax expense for third quarter 2018 was $3.3 million, with an effective tax rate of 23.0%, compared to income tax expense of $5.1 million and an effective tax rate of 34.9% for third quarter 2017.

BALANCE SHEET ANALYSIS

At September 30, 2018, assets were $3.0 billion, an increase of $68 million or 2% from December 31, 2017, including an increase of $56 million or 3% in loans, fully attributable to commercial-based loans. Deposits of $2.5 billion, increased $51 million or 2% over the same period. Total stockholders’ equity was $377 million, an increase of $13 million from December 31, 2017, with net income and stock issuances partially offset by stock repurchases and net fair value investment changes.

Compared to September 30, 2017, assets increased $155 million or 5%, including an increase of $92 million or 5% in loans, fully attributable to commercial-based loans. Deposits increased $155 million or 7% over the same period. Compared to September 30, 2017, stockholders’ equity increased $17 million, primarily due to net income and stock issuances, partially offset by stock repurchases over the year.

Loans

Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2018, no significant industry concentrations existed in Nicolet’s portfolio in excess of 10% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks. See also Note 6, “Loans, Allowance for Loan Losses, and Credit Quality” of the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional disclosures on loans.

An active credit risk management process is used to ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls. 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 ALLL, and sound nonaccrual and charge-off policies.

Table 6: Period End Loan Composition



	September 30, 2018				December 31, 2017				September 30, 2017
(in thousands)	Amount		% of Total		Amount		% of Total		Amount		% of Total
Commercial & industrial	$	665,754	31.1	%	$	637,337	30.5	%	$	625,729	30.5	%
Owner-occupied CRE	449,151		21.0		430,043		20.6		428,054		20.9
AG production	35,727		1.7		35,455		1.7		36,352		1.8
Commercial	1,150,632		53.8		1,102,835		52.8		1,090,135		53.2
AG real estate	52,378		2.4		51,778		2.5		48,443		2.4
CRE investment	331,312		15.5		314,463		15.1		303,448		14.8
Construction & land development	86,533		4.0		89,660		4.3		87,649		4.3
Commercial real estate	470,223		21.9		455,901		21.9		439,540		21.5
Commercial-based loans	1,620,855		75.7		1,558,736		74.7		1,529,675		74.7
Residential construction	30,295		1.4		36,995		1.8		33,163		1.6
Residential first mortgage	357,163		16.6		363,352		17.4		363,116		17.7
Residential junior mortgage	109,692		5.1		106,027		5.1		102,654		5.0
Residential real estate	497,150		23.1		506,374		24.3		498,933		24.3
Retail & other	25,452		1.2		22,815		1.0		22,514		1.0
Retail-based loans	522,602		24.3		529,189		25.3		521,447		25.3
Total loans	$	2,143,457	100.0	%	$	2,087,925	100.0	%	$	2,051,122	100.0	%

Broadly, the loan portfolio at September 30, 2018, is 76% commercial-based and 24% retail-based. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively. In addition, the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis. Credit risk on commercial-based 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-based loans of $1.6 billion increased $62 million or 4% since December 31, 2017, primarily due to a $28 million or 4% increase in commercial and industrial and a $19 million or 4% increase in owner-occupied CRE. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 31.1% of the total portfolio at September 30, 2018, up from 30.5% at December 31, 2017.

Commercial real estate loans of $0.5 billion increased $14 million or 3% from year-end 2017, primarily in CRE investment loans. Lending in the CRE investment and construction and land development categories has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development.

Residential real estate loans declined $9 million or 2% since year-end 2017, and represented 23.1% of total loans at September 30, 2018, compared to 24.3% at year-end 2017. Residential first mortgage loans include conventional first-lien home mortgages and residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. As part of its management of originating residential mortgage loans, Nicolet’s long-term, fixed-rate residential real estate mortgage loans are largely sold in the secondary market with or without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge-off rates.

Retail and other loans represented approximately 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. The loan balances in this portfolio remained relatively unchanged from December 31, 2017 to September 30, 2018.

Allowance for Loan Losses

In addition to the discussion that follows, see also Note 6, “Loans, Allowance for Loan Losses, and Credit Quality,” in the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional disclosures on the allowance for loan losses.

Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis — Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.

The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the appropriateness of the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan portfolios; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.

Management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Management has defined impaired loans as nonaccrual credit relationships over $250,000, all loans determined to be troubled debt restructurings (“restructured loans”), plus additional loans with impairment risk characteristics. Second, management allocates the ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. The look-back period on which the average historical loss rates are determined is a rolling 20-quarter (5 year) average. Lastly, management allocates the ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment. Management conducts its allocation methodology on both the originated loans and on the acquired loans separately to account for differences, such as different loss histories and qualitative factors, between the two loan portfolios.

At September 30, 2018, the ALLL was $13.0 million compared to $12.7 million at December 31, 2017. The increase in the ALLL was the net result of a $1.4 million provision for loan losses exceeding net charge-offs by $0.3 million. Comparatively, the provision for loan losses in the first nine months of 2017 was $1.9 million and net charge-offs were $1.1 million. Annualized net charge-offs as a percent of average loans were 0.06% in the first nine months of 2018 compared to 0.08% for the first nine months of 2017 and 0.08% for the entire 2017 year.

The ratio of the ALLL as a percentage of period-end loans was 0.61% at September 30, 2018, unchanged from 0.61% at both December 31, 2017, and September 30, 2017. The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s bank acquisitions, which combined at their acquisition dates (from 2013 to 2017) added no ALLL to the numerator and $1.3 billion of loans into the denominator at their then estimated fair values. Remaining outstanding acquired loans were $725 million and $844 million at September 30, 2018 and December 31, 2017, respectively. The related allowance for acquired loans was $1.9 million, representing 0.26% of acquired loans, at September 30, 2018, compared to an allowance for acquired loans of $2.1 million, representing 0.25% of acquired loans, at December 31, 2017. Originated loans outstanding, the related allowance and the ALLL to loans ratio at September 30, 2018 were $1.4 billion, $11.1 million and 0.78%, respectively, compared to $1.2 billion, $10.5 million and 0.85%, respectively, at December 31, 2017.

Table 7: Allowance for Loan Losses



	Nine Months Ended						Year Ended
(in thousands)	September 30, 2018			September 30, 2017			December 31, 2017
Allowance for loan losses (ALLL):
Balance at beginning of period	$	12,653		$	11,820		$	11,820
Provision for loan losses	1,360			1,875			2,325
Charge-offs	(1,110		)	(1,156		)	(1,604		)
Recoveries	89			71			112
Net charge-offs	(1,021		)	(1,085		)	(1,492		)
Balance at end of period	$	12,992		$	12,610		$	12,653

Net loan charge-offs (recoveries):
Commercial & industrial	$	713		$	1,077		$	1,404
Owner-occupied CRE	52			(29		)	(30		)
AG production	—			—			—
AG real estate	—			—			—
CRE investment	37			(1		)	(1		)
Construction & land development	—			13			13
Residential construction	—			—			—
Residential first mortgage	82			2			(17		)
Residential junior mortgage	(31		)	(2		)	69
Retail & other	168			25			54
Total net loans charged-off	$	1,021		$	1,085		$	1,492

ALLL to total loans	0.61		%	0.61		%	0.61		%
ALLL to net charge-offs	951.7		%	869.3		%	848.1		%
Net charge-offs to average loans, annualized	0.06		%	0.08		%	0.08		%

Nonperforming Assets

As part of its overall credit risk management process, Nicolet’s 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. See also Note 6, “Loans, Allowance for Loan Losses, and Credit Quality” of the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional disclosures on credit quality.

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans decreased to $10.2 million (consisting of $4.9 million originated loans and $5.3 million acquired loans) at September 30, 2018 compared to $13.1 million at December 31, 2017 (consisting of $3.3 million originated loans and $9.8 million acquired loans), with the decline primarily attributable to the favorable resolution of a large purchased credit impaired commercial loan. Nonperforming assets (which include nonperforming loans and OREO) were $11.5 million at September 30, 2018 compared to $14.4 million at December 31, 2017. OREO was $1.3 million at September 30, 2018, minimally changed from year-end 2017, the majority of which is closed bank branch property. Nonperforming assets as a percent of total assets were 0.38% at September 30, 2018 compared to 0.49% at December 31, 2017.

The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the appropriate level of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management

recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $14.0 million (0.7% of loans) and $13.6 million (0.7% of loans) at September 30, 2018 and December 31, 2017, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.

Table 8: Nonperforming Assets



(in thousands)	September 30, 2018			December 31, 2017			September 30, 2017
Nonperforming loans:
Commercial & industrial	$	5,803		$	6,016		$	5,078
Owner-occupied CRE	474			533			1,276
AG production	—			—			2
AG real estate	175			186			186
CRE investment	1,381			4,531			4,537
Construction & land development	80			—			723
Residential construction	28			80			80
Residential first mortgage	1,973			1,587			2,301
Residential junior mortgage	268			158			239
Retail & other	—			4			—
Total nonaccrual loans	10,182			13,095			14,422
Accruing loans past due 90 days or more	—			—			—
Total nonperforming loans	$	10,182		$	13,095		$	14,422
OREO:
Commercial real estate owned	$	505		$	185		$	275
Residential real estate owned	51			70			—
Bank property real estate owned	725			1,039			1,039
Total OREO	1,281			1,294			1,314
Total nonperforming assets	$	11,463		$	14,389		$	15,736
Performing troubled debt restructurings	$	—		$	—		$	—
Ratios:
Nonperforming loans to total loans	0.48		%	0.63		%	0.70		%
Nonperforming assets to total loans plus OREO	0.53		%	0.69		%	0.77		%
Nonperforming assets to total assets	0.38		%	0.49		%	0.55		%
ALLL to nonperforming loans	127.6		%	96.6		%	87.4		%

Deposits

Deposits represent Nicolet’s largest source of funds. The deposit composition, including brokered deposits within total deposits, is presented in Table 9 below.

Total deposits were $2.5 billion at September 30, 2018, $51 million or 2% higher than December 31, 2017. Notably, the increase in total deposits since year-end 2017 was largely due to noninterest-bearing demand accounts (up $33 million or 5%, mostly commercial in nature), as well as growth in savings and time accounts combined exceeding the decline in MMA and interest-bearing demand accounts. Given strong underlying growth in customer-based (“core”) deposits, brokered deposits were allowed to decline, down $44 million since year-end 2017. Core deposits increased $95 million over year-end 2017, including $58 million in time deposits and $37 million in transaction accounts (led by noninterest-bearing demand).

Table 9: Period End Deposit Composition



	September 30, 2018				December 31, 2017				September 30, 2017
(in thousands)	Amount		% of Total		Amount		% of Total		Amount		% of Total
Noninterest-bearing demand	$	664,788	26.4	%	$	631,831	25.6	%	$	638,447	27.0	%
Money market and interest-bearing demand	1,174,912		46.6	%	1,222,401		49.5	%	1,107,360		46.8	%
Savings	291,058		11.5	%	269,922		10.9	%	274,828		11.6	%
Time	391,398		15.5	%	346,910		14.0	%	346,316		14.6	%
Total deposits	$	2,522,156	100.0	%	$	2,471,064	100.0	%	$	2,366,951	100.0	%

Brokered transaction accounts	$	45,894	1.8	%	$	76,141	3.1	%	$	77,440	3.3	%
Brokered time deposits	31,056		1.2	%	44,645		1.8	%	48,249		2.0	%
Total brokered deposits	$	76,950	3.0	%	$	120,786	4.9	%	$	125,689	5.3	%

Customer transaction accounts	$	2,084,864	82.7	%	$	2,048,013	82.9	%	$	1,943,195	82.1	%
Customer time deposits	360,342		14.3	%	302,265		12.2	%	298,067		12.6	%
Total customer deposits (core)	$	2,445,206	97.0	%	$	2,350,278	95.1	%	$	2,241,262	94.7	%

Lending-Related Commitments

As of September 30, 2018 and December 31, 2017, Nicolet had the following off-balance sheet lending-related commitments.

Table 10: Commitments



(in thousands)	September 30, 2018		December 31, 2017
Commitments to extend credit	$	696,684	$	680,307
Financial standby letters of credit	9,176		8,783
Performance standby letters of credit	8,538		9,080

Interest rate lock commitments to originate residential mortgage loans held for sale (included above in commitments to extend credit) and forward commitments to sell residential mortgage loans held for sale are considered derivative instruments and represented $35.6 million and $16.2 million, respectively, at September 30, 2018. The fair value of these interest rate lock commitments and forward commitments was not significant at September 30, 2018.

Liquidity Management

Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.

Funds are available from a number of basic banking activity sources, including but not limited to, the core deposit base; repayment and maturity of loans; investment securities calls, maturities, and sales; and procurement of brokered deposits. All securities AFS and equity securities (included in other investments) are reported at fair value on the consolidated balance sheet. At September 30, 2018, approximately 33% of the $411 million securities AFS portfolio was pledged to secure public deposits and short-term borrowings, as applicable, and for other purposes as required by law. Additional funding sources at September 30, 2018, consist of a $10 million available and unused line of credit at the holding company, $158 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $180 million, and borrowing capacity in the brokered deposit market.

Cash and cash equivalents at September 30, 2018 and December 31, 2017 were $161 million and $155 million, respectively. The increase in cash and cash equivalents since year-end 2017 was largely attributable to earnings and deposit growth, partially offset by loan growth, net investment purchases, and common stock purchases. Nicolet’s liquidity resources were sufficient as of September 30, 2018 to fund loans, accommodate deposit cycles and trends, and to meet other cash needs as necessary.

Management is committed to the holding company being a source of strength to the Bank and its other subsidiaries, and therefore, regularly evaluates capital and liquidity positions of the holding company in light of current and projected needs, growth or strategies. The Parent Company uses cash for normal expenses, debt service requirements, and when opportune, for common stock repurchases or investment in other strategic actions such as mergers or acquisitions. Dividends from the Bank represent a significant source of incoming cash flow for the Parent Company, along with option exercises. Among others, additional cash sources available

to the Parent Company include its $10 million available and unused line of credit, and access to the public or private markets to issue new equity, subordinated debt or other debt. At September 30, 2018, the Parent Company had $31 million in cash.

Interest Rate Sensitivity Management and Impact of Inflation

A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).

Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.

To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.

Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps change in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on financial data at September 30, 2018 and December 31, 2017, the projected changes in net interest income over a one-year time horizon, versus the baseline, are presented in Table 11 below. The slight improvement to the rising rate scenario is mostly from the slightly lagged liability pricing. The results are within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% for +/- 200 bps.

Table 11: Interest Rate Sensitivity



	September 30, 2018		December 31, 2017
200 bps decrease in interest rates	(1.1	)%	(1.0	)%
100 bps decrease in interest rates	(0.2	)%	(0.2	)%
100 bps increase in interest rates	0.1	%	(0.1	)%
200 bps increase in interest rates	0.5	%	(0.2	)%

Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.

The effect of inflation on a financial institution differs significantly from the effect on an industrial company. While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation.

Capital

Management regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines and actively reviews capital strategies in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of returns available to shareholders. Management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.

As shown in Table 12, Nicolet’s regulatory capital ratios remain well above minimum regulatory ratios. At September 30, 2018, the Bank’s regulatory capital ratios qualify the Bank as well-capitalized under the prompt-corrective action framework. This strong base of capital has allowed Nicolet to be opportunistic in the current environment and in strategic growth. A summary of Nicolet’s

and the Bank’s regulatory capital amounts and ratios as of September 30, 2018 and December 31, 2017 are presented in the following table.

Table 12: Capital



(in millions)	September 30, 2018			December 31, 2017
Company:
Total risk-based capital	$	318.6		$	299.0
Tier 1 risk-based capital	292.6			274.5
Common equity Tier 1 capital	263.1			245.2
Total capital ratio	12.8		%	12.8		%
Tier 1 capital ratio	11.8		%	11.8		%
Common equity tier 1 capital ratio	10.6		%	10.5		%
Tier 1 leverage ratio	10.3		%	10.0		%
Bank:
Total risk-based capital	$	280.7		$	267.2
Tier 1 risk-based capital	267.7			254.5
Common equity Tier 1 capital	267.7			254.5
Total capital ratio	11.3		%	11.5		%
Tier 1 capital ratio	10.8		%	10.9		%
Common equity tier 1 capital ratio	10.8		%	10.9		%
Tier 1 leverage ratio	9.4		%	9.3		%

In managing capital for optimal return, we evaluate capital sources and uses, pricing and availability of our stock in the market, and alternative uses of capital (such as the level of organic growth or acquisition opportunities) in light of strategic plans. During the first nine months of 2018, $16.9 million was utilized to repurchase and cancel approximately 307,800 shares of common stock pursuant to our 2014 common stock repurchase program, bringing the life-to-date cumulative totals to just over 1 million shares repurchased for $41.1 million. As of September 30, 2018, there remains $12.9 million authorized under the repurchase program to be utilized from time-to-time to repurchase shares in the open market, through block transactions or in private transactions.

Critical Accounting Policies

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the valuation of loan acquisition transactions, as well as the determination of the allowance for loan losses and income taxes. A discussion of these policies can be found in the “Critical Accounting Policies” section in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2017 Annual Report on Form 10-K. There have been no changes in the Company’s application of critical accounting policies since December 31, 2017.

Future Accounting Pronouncements

Recent accounting pronouncements adopted are included in Note 1, “Basis of Presentation” of the Notes to Unaudited Consolidated Financial Statements within Part I, Item 1.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. The updated guidance is effective for annual reporting periods, including interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. As the new ASU only revises disclosure requirements, it is not expected to have a material impact on the Company's consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 expands the activities that qualify for hedge accounting and simplifies the rules for reporting hedging transactions. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements, and it is not expected to have a significant impact on its consolidated financial statements because the Company does not have any significant derivatives and does not currently apply hedge accounting to derivatives.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring earlier recognition of credit losses on loans and certain other financial assets. Topic 326 replaces the current incurred loss impairment model (which recognizes losses when a

probable threshold is met) with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The measurement of lifetime expected credit losses will be based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Entities should apply the amendment by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company expects to adopt the new accounting standard in 2020, as required. Nicolet has established a cross-functional team to assess the impact of the new guidance on its consolidated financial statements and implement the new standard. This team is currently in the process of developing credit models, as well as accounting, reporting, and governance processes to comply with the new credit loss requirements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), with several subsequent updates. Topic 842 introduces a new accounting model for lessors and lessees. For lessees, almost all leases will be required to be recognized on the balance sheet as a right-of-use asset and lease liability, unlike current GAAP which requires only capital leases to be recognized on the balance sheet. The accounting applied by lessors is largely unchanged from existing guidance. Topic 842 also requires additional disclosures concerning the amount, timing and uncertainty of cash flows arising from leases. The updated guidance is effective for annual reporting periods beginning after December 15, 2018, with early application permitted. The Company will adopt the new accounting standard in 2019, as required, and is currently assessing the impact of the new guidance on its consolidated financial statements. At adoption, Nicolet will recognize right-of-use assets and lease liabilities for virtually all of its operating lease commitments. The amounts of these assets and liabilities recorded will be based, primarily, on the present value of unpaid future minimum lease payments as of January 1, 2019, the date of adoption. Those amounts will also be impacted by assumptions around renewals and/or extensions, and the interest rate used to discount those future lease commitments. As of December 31, 2017, Nicolet reported approximately $5 million in minimum lease payments due under lease commitments for January 1, 2019 forward. While these leases represent a majority of the leases within the scope of the standard, the lease portfolio is subject to change from the execution of new leases and termination of existing leases prior to the effective date.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See section “Interest Rate Sensitivity Management and Impact of Inflation” within Management’s Discussion and Analysis of Financial Condition and Results of Operations under Part I, Item 2.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, management, under the supervision, and with the participation, of our Chairman, President and Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act pursuant to Exchange Act Rule 13a-15). Based upon, and as of the date of such evaluation, the Chairman, President and Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.

There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We and our subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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

Following are Nicolet’s monthly common stock purchases during the third quarter of 2018.



	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(a)
	(#)	($)		(#)	(#)
Period
July 1 – July 31, 2018	2,014	$	55.04	1,700	514,000
August 1 – August 31, 2018	4,337	$	54.96	2,457	512,000
September 1 – September 30, 2018	77,123	$	54.45	77,123	435,000
Total	83,474	$	54.49	81,280	435,000

(a)

During third quarter 2018, Nicolet utilized $4.4 million to repurchase and cancel approximately 81,300 shares of common stock pursuant to our 2014 common stock repurchase program, bringing the life-to-date cumulative totals to $41.1 million to repurchase and cancel just over 1 million shares at a weighted average price of $40.47 per share excluding commissions. At September 30, 2018, approximately $12.9 million remained available to repurchase up to 435,000 common shares.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The following exhibits are filed herewith:



Exhibit Number		Description
31.1		Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2		Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1		Certification of CEO Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of CFO Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
101		The following material from Nicolet’s Form 10-Q Report for the three and nine months ended September 30, 2018, formatted in eXtensible Business Reporting Language: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Unaudited Consolidated Financial Statements.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	NICOLET BANKSHARES, INC.

November 2, 2018	/s/ Robert B. Atwell
	Robert B. Atwell
	Chairman, President and Chief Executive Officer

November 2, 2018	/s/ Ann K. Lawson
	Ann K. Lawson
	Chief Financial Officer

Nicolet Bankshares - 10-Q quarterly report FY2018 Q3

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