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, 2019

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)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	NCBS	The NASDAQ Stock Market LLC

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 ¨

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 30, 2019 there were 9,366,490 shares of $0.01 par value common stock outstanding.

Nicolet Bankshares, Inc.

Quarterly Report on Form 10-Q

September 30, 2019

TABLE OF CONTENTS

			PAGE
PART I	FINANCIAL INFORMATION
	Item 1.	Financial Statements:
		Consolidated Balance Sheets	3
		Consolidated Statements of Income	4
		Consolidated Statements of Comprehensive Income	5
		Consolidated Statements of Stockholders’ Equity	6
		Consolidated Statements of Cash Flows	7
		Notes to Unaudited Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
	Item 4.	Controls and Procedures	44
PART II	OTHER INFORMATION
	Item 1.	Legal Proceedings	44
	Item 1A.	Risk Factors	44
	Item 2.	Unregistered Sales of Equity Securities and Use of  Proceeds	44
	Item 3.	Defaults Upon Senior Securities	45
	Item 4.	Mine Safety Disclosures	45
	Item 5.	Other Information	45
	Item 6.	Exhibits	45
		Signatures	46

2

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS:

NICOLET BANKSHARES, INC.

Consolidated Balance Sheets

(In thousands, except share and per share data)

	September 30, 2019			December 31, 2018
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	88,371		$	85,896
Interest-earning deposits	55,598			163,630
Cash and cash equivalents	143,969			249,526
Certificates of deposit in other banks	5,395			993
Securities available for sale (“AFS”), at fair value	419,300			400,144
Other investments	20,697			17,997
Loans held for sale	10,564			1,639
Loans	2,242,931			2,166,181
Allowance for loan losses ("ALLL")	(13,620		)	(13,153		)
Loans, net	2,229,311			2,153,028
Premises and equipment, net	47,680			48,173
Bank owned life insurance (“BOLI”)	71,796			66,310
Goodwill and other intangibles, net	121,371			124,307
Accrued interest receivable and other assets	35,588			34,418
Total assets	$	3,105,671		$	3,096,535
Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing demand deposits	$	782,968		$	753,065
Interest-bearing deposits	1,801,479			1,861,073
Total deposits	2,584,447			2,614,138
Long-term borrowings	57,495			77,305
Accrued interest payable and other liabilities	34,987			17,740
Total liabilities	2,676,929			2,709,183
Stockholders’ Equity:
Common stock	94			95
Additional paid-in capital	236,534			247,790
Retained earnings	186,710			144,364
Accumulated other comprehensive income (loss)	4,676			(5,640		)
Total Nicolet Bankshares, Inc. stockholders’ equity	428,014			386,609
Noncontrolling interest	728			743
Total stockholders’ equity and noncontrolling interest	428,742			387,352
Total liabilities, noncontrolling interest and stockholders’ equity	$	3,105,671		$	3,096,535
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	9,363,407			9,495,265
Common shares issued	9,387,096			9,524,777

See accompanying notes to unaudited consolidated financial statements.

3

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,
	2019		2018		2019		2018
Interest income:
Loans, including loan fees	$	31,334	$	28,997	$	92,511	$	84,644
Investment securities:
Taxable	1,904		1,564		5,578		4,503
Tax-exempt	503		572		1,574		1,737
Other interest income	926		747		2,733		2,326
Total interest income	34,667		31,880		102,396		93,210
Interest expense:
Deposits	4,596		4,055		14,103		11,012
Short-term borrowings	—		—		—		8
Long-term borrowings	881		883		2,684		2,571
Total interest expense	5,477		4,938		16,787		13,591
Net interest income	29,190		26,942		85,609		79,619
Provision for loan losses	400		340		900		1,360
Net interest income after provision for loan losses	28,790		26,602		84,709		78,259
Noninterest income:
Trust services fee income	1,594		1,638		4,631		4,915
Brokerage fee income	2,113		1,732		5,925		5,074
Mortgage income, net	3,700		1,902		6,962		4,510
Service charges on deposit accounts	1,223		1,247		3,587		3,637
Card interchange income	1,735		1,481		4,815		4,082
BOLI income	495		1,019		1,834		1,929
Asset gains (losses), net	286		146		8,030		1,322
Other income	1,166		1,484		4,274		4,243
Total noninterest income	12,312		10,649		40,058		29,712
Noninterest expense:
Personnel	12,914		12,983		40,809		38,149
Occupancy, equipment and office	3,454		3,660		10,961		10,901
Business development and marketing	1,428		1,334		4,288		4,139
Data processing	2,515		2,375		7,220		7,094
Intangibles amortization	914		1,054		2,936		3,336
Other expense	1,662		1,638		5,159		4,518
Total noninterest expense	22,887		23,044		71,373		68,137
Income before income tax expense	18,215		14,207		53,394		39,834
Income tax expense	4,603		3,268		10,788		9,431
Net income	13,612		10,939		42,606		30,403
Less: Net income attributable to noncontrolling interest	82		80		260		230
Net income attributable to Nicolet Bankshares, Inc.	$	13,530	$	10,859	$	42,346	$	30,173
Earnings per common share:
Basic	$	1.45	$	1.13	$	4.51	$	3.12
Diluted	$	1.40	$	1.09	$	4.36	$	3.02
Weighted average common shares outstanding:
Basic	9,346,814		9,633,158		9,393,795		9,678,726
Diluted	9,696,850		9,949,295		9,706,795		10,004,316

See accompanying notes to unaudited consolidated financial statements.

4

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,
	2019			2018			2019			2018
Net income	$	13,612		$	10,939		$	42,606		$	30,403
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities AFS:
Net unrealized holding gains (losses)	2,053			(1,836		)	14,165			(6,814		)
Net realized (gains) losses included in income	—			—			(32		)	—
Income tax (expense) benefit	(555		)	497			(3,817		)	1,840
Total other comprehensive income (loss)	1,498			(1,339		)	10,316			(4,974		)
Comprehensive income	$	15,110		$	9,600		$	52,922		$	25,429

See accompanying notes to unaudited consolidated financial statements.

5

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Stockholders’ Equity

(In thousands) (Unaudited)

	Nicolet Bankshares, Inc. Stockholders’ Equity
	Common Stock			Additional Paid-In Capital			Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Non- controlling Interest			Total
Balances at June 30, 2019	$	94		$	234,963		$	173,180	$	3,178		$	733		$	412,148
Comprehensive income:
Net income, three months ended September 30, 2019	—			—			13,530		—			82			13,612
Other comprehensive income (loss)	—			—			—		1,498			—			1,498
Stock-based compensation expense	—			1,144			—		—			—			1,144
Exercise of stock options, net	—			1,200			—		—			—			1,200
Issuance of common stock	—			166			—		—			—			166
Purchase and retirement of common stock	—			(939		)	—		—			—			(939		)
Distribution to noncontrolling interest	—			—			—		—			(87		)	(87		)
Balances at September 30, 2019	$	94		$	236,534		$	186,710	$	4,676		$	728		$	428,742
Balances at June 30, 2018	$	96		$	254,564		$	122,642	$	(6,718	)	$	701		$	371,285
Comprehensive income:
Net income, three months ended September 30, 2018	—			—			10,859		—			80			10,939
Other comprehensive income (loss)	—			—			—		(1,339		)	—			(1,339		)
Stock-based compensation expense	—			1,299			—		—			—			1,299
Exercise of stock options, net	1			261			—		—			—			262
Issuance of common stock	—			59			—		—			—			59
Purchase and retirement of common stock	(1		)	(4,552		)	—		—			—			(4,553		)
Distribution to noncontrolling interest	—			—			—		—			(49		)	(49		)
Balances at September 30, 2018	$	96		$	251,631		$	133,501	$	(8,057	)	$	732		$	377,903
Balances at December 31, 2018	$	95		$	247,790		$	144,364	$	(5,640	)	$	743		$	387,352
Comprehensive income:
Net income, nine months ended September 30, 2019	—			—			42,346		—			260			42,606
Other comprehensive income (loss)	—			—			—		10,316			—			10,316
Stock-based compensation expense	—			3,643			—		—			—			3,643
Exercise of stock options, net	2			4,380			—		—			—			4,382
Issuance of common stock	—			449			—		—			—			449
Purchase and retirement of common stock	(3		)	(19,728		)	—		—			—			(19,731		)
Distribution to noncontrolling interest	—			—			—		—			(275		)	(275		)
Balances at September 30, 2019	$	94		$	236,534		$	186,710	$	4,676		$	728		$	428,742
Balances at December 31, 2017	$	98		$	263,835		$	102,391	$	(2,146	)	$	701		$	364,879
Comprehensive income:
Net income, nine months ended September 30, 2018	—			—			30,173		—			230			30,403
Other comprehensive income (loss)	—			—			—		(4,974		)	—			(4,974		)
Stock-based compensation expense	—			3,613			—		—			—			3,613
Exercise of stock options, net	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 new accounting pronouncement	—			—			937		(937		)	—			—
Balances at September 30, 2018	$	96		$	251,631		$	133,501	$	(8,057	)	$	732		$	377,903

See accompanying notes to unaudited consolidated financial statements.

6

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)	Nine Months Ended September 30,
	2019			2018
Cash Flows From Operating Activities:
Net income	$	42,606		$	30,403
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion	5,260			4,643
Provision for loan losses	900			1,360
Increase in cash surrender value of life insurance	(1,432		)	(1,367		)
Stock-based compensation expense	3,643			3,613
Asset (gains) losses, net	(8,030		)	(1,322		)
Gain on sale of loans held for sale, net	(7,042		)	(4,026		)
Proceeds from sale of loans held for sale	255,775			184,314
Origination of loans held for sale	(259,465		)	(178,911		)
Net change in:
Accrued interest receivable and other assets	(5,020		)	(4,952		)
Accrued interest payable and other liabilities	9,310			6,798
Net cash provided by (used in) operating activities	36,505			40,553
Cash Flows From Investing Activities:
Net (increase) decrease in loans	(74,131		)	(50,703		)
Net (increase) decrease in certificates of deposit in other banks	(4,402		)	751
Purchases of securities AFS	(57,875		)	(57,891		)
Proceeds from sales of securities AFS	13,240			—
Proceeds from calls and maturities of securities AFS	38,128			40,302
Purchases of other investments	(1,941		)	(634		)
Proceeds from sales of other investments	17,144			807
Purchases of BOLI	(5,000		)	—
Proceeds from redemption of BOLI	1,348			561
Net (increase) decrease in premises and equipment	(3,529		)	(2,974		)
Net (increase) decrease in other real estate and other assets	15			1,486
Net cash provided by (used in) investing activities	(77,003		)	(68,295		)
Cash Flows From Financing Activities:
Net increase (decrease) in deposits	(29,691		)	51,171
Repayments of long-term borrowings	(20,193		)	(1,189		)
Purchase and retirement of common stock	(19,731		)	(17,210		)
Proceeds from issuance of common stock	449			167
Proceeds from exercise of stock options	4,382			1,224
Distribution to noncontrolling interest	(275		)	(199		)
Net cash provided by (used in) financing activities	(65,059		)	33,964
Net increase (decrease) in cash and cash equivalents	(105,557		)	6,222
Cash and cash equivalents:
Beginning	249,526			154,933
Ending *	$	143,969		$	161,155
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	16,682		$	13,294
Cash paid for taxes	11,690			9,325
Transfer of loans and bank premises to other real estate owned	1,025			587
Capitalized mortgage servicing rights	1,807			696
Initial recognition of operating lease right of use asset	5,403			—
Initial recognition of operating lease liability	5,403			—

* Cash and cash equivalents include restricted cash of $6.3 million and $7.4 million at September 30, 2019 and 2018, respectively, for the reserve balance required with the Federal Reserve Bank. At September 30, 2019, cash and cash equivalents also includes restricted cash of $1.3 million pledged as collateral on interest rate swaps.

See accompanying notes to unaudited consolidated financial statements.

7

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, 2018.

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, 2018.

Recent Accounting Developments Adopted

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 adopted the updated guidance effective January 1, 2019 with no material 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 February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), with several subsequent updates. Topic 842 introduced a new accounting model for lessors and lessees. For lessees, almost all leases are now recognized on the balance sheet as a right-of-use ("ROU") asset and lease liability, unlike previous GAAP which required 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, and provides a modified retrospective transition approach that allows lessees to recognize and measure leases on the balance sheet at the beginning of either the earliest period presented or as of the beginning of the period of adoption (the "effective date" method), with the option to elect certain practical expedients. Nicolet adopted the new guidance prospectively as of January 1, 2019, using the effective date method; thus, prior comparative periods have not been restated.

Upon adoption, Nicolet recognized an ROU asset and lease liability of approximately $5 million. There was no impact to its consolidated statements of income or cash flows compared to the prior lease accounting model. The ROU asset and lease liability are recorded in other assets and other liabilities, respectively, in the consolidated balance sheets. As part of the adoption, Nicolet elected the package of practical expedients permitted under the transition guidance of the new standard which allowed the carry forward of the historical lease classification. Nicolet also elected the practical expedient to group lease and non-lease components as a single lease component; thus, the Company's leases include both lease (e.g., fixed payments including rent, taxes, and insurance

8

costs) and non-lease components (e.g., common area or other maintenance costs). See Note 10 for the new disclosures required by Topic 842.

Reclassifications

Certain amounts in the 2018 consolidated financial statements have been reclassified to conform to the 2019 presentation.

Note 2 – Pending Acquisition

Nicolet entered into an Agreement and Plan of Merger with Choice Bancorp, Inc. ("Choice" (OTC Pink "CBKW")) on June 26, 2019 (the "Merger Agreement"), pursuant to which Choice will merge with and into Nicolet (the "Merger") to create the largest community bank in the Oshkosh, Wisconsin marketplace. Immediately following the Merger, Choice Bank, the wholly owned bank subsidiary of Choice, will merge with and into Nicolet's wholly owned bank subsidiary (the "Bank Merger"), with Nicolet National Bank as the surviving entity in the Bank Merger.

The transaction will involve stock-for-stock consideration at a fixed exchange ratio, subject to cap and collar provisions provided for in the Merger Agreement. At September 30, 2019, Choice had total assets of $436 million, loans of $352 million, deposits of $306 million, and equity of $41 million. Choice assets represented approximately 14% of Nicolet assets at September 30, 2019.

As of September 17, 2019, Nicolet received all regulatory approvals for the Merger and Bank Merger, and Choice shareholders approved the Merger on October 22, 2019. The merger is expected to close on November 8, 2019, pending satisfaction of customary closing conditions.

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)	2019		2018		2019		2018
Net income attributable to Nicolet Bankshares, Inc.	$	13,530	$	10,859	$	42,346	$	30,173
Weighted average common shares outstanding	9,347		9,633		9,394		9,679
Effect of dilutive common stock awards	350		316		313		325
Diluted weighted average common shares outstanding	9,697		9,949		9,707		10,004
Basic earnings per common share*	$	1.45	$	1.13	$	4.51	$	3.12
Diluted earnings per common share*	$	1.40	$	1.09	$	4.36	$	3.02

*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 endedSeptember 30, 2019, options to purchase less than 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. For the three and nine months endedSeptember 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.

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. These plans are administered by a committee of the Board of Directors. In February 2019, with subsequent shareholder approval, the 2011 Long-Term Incentive Plan was amended to increase the shares reserved for potential stock-based awards from 1,500,000 shares to 3,000,000 shares. At September 30, 2019, approximately 1.6 million shares were available for grant under these stock-based compensation plans.

9

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,
	2019			2018
Dividend yield	—		%	—		%
Expected volatility	25		%	25		%
Risk-free interest rate	2.37		%	2.48		%
Expected average life	7 years			7 years
Weighted average per share fair value of options	$	19.23		$	17.60

A summary of the Company’s stock option activity is summarized below.

Stock Options	Option Shares Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Life (Years)	Aggregate Intrinsic Value (in thousands)
Outstanding - December 31, 2018	1,581,699		$	40.77
Granted	15,000		59.55
Exercise of stock options *	(185,328	)	23.64
Forfeited	(3,538	)	27.43
Outstanding - September 30, 2019	1,407,833		$	43.25	7.0	$	32,829
Exercisable - September 30, 2019	644,033		$	39.28	6.5	$	17,577

* 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. For the nine months endedSeptember 30, 2019, 70,068 such shares were surrendered to the Company.

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 the nine months endedSeptember 30, 2019 and 2018 was approximately $6.9 million and $1.8 million, respectively.

A summary of the Company’s restricted stock activity is summarized below.

Restricted Stock	Weighted Average Grant Date Fair Value		Restricted Shares Outstanding
Outstanding - December 31, 2018	$	39.37	29,512
Granted	61.96		4,257
Vested *	45.05		(9,672	)
Forfeited	16.50		(408	)
Outstanding - September 30, 2019	$	41.50	23,689

* 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, 1,637 shares were surrendered during the nine months endedSeptember 30, 2019.

The Company recognized approximately $3.4 million of stock-based compensation expense (included in personnel on the consolidated statements of income) for both the nine months endedSeptember 30, 2019 and 2018, associated with its common stock awards granted to officers and employees. In addition, during 2019 the Company recognized approximately $0.3 million of director expense (included in other expense on the consolidated statements of income) for a total restricted stock grant of 4,257 shares with immediate vesting to non-employee directors. During 2018, the Company recognized approximately $0.2 million of director expense for a total restricted stock grant of 3,510 shares with immediate vesting to non-employee directors. As of September 30, 2019, there was approximately $9.9 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 $1.0 million and $0.2 million for the nine months endedSeptember 30, 2019 and 2018, respectively, for the tax impact of stock option exercises and vesting of restricted stock.

10

Note 5 – Securities Available for Sale

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

	September 30, 2019
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government agency securities	$	16,697	$	—	$	207	$	16,490
State, county and municipals	147,186		798		198		147,786
Mortgage-backed securities	169,262		3,267		652		171,877
Corporate debt securities	79,749		3,408		10		83,147
Total	$	412,894	$	7,473	$	1,067	$	419,300

	December 31, 2018
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government agency securities	$	22,467	$	—	$	818	$	21,649
State, county and municipals	163,702		76		3,252		160,526
Mortgage-backed securities	134,350		328		3,034		131,644
Corporate debt securities	87,352		66		1,093		86,325
Total	$	407,871	$	470	$	8,197	$	400,144

The following table presents 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, 2019
	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	$	—	$	—	$	16,490	$	207	$	16,490	$	207	3
State, county and municipals	44,012		138		8,370		60		52,382		198		139
Mortgage-backed securities	38,515		127		40,783		525		79,298		652		150
Corporate debt securities	2,044		10		—		—		2,044		10		1
Total	$	84,571	$	275	$	65,643	$	792	$	150,214	$	1,067	293

	December 31, 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	$	—	$	—	$	21,649	$	818	$	21,649	$	818	3
State, county and municipals	16,136		98		130,975		3,154		147,111		3,252		440
Mortgage-backed securities	20,568		132		89,189		2,902		109,757		3,034		204
Corporate debt securities	51,592		677		9,757		416		61,349		1,093		33
Total	$	88,296	$	907	$	251,570	$	7,290	$	339,866	$	8,197	680

As of September 30, 2019, 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 endedSeptember 30, 2019 or 2018.

11

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, 2019
(in thousands)	Amortized Cost		Fair Value
Due in less than one year	$	18,762	$	18,770
Due in one year through five years	184,588		187,185
Due after five years through ten years	33,877		34,314
Due after ten years	6,405		7,154
	243,632		247,423
Mortgage-backed securities	169,262		171,877
Securities AFS	$	412,894	$	419,300

Proceeds and realized gains / losses from the sale of securities AFS were as follows.

	Nine Months Ended September 30,
(in thousands)	2019			2018
Gross gains	$	152		$	—
Gross losses	(120		)	—
Gains (losses) on sales of securities AFS, net	$	32		$	—
Proceeds from sales of securities AFS	$	13,240		$	—

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

The loan composition is summarized as follows.

	September 30, 2019					December 31, 2018
(in thousands)	Amount			% of Total		Amount			% of Total
Commercial & industrial	$	763,742		34	%	$	684,920		32	%
Owner-occupied commercial real estate (“CRE”)	456,508			20		441,353			20
Agricultural (“AG”) production	36,050			2		35,625			2
AG real estate	58,591			3		53,444			2
CRE investment	336,442			15		343,652			16
Construction & land development	61,810			3		80,599			4
Residential construction	41,496			2		30,926			1
Residential first mortgage	343,400			15		357,841			17
Residential junior mortgage	116,179			5		111,328			5
Retail & other	28,713			1		26,493			1
Loans	2,242,931			100	%	2,166,181			100	%
Less allowance for loan losses (“ALLL”)	13,620					13,153
Loans, net	$	2,229,311				$	2,153,028
Allowance for loan losses to loans	0.61		%			0.61		%

12

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

	September 30, 2019										December 31, 2018
(in thousands)	Originated Amount			% of Total		Acquired Amount			% of Total		Originated Amount			% of Total		Acquired Amount			% of Total
Commercial & industrial	$	660,040		40	%	$	103,702		18	%	$	568,100		38	%	$	116,820		17	%
Owner-occupied CRE	321,323			19		135,185			23		283,531			19		157,822			23
AG production	11,450			1		24,600			4		11,113			1		24,512			4
AG real estate	38,616			2		19,975			3		31,374			2		22,070			3
CRE investment	180,427			11		156,015			26		171,087			12		172,565			25
Construction & land development	52,806			3		9,004			2		66,478			4		14,121			2
Residential construction	41,246			3		250			—		30,926			2		—			—
Residential first mortgage	228,312			14		115,088			19		220,368			15		137,473			20
Residential junior mortgage	89,241			5		26,938			5		78,379			5		32,949			5
Retail & other	27,232			2		1,481			—		23,809			2		2,684			1
Loans	1,650,693			100	%	592,238			100	%	1,485,165			100	%	681,016			100	%
Less ALLL	12,064					1,556					11,448					1,705
Loans, net	$	1,638,629				$	590,682				$	1,473,717				$	679,311
ALLL to loans	0.73		%			0.26		%			0.77		%			0.25		%
Loans as a percent of total loans	74		%			26		%			69		%			31		%

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.

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

	Nine Months Ended						Year Ended
(in thousands)	September 30, 2019			September 30, 2018			December 31, 2018
Beginning balance	$	13,153		$	12,653		$	12,653
Provision for loan losses	900			1,360			1,600
Charge-offs	(629		)	(1,110		)	(1,213		)
Recoveries	196			89			113
Net (charge-offs) recoveries	(433		)	(1,021		)	(1,100		)
Ending balance	$	13,620		$	12,992		$	13,153

13

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, 2019
(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	$	5,271		$	2,847		$	121		$	301		$	1,470		$	510		$	211		$	1,646		$	472		$	304		$	13,153
Provision	356			(57		)	85			46			32			(140		)	357			(75		)	71			225			900
Charge-offs	(59		)	(13		)	—			—			—			—			(226		)	—			(80		)	(251		)	(629		)
Recoveries	90			2			—			—			—			—			—			36			32			36			196
Net (charge-offs) recoveries	31			(11		)	—			—			—			—			(226		)	36			(48		)	(215		)	(433		)
Ending balance	$	5,658		$	2,779		$	206		$	347		$	1,502		$	370		$	342		$	1,607		$	495		$	314		$	13,620
As % of ALLL	42		%	20		%	1		%	3		%	11		%	3		%	2		%	12		%	4		%	2		%	100		%
ALLL:
Individually evaluated	$	308		$	—		$	119		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	427
Collectively evaluated	5,350			2,779			87			347			1,502			370			342			1,607			495			314			13,193
Ending balance	$	5,658		$	2,779		$	206		$	347		$	1,502		$	370		$	342		$	1,607		$	495		$	314		$	13,620
Loans:
Individually evaluated	$	2,143		$	2,552		$	1,251		$	1,089		$	2,483		$	427		$	—		$	2,560		$	221		$	12		$	12,738
Collectively evaluated	761,599			453,956			34,799			57,502			333,959			61,383			41,496			340,840			115,958			28,701			2,230,193
Total loans	$	763,742		$	456,508		$	36,050		$	58,591		$	336,442		$	61,810		$	41,496		$	343,400		$	116,179		$	28,713		$	2,242,931
Less ALLL	5,658			2,779			206			347			1,502			370			342			1,607			495			314			13,620
Net loans	$	758,084		$	453,729		$	35,844		$	58,244		$	334,940		$	61,440		$	41,154		$	341,793		$	115,684		$	28,399		$	2,229,311

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

	Originated – Nine Months Ended September 30, 2019
(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	$	4,683		$	2,439		$	110		$	255		$	1,230		$	431		$	211		$	1,400		$	408		$	281		$	11,448
Provision	395			(17		)	84			45			68			(111		)	323			(42		)	22			227			994
Charge-offs	(59		)	(13		)	—			—			—			—			(226		)	—			(20		)	(251		)	(569		)
Recoveries	90			2			—			—			—			—			—			36			27			36			191
Net (charge-offs) recoveries	31			(11		)	—			—			—			—			(226		)	36			7			(215		)	(378		)
Ending balance	$	5,109		$	2,411		$	194		$	300		$	1,298		$	320		$	308		$	1,394		$	437		$	293		$	12,064
As % of ALLL	42		%	20		%	1		%	2		%	11		%	3		%	3		%	12		%	4		%	2		%	100		%
ALLL:
Individually evaluated	$	308		$	—		$	119		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	427
Collectively evaluated	4,801			2,411			75			300			1,298			320			308			1,394			437			293			11,637
Ending balance	$	5,109		$	2,411		$	194		$	300		$	1,298		$	320		$	308		$	1,394		$	437		$	293		$	12,064
Loans:
Individually evaluated	$	722		$	1,792		$	1,095		$	878		$	—		$	—		$	—		$	—		$	—		$	—		$	4,487
Collectively evaluated	659,318			319,531			10,355			37,738			180,427			52,806			41,246			228,312			89,241			27,232			1,646,206
Total loans	$	660,040		$	321,323		$	11,450		$	38,616		$	180,427		$	52,806		$	41,246		$	228,312		$	89,241		$	27,232		$	1,650,693
Less ALLL	5,109			2,411			194			300			1,298			320			308			1,394			437			293			12,064
Net loans	$	654,931		$	318,912		$	11,256		$	38,316		$	179,129		$	52,486		$	40,938		$	226,918		$	88,804		$	26,939		$	1,638,629

14

	Acquired – Nine Months Ended September 30, 2019
(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	$	588		$	408		$	11		$	46		$	240		$	79		$	—		$	246		$	64		$	23		$	1,705
Provision	(39		)	(40		)	1			1			(36		)	(29		)	34			(33		)	49			(2		)	(94		)
Charge-offs	—			—			—			—			—			—			—			—			(60		)	—			(60		)
Recoveries	—			—			—			—			—			—			—			—			5			—			5
Net (charge-offs) recoveries	—			—			—			—			—			—			—			—			(55		)	—			(55		)
Ending balance	$	549		$	368		$	12		$	47		$	204		$	50		$	34		$	213		$	58		$	21		$	1,556
As % of ALLL	35		%	24		%	1		%	3		%	13		%	3		%	2		%	14		%	4		%	1		%	100		%
ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	549			368			12			47			204			50			34			213			58			21			1,556
Ending balance	$	549		$	368		$	12		$	47		$	204		$	50		$	34		$	213		$	58		$	21		$	1,556
Loans:
Individually evaluated	$	1,421		$	760		$	156		$	211		$	2,483		$	427		$	—		$	2,560		$	221		$	12		$	8,251
Collectively evaluated	102,281			134,425			24,444			19,764			153,532			8,577			250			112,528			26,717			1,469			583,987
Total loans	$	103,702		$	135,185		$	24,600		$	19,975		$	156,015		$	9,004		$	250		$	115,088		$	26,938		$	1,481		$	592,238
Less ALLL	549			368			12			47			204			50			34			213			58			21			1,556
Net loans	$	103,153		$	134,817		$	24,588		$	19,928		$	155,811		$	8,954		$	216		$	114,875		$	26,880		$	1,460		$	590,682

For comparison purposes, the following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment for the prior year-end period.

	TOTAL – Year Ended December 31, 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	1,107			300			(8		)	5			119			(216		)	(40		)	117			(51		)	267			1,600
Charge-offs	(813		)	(74		)	—			—			(37		)	—			—			(85		)	—			(204		)	(1,213		)
Recoveries	43			14			—			—			—			—			—			5			35			16			113
Net (charge-offs) recoveries	(770		)	(60		)	—			—			(37		)	—			—			(80		)	35			(188		)	(1,100		)
Ending balance	$	5,271		$	2,847		$	121		$	301		$	1,470		$	510		$	211		$	1,646		$	472		$	304		$	13,153
As % of ALLL	40		%	22		%	1		%	2		%	11		%	4		%	2		%	12		%	4		%	2		%	100		%
ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	5,271			2,847			121			301			1,470			510			211			1,646			472			304			13,153
Ending balance	$	5,271		$	2,847		$	121		$	301		$	1,470		$	510		$	211		$	1,646		$	472		$	304		$	13,153
Loans:
Individually evaluated	$	2,927		$	1,506		$	—		$	222		$	1,686		$	603		$	—		$	2,750		$	233		$	12		$	9,939
Collectively evaluated	681,993			439,847			35,625			53,222			341,966			79,996			30,926			355,091			111,095			26,481			2,156,242
Total loans	$	684,920		$	441,353		$	35,625		$	53,444		$	343,652		$	80,599		$	30,926		$	357,841		$	111,328		$	26,493		$	2,166,181
Less ALLL	5,271			2,847			121			301			1,470			510			211			1,646			472			304			13,153
Net loans	$	679,649		$	438,506		$	35,504		$	53,143		$	342,182		$	80,089		$	30,715		$	356,195		$	110,856		$	26,189		$	2,153,028

15

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

	Originated – Year Ended December 31, 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	1,262			385			(2		)	20			113			(197		)	11			187			(31		)	266			2,014
Charge-offs	(813		)	(64		)	—			—			(37		)	—			—			(85		)	—			(201		)	(1,200		)
Recoveries	42			3			—			—			—			—			—			1			30			16			92
Net (charge-offs) recoveries	(771		)	(61		)	—			—			(37		)	—			—			(84		)	30			(185		)	(1,108		)
Ending balance	$	4,683		$	2,439		$	110		$	255		$	1,230		$	431		$	211		$	1,400		$	408		$	281		$	11,448
As % of ALLL	41		%	21		%	1		%	2		%	11		%	4		%	2		%	12		%	4		%	2		%	100		%
ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	4,683			2,439			110			255			1,230			431			211			1,400			408			281			11,448
Ending balance	$	4,683		$	2,439		$	110		$	255		$	1,230		$	431		$	211		$	1,400		$	408		$	281		$	11,448
Loans:
Individually evaluated	$	227		$	321		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	548
Collectively evaluated	567,873			283,210			11,113			31,374			171,087			66,478			30,926			220,368			78,379			23,809			1,484,617
Total loans	$	568,100		$	283,531		$	11,113		$	31,374		$	171,087		$	66,478		$	30,926		$	220,368		$	78,379		$	23,809		$	1,485,165
Less ALLL	4,683			2,439			110			255			1,230			431			211			1,400			408			281			11,448
Net loans	$	563,417		$	281,092		$	11,003		$	31,119		$	169,857		$	66,047		$	30,715		$	218,968		$	77,971		$	23,528		$	1,473,717

	Acquired – Year Ended December 31, 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	(155		)	(85		)	(6		)	(15		)	6			(19		)	(51		)	(70		)	(20		)	1			(414		)
Charge-offs	—			(10		)	—			—			—			—			—			—			—			(3		)	(13		)
Recoveries	1			11			—			—			—			—			—			4			5			—			21
Net (charge-offs) recoveries	1			1			—			—			—			—			—			4			5			(3		)	8
Ending balance	$	588		$	408		$	11		$	46		$	240		$	79		$	—		$	246		$	64		$	23		$	1,705
As % of ALLL	34		%	24		%	1		%	3		%	14		%	5		%	—		%	14		%	4		%	1		%	100		%
ALLL:
Individually evaluated	$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—		$	—
Collectively evaluated	588			408			11			46			240			79			—			246			64			23			1,705
Ending balance	$	588		$	408		$	11		$	46		$	240		$	79		$	—		$	246		$	64		$	23		$	1,705
Loans:
Individually evaluated	$	2,700		$	1,185		$	—		$	222		$	1,686		$	603		$	—		$	2,750		$	233		$	12		$	9,391
Collectively evaluated	114,120			156,637			24,512			21,848			170,879			13,518			—			134,723			32,716			2,672			671,625
Total loans	$	116,820		$	157,822		$	24,512		$	22,070		$	172,565		$	14,121		$	—		$	137,473		$	32,949		$	2,684		$	681,016
Less ALLL	588			408			11			46			240			79			—			246			64			23			1,705
Net loans	$	116,232		$	157,414		$	24,501		$	22,024		$	172,325		$	14,042		$	—		$	137,227		$	32,885		$	2,661		$	679,311

16

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, 2019			% of Total		December 31, 2018			% of Total
Commercial & industrial	$	2,279		25	%	$	2,816		52	%
Owner-occupied CRE	2,302			25		673			12
AG production	1,251			14		—			—
AG real estate	846			9		164			3
CRE investment	1,111			12		210			4
Construction & land development	—			—		80			1
Residential construction	—			—		1			—
Residential first mortgage	865			9		1,265			23
Residential junior mortgage	576			6		262			5
Retail & other	8			—		—			—
Nonaccrual loans	$	9,238		100	%	$	5,471		100	%
Percent of total loans	0.4		%			0.2		%

	September 30, 2019										December 31, 2018
(in thousands)	Originated Amount			% of Total		Acquired Amount			% of Total		Originated Amount			% of Total		Acquired Amount			% of Total
Commercial & industrial	$	833		16	%	$	1,446		35	%	$	352		25	%	$	2,464		61	%
Owner-occupied CRE	1,792			35		510			12		362			26		311			8
AG production	1,095			22		156			4		—			—		—			—
AG real estate	635			13		211			5		—			—		164			4
CRE investment	—			—		1,111			27		—			—		210			5
Construction & land development	—			—		—			—		—			—		80			2
Residential construction	—			—		—			—		1			—		—			—
Residential first mortgage	458			9		407			10		629			45		636			15
Residential junior mortgage	263			5		313			7		65			4		197			5
Retail & other	—			—		8			—		—			—		—			—
Nonaccrual loans	$	5,076		100	%	$	4,162		100	%	$	1,409		100	%	$	4,062		100	%
Percent of nonaccrual loans	55		%			45		%			26		%			74		%

The following tables present past due loans by portfolio segment.

	September 30, 2019
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	215		$	2,279		$	761,248		$	763,742
Owner-occupied CRE	—			2,302			454,206			456,508
AG production	—			1,251			34,799			36,050
AG real estate	—			846			57,745			58,591
CRE investment	—			1,111			335,331			336,442
Construction & land development	—			—			61,810			61,810
Residential construction	—			—			41,496			41,496
Residential first mortgage	319			865			342,216			343,400
Residential junior mortgage	283			576			115,320			116,179
Retail & other	124			8			28,581			28,713
Total loans	$	941		$	9,238		$	2,232,752		$	2,242,931
Percent of total loans	—		%	0.4		%	99.6		%	100.0		%

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	December 31, 2018
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	—		$	2,816		$	682,104		$	684,920
Owner-occupied CRE	557			673			440,123			441,353
AG production	19			—			35,606			35,625
AG real estate	35			164			53,245			53,444
CRE investment	180			210			343,262			343,652
Construction & land development	—			80			80,519			80,599
Residential construction	—			1			30,925			30,926
Residential first mortgage	758			1,265			355,818			357,841
Residential junior mortgage	12			262			111,054			111,328
Retail & other	10			—			26,483			26,493
Total loans	$	1,571		$	5,471		$	2,159,139		$	2,166,181
Percent of total loans	0.1		%	0.2		%	99.7		%	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, 2019
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	725,484		$	22,299		$	2,076		$	13,883		$	—	$	—	$	763,742
Owner-occupied CRE	428,332			15,110			963			12,103			—		—		456,508
AG production	27,350			4,044			1,669			2,987			—		—		36,050
AG real estate	48,740			4,077			2,344			3,430			—		—		58,591
CRE investment	332,078			2,345			908			1,111			—		—		336,442
Construction & land development	61,794			—			16			—			—		—		61,810
Residential construction	41,496			—			—			—			—		—		41,496
Residential first mortgage	338,627			1,664			1,193			1,916			—		—		343,400
Residential junior mortgage	115,595			—			—			584			—		—		116,179
Retail & other	28,705			—			—			8			—		—		28,713
Total loans	$	2,148,201		$	49,539		$	9,169		$	36,022		$	—	$	—	$	2,242,931
Percent of total	95.8		%	2.2		%	0.4		%	1.6		%	—		—		100.0		%

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	December 31, 2018
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	649,475		$	16,145		$	6,178		$	13,122		$	—	$	—	$	684,920
Owner-occupied CRE	405,198			22,776			6,569			6,810			—		—		441,353
AG production	29,363			3,302			2,351			609			—		—		35,625
AG real estate	46,248			3,246			2,983			967			—		—		53,444
CRE investment	334,080			6,792			—			2,780			—		—		343,652
Construction & land development	75,365			5,138			16			80			—		—		80,599
Residential construction	30,926			—			—			—			—		—		30,926
Residential first mortgage	353,239			1,406			510			2,686			—		—		357,841
Residential junior mortgage	111,037			17			—			274			—		—		111,328
Retail & other	26,493			—			—			—			—		—		26,493
Total loans	$	2,061,424		$	58,822		$	18,607		$	27,328		$	—	$	—	$	2,166,181
Percent of total	95.1		%	2.7		%	0.9		%	1.3		%	—		—		100.0		%

The following tables present impaired loans.

	Total Impaired Loans – September 30, 2019
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	2,143	$	4,271	$	308	$	2,807	$	739
Owner-occupied CRE	2,552		2,930		—		2,742		170
AG production	1,251		1,263		119		1,295		12
AG real estate	1,089		1,091		—		1,098		2
CRE investment	2,483		2,490		—		2,524		8
Construction & land development	427		427		—		480		—
Residential construction	—		—		—		—		—
Residential first mortgage	2,560		2,785		—		2,611		97
Residential junior mortgage	221		231		—		225		2
Retail & other	12		15		—		12		3
Total	$	12,738	$	15,503	$	427	$	13,794	$	1,033
Originated impaired loans	$	4,487	$	4,707	$	427	$	4,649	$	176
Acquired impaired loans	8,251		10,796		—		9,145		857
Total	$	12,738	$	15,503	$	427	$	13,794	$	1,033

	Total Impaired Loans – December 31, 2018
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	2,927	$	6,736	$	—	$	4,041	$	660
Owner-occupied CRE	1,506		1,833		—		1,659		137
AG production	—		—		—		—		—
AG real estate	222		281		—		238		26
CRE investment	1,686		2,484		—		1,606		163
Construction & land development	603		1,506		—		603		21
Residential construction	—		—		—		—		—
Residential first mortgage	2,750		2,907		—		2,478		176
Residential junior mortgage	233		262		—		62		15
Retail & other	12		12		—		12		1
Total	$	9,939	$	16,021	$	—	$	10,699	$	1,199
Originated impaired loans	$	548	$	548	$	—	$	899	$	154
Acquired impaired loans	9,391		15,473		—		9,800		1,045
Total	$	9,939	$	16,021	$	—	$	10,699	$	1,199

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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 nonaccretable mark and a zero accretable mark. At September 30, 2019, $8.3 million of the $43.6 million remain in impaired loans.

Nonaccretable discount on purchased credit impaired loans:	Nine Months Ended						Year Ended
(in thousands)	September 30, 2019			September 30, 2018			December 31, 2018
Balance at beginning of period	$	6,408		$	9,471		$	9,471
Accretion to loan interest income	(3,293		)	(1,872		)	(1,976		)
Transferred to accretable	—			(513		)	(990		)
Disposals of loans	(660		)	(97		)	(97		)
Balance at end of period	$	2,455		$	6,989		$	6,408

Troubled Debt Restructurings

At September 30, 2019, there were five loans classified as troubled debt restructurings with a current outstanding balance of $1.2 million (including performing TDRs of $0.5 million and the remainder on nonaccrual) and pre-modification balance of $1.4 million. In comparison, at December 31, 2018, there were four loans classified as troubled debt restructurings with an outstanding balance of $0.6 million and pre-modification balance of $2.7 million. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the nine months endedSeptember 30, 2019. As of September 30, 2019, 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, 2018 or the nine months endedSeptember 30, 2019. A summary of goodwill and other intangibles was as follows.

	Nine Months Ended		Year Ended
(in thousands)	September 30, 2019		December 31, 2018
Goodwill	$	107,366	$	107,366
Core deposit intangibles	10,006		12,562
Customer list intangibles	3,999		4,379
Other intangibles	14,005		16,941
Goodwill and other intangibles, net	$	121,371	$	124,307

Goodwill: Goodwill was $107.4 million at both September 30, 2019 and December 31, 2018.

Other intangible assets: Other intangible assets, consisting of core deposit intangibles and customer list intangibles, are amortized over their estimated finite lives.

	Nine Months Ended			Year Ended
(in thousands)	September 30, 2019			December 31, 2018
Core deposit intangibles:
Gross carrying amount	$	29,015		$	29,015
Accumulated amortization	(19,009		)	(16,453		)
Net book value	$	10,006		$	12,562
Additions during the period	$	—		$	—
Amortization during the period	$	2,556		$	3,915
Customer list intangibles:
Gross carrying amount	$	5,523		$	5,523
Accumulated amortization	(1,524		)	(1,144		)
Net book value	$	3,999		$	4,379
Additions during the period	$	—		$	290
Amortization during the period	$	380		$	474

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

20

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. A summary of the changes in the mortgage servicing rights asset was as follows.

	Nine Months Ended			Year Ended
(in thousands)	September 30, 2019			December 31, 2018
Mortgage servicing rights ("MSR") asset:
MSR asset at beginning of year	$	3,749		$	3,187
Capitalized MSR	1,807			1,203
Amortization during the period	(611		)	(641		)
MSR asset at end of period	$	4,945		$	3,749
Fair value of MSR asset at end of period	$	6,960		$	6,347
Residential mortgage loans serviced for others	$	721,569		$	603,446
Net book value of MSR asset to loans serviced for others	0.69		%	0.62		%

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans (predominantly loan type and note interest rate). No valuation allowance or impairment charge was recorded for the year ended December 31, 2018 or the nine months endedSeptember 30, 2019. 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 September 30, 2019. 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,
2019 (remaining three months)	$	781	$	127	$	224
2020	2,657		507		879
2021	2,167		507		730
2022	1,735		507		730
2023	1,273		483		658
2024	841		449		400
Thereafter	552		1,419		1,324
Total	$	10,006	$	3,999	$	4,945

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, 2019 or December 31, 2018.

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, 2019			December 31, 2018
FHLB advances	$	15,056		$	35,252
Junior subordinated debentures	30,455			30,096
Subordinated notes	11,984			11,957
Total long-term borrowings	$	57,495		$	77,305
Percent of fixed rate long-term borrowings	58		%	69		%
Percent of floating rate long-term borrowings	42		%	31		%

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 1.95% at September 30, 2019 and 1.72% at December 31, 2018. During third quarter 2019, the Company repaid a $20 million puttable FHLB advance.

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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, 2019 and December 31, 2018, $29.3 million and $28.9 million, respectively, qualify as Tier 1 capital.

		Junior Subordinated Debentures
				9/30/2019			9/30/2019		12/31/18
(in thousands)	Maturity Date	Par		Unamortized Discount			Carrying Value		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		(3,222		)	7,088		6,939
2006 Baylake Corp. (3)	9/30/2036	16,598		(3,942		)	12,656		12,478
2004 First Menasha Bancshares, Inc. (4)	3/17/2034	5,155		(630		)	4,525		4,493
Total		$	38,249	$	(7,794	)	$	30,455	$	30,096

(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 3.55% and 4.22% as of September 30, 2019 and December 31, 2018, 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 3.45% and 4.15% as of September 30, 2019 and December 31, 2018, 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 4.93% and 5.58% as of September 30, 2019 and December 31, 2018, 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.

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.

22

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, 2019
U.S. government agency securities	$	16,490	$	—	$	16,490	$	—
State, county and municipals	147,786		—		147,786		—
Mortgage-backed securities	171,877		—		171,877		—
Corporate debt securities	83,147		—		80,317		2,830
Securities AFS	$	419,300	$	—	$	416,470	$	2,830
Other investments (equity securities)	$	4,080	$	4,080	$	—	$	—
December 31, 2018
U.S. government agency securities	$	21,649	$	—	$	21,649	$	—
State, county and municipals	160,526		—		160,460		66
Mortgage-backed securities	131,644		—		131,644		—
Corporate debt securities	86,325		—		77,901		8,424
Securities AFS	$	400,144	$	—	$	391,654	$	8,490
Other investments (equity securities)	$	2,650	$	2,650	$	—	$	—

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, 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, 2019 and December 31, 2018, 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, 2019			December 31, 2018
Balance at beginning of year	$	8,490		$	9,151
Paydowns/Sales/Settlements	(5,660		)	(661		)
Balance at end of period	$	2,830		$	8,490

Nonrecurring basis fair value measurements:

The following table presents the Company’s assets measured at fair value on a nonrecurring basis, 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, 2019
Impaired loans	$	12,311	$	—	$	—	$	12,311
Other real estate owned (“OREO”)	1,325		—		—		1,325
MSR asset	6,960		—		—		6,960
December 31, 2018
Impaired loans	$	9,939	$	—	$	—	$	9,939
OREO	420		—		—		420
MSR asset	6,347		—		—		6,347

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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, 2019
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	143,969	$	143,969	$	143,969	$	—	$	—
Certificates of deposit in other banks	5,395		5,390		—		5,390		—
Securities AFS	419,300		419,300		—		416,470		2,830
Other investments, including equity securities	20,697		20,697		4,080		13,259		3,358
Loans held for sale	10,564		10,710		—		10,710		—
Loans, net	2,229,311		2,244,410		—		—		2,244,410
BOLI	71,796		71,796		71,796		—		—
MSR asset	4,945		6,960		—		—		6,960
Financial liabilities:
Deposits	$	2,584,447	$	2,584,662	$	—	$	—	$	2,584,662
Long-term borrowings	57,495		56,679		—		15,135		41,544

December 31, 2018
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	249,526	$	249,526	$	249,526	$	—	$	—
Certificates of deposit in other banks	993		993		—		993		—
Securities AFS	400,144		400,144		—		391,654		8,490
Other investments, including equity securities	17,997		17,997		2,650		13,189		2,158
Loans held for sale	1,639		1,662		—		1,662		—
Loans, net	2,153,028		2,139,322		—		—		2,139,322
BOLI	66,310		66,310		66,310		—		—
MSR asset	3,749		6,347		—		—		6,347
Financial liabilities:
Deposits	$	2,614,138	$	2,614,995	$	—	$	—	$	2,614,995
Long-term borrowings	77,305		75,923		—		34,907		41,016

The carrying value of certain assets and liabilities such as cash and cash equivalents, BOLI, 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 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

24

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 noninterest 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 and derivative financial instruments: At September 30, 2019 and December 31, 2018, the estimated fair value of letters of credit, interest rate lock commitments on residential mortgage loans, outstanding mandatory commitments to sell residential mortgage loans into the secondary market, and mirror interest rate swap agreements were not significant.

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 – Operating Leases

As of January 1, 2019, the Company adopted ASU 2016-02 (Topic 842) on a prospective basis using the effective date method. The adoption of the new standard did not have a material impact on Nicolet's financial statements; however, additional disclosures have been added in accordance with the ASU. See Note 1 for additional information on this new accounting standard.

The operating lease ROU asset represents the right to use an underlying asset during the lease term, while the operating lease liability represents the obligation to make lease payments arising from the lease. The ROU asset and lease liability are recognized at lease commencement based on the present value of the remaining lease payments, considering a discount rate that represents Nicolet's incremental borrowing rate. Operating lease expense is recognized on a straight-line basis over the lease term and is recognized in occupancy, equipment, and office on the consolidated statements of income.

Nicolet leases space under non-cancelable operating lease agreements for certain bank and nonbank branch facilities with remaining lease terms of 2 to 7 years. Certain lease arrangements contain extension options which typically range from 5 to 10 years at the then fair market rental rates. The lease asset and liability considers renewal options when they are reasonably certain of being exercised.

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A summary of net lease cost and selected other information related to operating leases was as follows.

	Nine Months Ended
($ in thousands)	September 30, 2019
Net lease cost:
Operating lease cost	$	737
Variable lease cost	179
Net lease cost	$	916
Selected other operating lease information:
Weighted average remaining lease term (years)	5
Weighted average discount rate	2.5		%

The following table summarizes the maturity of remaining lease liabilities.

(in thousands)
Year ending December 31,
2019 (remaining three months)	$	951
2020	1,037
2021	911
2022	851
2023	607
2024	499
Thereafter	16
Total future minimum lease payments	4,872
Less: amount representing interest	(122		)
Present value of net future minimum lease payments	$	4,750

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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, market, political and competitive forces affecting Nicolet’s banking and wealth management businesses;

• changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;

• potential difficulties in integrating the operations of Nicolet with those of Choice following the merger;

• adoption of new accounting standards, including the effects from the adoption of the current expected credit loss ("CECL") model on January 1, 2020, or changes in existing standards;

• 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 analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. 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, 2019 and December 31, 2018 and results of operations for the three and nine-month periods ended September 30, 2019 and 2018. 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, 2018.

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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)	9/30/2019			6/30/2019			3/31/2019			12/31/2018			9/30/2018			9/30/2019			9/30/2018
Results of operations:
Interest income	$	34,667		$	34,570		$	33,159		$	32,327		$	31,880		$	102,396		$	93,210
Interest expense	5,477			5,626			5,684			5,298			4,938			16,787			13,591
Net interest income	29,190			28,944			27,475			27,029			26,942			85,609			79,619
Provision for loan losses	400			300			200			240			340			900			1,360
Net interest income after provision for loan losses	28,790			28,644			27,275			26,789			26,602			84,709			78,259
Noninterest income	12,312			18,560			9,186			9,797			10,649			40,058			29,712
Noninterest expense	22,887			25,727			22,759			21,621			23,044			71,373			68,137
Income before income tax expense	18,215			21,477			13,702			14,965			14,207			53,394			39,834
Income tax expense	4,603			2,833			3,352			4,015			3,268			10,788			9,431
Net income	13,612			18,644			10,350			10,950			10,939			42,606			30,403
Net income attributable to noncontrolling interest	82			95			83			87			80			260			230
Net income attributable to Nicolet Bankshares, Inc.	$	13,530		$	18,549		$	10,267		$	10,863		$	10,859		$	42,346		$	30,173
Earnings per common share:
Basic	$	1.45		$	1.98		$	1.09		$	1.14		$	1.13		$	4.51		$	3.12
Diluted	$	1.40		$	1.91		$	1.05		$	1.11		$	1.09		$	4.36		$	3.02
Common Shares:
Basic weighted average	9,347			9,374			9,461			9,526			9,633			9,394			9,679
Diluted weighted average	9,697			9,692			9,758			9,814			9,949			9,707			10,004
Outstanding (period end)	9,363			9,327			9,431			9,495			9,577			9,363			9,577
Period-End Balances:
Loans	$	2,242,931		$	2,203,273		$	2,189,688		$	2,166,181		$	2,143,457		$	2,242,931		$	2,143,457
Allowance for loan losses	13,620			13,571			13,370			13,153			12,992			13,620			12,992
Securities available-for-sale, at fair value	419,300			403,989			407,693			400,144			410,911			419,300			410,911
Goodwill and other intangibles, net	121,371			122,285			123,254			124,307			125,360			121,371			125,360
Total assets	3,105,671			3,054,813			3,041,091			3,096,535			3,000,902			3,105,671			3,000,902
Deposits	2,584,447			2,536,639			2,538,486			2,614,138			2,522,156			2,584,447			2,522,156
Stockholders’ equity	428,014			411,415			398,767			386,609			377,171			428,014			377,171
Book value per common share	45.71			44.11			42.28			40.72			39.38			45.71			39.38
Tangible book value per common share (2)	32.75			31.00			29.21			27.62			26.29			32.75			26.29
Average Balances:
Loans	$	2,218,307		$	2,189,070		$	2,179,420		$	2,142,870		$	2,134,448		$	2,195,742		$	2,122,280
Interest-earning assets	2,763,997			2,702,357			2,734,936			2,693,752			2,664,316			2,733,870			2,664,081
Goodwill and other intangibles, net	121,895			122,841			123,892			124,930			125,798			122,869			126,741
Total assets	3,094,546			3,022,383			3,047,068			2,996,553			2,971,247			3,054,840			2,971,022
Deposits	2,563,821			2,514,226			2,556,927			2,518,378			2,497,439			2,545,017			2,505,776
Interest-bearing liabilities	1,895,754			1,892,775			1,946,210			1,867,327			1,931,119			1,911,395			1,980,329
Stockholders’ equity	420,864			404,345			391,027			379,846			375,507			405,521			368,867
Financial Ratios: (1)
Return on average assets	1.73		%	2.46		%	1.37		%	1.44		%	1.45		%	1.85		%	1.36		%
Return on average common equity	12.75			18.40			10.65			11.35			11.47			13.96			10.94
Return on average tangible common equity (2)	17.95			26.43			15.59			16.91			17.25			20.03			16.66
Average equity to average assets	13.60			13.38			12.83			12.68			12.64			13.27			12.42
Stockholders' equity to assets	13.78			13.47			13.11			12.49			12.57			13.78			12.57
Tangible common equity to tangible assets (2)	10.28			9.86			9.44			8.83			8.76			10.28			8.76
Net interest margin	4.19			4.28			4.05			3.98			4.02			4.17			3.99
Net loan charge-offs to average loans	0.06			0.02			(0.00		)	0.01			0.04			0.03			0.06
Nonperforming loans to total loans	0.41			0.35			0.40			0.25			0.48			0.41			0.48
Nonperforming assets to total assets	0.34			0.26			0.30			0.19			0.38			0.34			0.38
Efficiency ratio	55.19			64.01			61.91			58.03			61.08			60.27			62.58
Effective tax rate	25.27			13.19			24.46			26.83			23.00			20.20			23.68
Selected Items:
Interest income from resolving PCI loans (rounded)	$	1,800		$	1,300		$	200		$	100		$	300		$	3,300		$	1,900
Tax-equivalent adjustment on net interest income	251			263			272			278			285			786			872
Tax benefit on stock-based compensation	(128		)	(739		)	(144		)	(23		)	—			(1,011		)	(159		)

(1) Income statement-related ratios for partial-year periods are annualized.

(2) The ratios of tangible book value per common share, return on average tangible common equity, and tangible common equity to tangible assets exclude goodwill and other intangibles, net. These financial ratios have been included as they are considered to be critical metrics with which to analyze and evaluate financial condition and capital strength.

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Net income was $42.3 million for the nine months endedSeptember 30, 2019, an increase of $12.2 million or 40% over $30.2 million for the nine months endedSeptember 30, 2018. Earnings per diluted common share was $4.36 for the first nine months of 2019, 44% higher than $3.02 for the comparable 2018 period.

• During second quarter 2019, net income favorably included $5.4 million (or $0.55 of diluted earnings per common share) related to two actions combined, the sale of 80% of Nicolet's equity investment in UFS, LLC, a data processing and e-banking entity ($7.4 million after-tax gain included in noninterest income under asset gains) and retirement-related compensation declared to benefit all employees after that sale ($2.75 million, or $2.0 million after-tax cost, included in noninterest expense under personnel), impacting the 2019 year-to-date and quarter comparisons.

• Net interest income was $85.6 million for the first nine months of 2019, up $6.0 million or 8% over the first nine months of 2018. Interest income grew $9.2 million (overcoming $1.0 million lower aggregate discount income on purchased loans), aided by a slightly higher mix of average interest-earning assets in loans and the elevated rate environment on new, renewed and variable rate loans. Interest expense increased $3.2 million primarily due to rising rates. Net interest margin was 4.17% for the nine months endedSeptember 30, 2019, compared to 3.99% for the nine months endedSeptember 30, 2018. For additional information regarding net interest income, see “Income Statement Analysis — Net Interest Income.”

• Noninterest income was $40.1 million for the first nine months of 2019, up $10.3 million or 35% over the comparable 2018 period, mostly due to the $7.4 million gain on the equity investment sale noted above. Excluding net asset gains, noninterest income was $32.0 million for the first nine months of 2019, up $3.6 million or 12.8% over 2018, predominantly on stellar net mortgage income. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”

• Noninterest expense was $71.4 million, $3.2 million or 5% higher than the first nine months of 2018, mostly due to the retirement-related compensation actions in second quarter 2019 noted above. Personnel costs increased $2.7 million, and non-personnel expenses combined increased $0.6 million or 2% over the comparable 2018 period. For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

• Asset quality remains exceptional. Nonperforming assets were only $10.6 million, representing 0.34% of total assets at September 30, 2019, compared to 0.19% at December 31, 2018 and 0.38% at September 30, 2018. For additional information regarding nonperforming assets, see “Balance Sheet Analysis – Nonperforming Assets.”

• At September 30, 2019, assets were $3.1 billion, up slightly (less than l%) from December 31, 2018, with cash and cash equivalents funding strong loan growth, debt repayments and seasonably lower deposits. Compared to September 30, 2018, assets increased $105 million or 3%, on solid growth in loans and deposits.

• At September 30, 2019, loans were $2.2 billion, 4% higher than December 31, 2018 and 5% higher than September 30, 2018. On average, loans grew $73 million or 3% over the first nine months of 2018. For additional information regarding loans, see “Balance Sheet Analysis — Loans.”

• Total deposits were $2.6 billion at September 30, 2019, a decrease of 1% from December 31, 2018 and 2% higher than September 30, 2018. Year-to-date average deposits were $39 million or 2% higher than the first nine months of 2018. For additional information regarding deposits, see “Balance Sheet Analysis – Deposits.”

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.

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

	For the Nine Months Ended September 30,
	2019						2018
(in thousands)	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,195,742	$	92,650	5.58	%	$	2,122,280	$	84,786	5.28	%
Investment securities:
Taxable	269,663		5,578		2.76	%	255,763		4,503		2.35	%
Tax-exempt (2)	134,166		2,221		2.21	%	151,643		2,467		2.17	%
Other interest-earning assets	134,299		2,733		2.69	%	134,395		2,326		2.29	%
Total non-loan earning assets	538,128		10,532		2.60	%	541,801		9,296		2.28	%
Total interest-earning assets	2,733,870		$	103,182	4.99	%	2,664,081		$	94,082	4.67	%
Other assets, net	320,970						306,941
Total assets	$	3,054,840					$	2,971,022
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	311,438	$	1,136	0.49	%	$	282,606	$	818	0.39	%
Interest-bearing demand	490,661		3,748		1.02	%	545,980		3,361		0.82	%
Money market accounts (“MMA”)	569,850		2,858		0.67	%	650,485		2,897		0.60	%
Core time deposits	397,530		6,070		2.04	%	323,570		3,481		1.44	%
Brokered deposits	64,588		291		0.60	%	99,818		455		0.61	%
Total interest-bearing deposits	1,834,067		14,103		1.03	%	1,902,459		11,012		0.77	%
Other interest-bearing liabilities	77,328		2,684		4.59	%	77,870		2,579		4.38	%
Total interest-bearing liabilities	1,911,395		16,787		1.17	%	1,980,329		13,591		0.92	%
Noninterest-bearing demand	710,950						603,317
Other liabilities	26,974						18,509
Stockholders’ equity	405,521						368,867
Total liabilities and  stockholders’ equity	$	3,054,840					$	2,971,022
Net interest income and rate spread			$	86,395	3.82	%			$	80,491	3.75	%
Tax-equivalent adjustment			$	786					$	872
Net interest margin					4.17	%					3.99	%

(1) Nonaccrual loans and loans held for sale are included in the daily average loan balances outstanding.

(2) The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 21% and adjusted for the disallowance of interest expense.

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

	For the Three Months Ended September 30,
	2019						2018
(in thousands)	Average Balance		Interest		Average Yield/Rate		Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,218,307	$	31,380	5.56	%	$	2,134,448	$	29,045	5.35	%
Investment securities:
Taxable	271,632		1,904		2.80	%	264,733		1,564		2.36	%
Tax-exempt (2)	127,458		708		2.22	%	147,547		809		2.19	%
Other interest-earning assets	146,600		926		2.49	%	117,588		747		2.51	%
Total non-loan earning assets	545,690		3,538		2.58	%	529,868		3,120		2.35	%
Total interest-earning assets	2,763,997		$	34,918	4.97	%	2,664,316		$	32,165	4.75	%
Other assets, net	330,549						306,931
Total assets	$	3,094,546					$	2,971,247
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	323,222	$	384	0.47	%	$	291,811	$	313	0.43	%
Interest-bearing demand	480,395		1,199		0.99	%	536,830		1,191		0.88	%
MMA	571,194		873		0.61	%	594,937		979		0.65	%
Core time deposits	389,033		2,010		2.05	%	348,899		1,472		1.67	%
Brokered deposits	54,661		130		0.94	%	81,441		100		0.49	%
Total interest-bearing deposits	1,818,505		4,596		1.00	%	1,853,918		4,055		0.87	%
Other interest-bearing liabilities	77,249		881		4.48	%	77,201		883		4.49	%
Total interest-bearing liabilities	1,895,754		5,477		1.14	%	1,931,119		4,938		1.01	%
Noninterest-bearing demand	745,316						643,521
Other liabilities	32,612						21,100
Stockholders’ equity	420,864						375,507
Total liabilities and  stockholders’ equity	$	3,094,546					$	2,971,247
Net interest income and rate spread			$	29,441	3.83	%			$	27,227	3.74	%
Tax-equivalent adjustment			$	251					$	285
Net interest margin					4.19	%					4.02	%

(1) Nonaccrual loans and loans held for sale are included in the daily average loan balances outstanding.

(2) The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 21% and adjusted for the disallowance of interest expense.

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

	For the Three Months Ended  September 30, 2019 Compared to September 30, 2018:									For the Nine Months Ended  September 30, 2019 Compared to September 30, 2018:
	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)	$	1,214		$	1,121		$	2,335		$	3,179		$	4,685		$	7,864
Investment securities:
Taxable	91			249			340			568			507			1,075
Tax-exempt (2)	(111		)	10			(101		)	(288		)	42			(246		)
Other interest-earning assets	172			7			179			24			383			407
Total non-loan earning assets	152			266			418			304			932			1,236
Total interest-earning assets	$	1,366		$	1,387		$	2,753		$	3,483		$	5,617		$	9,100
Interest-bearing liabilities
Savings	$	36		$	35		$	71		$	89		$	229		$	318
Interest-bearing demand	(132		)	140			8			(365		)	752			387
MMA	(38		)	(68		)	(106		)	(382		)	343			(39		)
Core time deposits	182			356			538			913			1,676			2,589
Brokered deposits	(41		)	71			30			(158		)	(6		)	(164		)
Total interest-bearing deposits	7			534			541			97			2,994			3,091
Other interest-bearing liabilities	7			(9		)	(2		)	7			98			105
Total interest-bearing liabilities	14			525			539			104			3,092			3,196
Net interest income	$	1,352		$	862		$	2,214		$	3,379		$	2,525		$	5,904

(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% and adjusted for the disallowance of interest expense.

The Federal Reserve raised short-term interest rates by 25 bps in eight moves from fourth quarter 2016 through fourth quarter 2018 (up 200 bps total) to 2.50% at December 31, 2018, then reduced rates by 50 bps total in two moves during third quarter 2019 to 2.00% at September 30, 2019. These changes impacted the rate earned on short-term assets and pressured the cost of shorter-term borrowings, but have not proportionally influenced the rates further out on the yield curve. Hence, 2018 was characterized by rising short-term interest rates and a flattening yield curve, while the first nine months of 2019 had periods of an inverted yield curve and unchanging short-term rates until third quarter.

Tax-equivalent net interest income was $86.4 million for the first nine months of 2019, comprised of net interest income of $85.6 million ($5.9 million or 7% higher than the first nine months of 2018, overcoming $1.0 million lower aggregate discount accretion on purchased loans), and a $0.8 million tax-equivalent adjustment (relatively unchanged between the periods). The $5.9 million increase in tax-equivalent net interest income was due to favorable volumes (which added $3.4 million, with $3.2 million from higher loan volumes) and net favorable rates (which added $2.5 million). The net $2.5 million increase from rates was from interest-earning asset rate changes in the higher interest rate environment (improving net interest income by $5.6 million, of which $4.7 million was from loans, inclusive of the lower aggregate discount accretion), exceeding the rising cost of funds (which cost $3.1 million more, led by interest-bearing deposits and most notably time deposits).

Between the comparable nine-month periods, the interest rate spread increased 7 bps due to an increase in the interest-earning asset yield (up 32 bps to 4.99%, both mostly rate related, as the mix of interest-earning assets and liabilities were similar between the periods), exceeding a rise in the cost of funds (up 25 bps to 1.17%). The contribution from net free funds increased 11 bps, due mostly to the increase in average noninterest-bearing demand deposits (up 18%) and their increased value in the higher rate environment. As a result, the tax-equivalent net interest margin was 4.17% for the first nine months of 2019, up 18 bps compared to 3.99% for the comparable 2018 period.

Average interest-earning assets increased $70 million or 3% to $2.7 billion for the first nine months of 2019, primarily due to strong loan growth. Between the nine-month periods, average loans increased $73 million or 3%, while all other interest-earning assets declined $3.7 million (mainly in lower municipal securities). The mix of average interest-earning assets was relatively unchanged at 80% loans, 15% investments, and 5% other interest-earning assets (mostly cash) for both nine-month periods.

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Tax-equivalent interest income was $103.2 million for the first nine months of 2019, up $9.1 million or 10% over the first nine months of 2018, while the related interest-earning asset yield was 4.99%, up 32 bps over comparable period in 2018. Interest income on loans increased $7.9 million or 9% over the first nine months of 2018, despite $1.0 million lower aggregate discount accretion income between the periods (predominantly attributable to aging discounts on purchased loans, offset partly by higher recovered discount income on resolved purchased credit impaired loans). The 2019 loan yield was 5.58%, up 30 bps over the first nine months of 2018 (which, if excluding the aggregate discount accretion income from both nine-month periods, would have increased 37 bps), as improved yields on new, renewed and variable rate loans in the higher rate environment more than offset the lower aggregate discount income. Between the comparable nine-month periods, interest income on non-loan earning assets combined increased $1.2 million or 13%, while the related yield increased 32 bps to 2.60%, due mostly to the higher rate on cash levels, as well as higher yields on new investments added in the higher rate environment.

Average interest-bearing liabilities were $1.9 billion, a decrease of $69 million or 3% compared to the first nine months of 2018, primarily due to a $68 million or 4% decrease in interest-bearing deposits (roughly half the decline coming from brokered deposits and the remainder from seasonality in the deposit base). With core deposit growth (especially in noninterest-bearing demand deposits and in core time deposits, responding to more favorable rate offerings between the years), brokered deposits have continued to decline. The mix of average interest-bearing liabilities was 93% core deposits, 3% brokered deposits and 4% other funding, compared to 91%, 5% and 4%, respectively, for the first nine months of 2018.

Interest expense was $16.8 million for the first nine months of 2019, up $3.2 million over the first nine months of 2018, and the related cost of funds increased 25 bps to 1.17%, driven predominantly by the cost, mix and volume of deposits. Interest expense on deposits increased $3.1 million from the first nine months of 2018 and the average cost of interest-bearing deposits increased 26 bps to 1.03%, influenced by increases in select deposit rates from general rate pressures of the higher rate environment and the larger proportion of core time deposits. The 2019 cost of savings, interest-bearing demand and money market accounts increased over the first nine months of 2018 by 10 bps, 20 bps and 7 bps, respectively, as product rate changes lagged the incremental rise in the rate environment, and time deposits cost 60 bps more between the nine-month periods commensurate with paying more for a customer's commitment of term in the higher rate environment.

Provision for Loan Losses

Asset quality trends remained strong. The provision for loan losses was $0.9 million for the nine months endedSeptember 30, 2019, compared to $1.4 million for the nine months endedSeptember 30, 2018. The ALLL was $13.6 million (0.61% of loans) at September 30, 2019, compared to $13.2 million (0.61% of loans) at December 31, 2018 and $13.0 million (0.61% of loans) at September 30, 2018.

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.”

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Noninterest Income

Table 4: Noninterest Income

	Three Months Ended September 30,									Nine Months Ended September 30,
(in thousands)	2019		2018		$ Change			% Change		2019		2018		$ Change			% Change
Trust services fee income	$	1,594	$	1,638	$	(44	)	(3	)%	$	4,631	$	4,915	$	(284	)	(6	)%
Brokerage fee income	2,113		1,732		381			22		5,925		5,074		851			17
Mortgage income, net	3,700		1,902		1,798			95		6,962		4,510		2,452			54
Service charges on deposit accounts	1,223		1,247		(24		)	(2	)	3,587		3,637		(50		)	(1	)
Card interchange income	1,735		1,481		254			17		4,815		4,082		733			18
BOLI income	495		1,019		(524		)	(51	)	1,834		1,929		(95		)	(5	)
Other income	1,166		1,484		(318		)	(21	)	4,274		4,243		31			1
Noninterest income without  net gains	12,026		10,503		1,523			15		32,028		28,390		3,638			13
Asset gains (losses), net	286		146		140			N/M		8,030		1,322		6,708			N/M
Total noninterest income	$	12,312	$	10,649	$	1,663		16	%	$	40,058	$	29,712	$	10,346		35	%
Trust services fee income & Brokerage fee income combined	$	3,707	$	3,370	$	337		10	%	$	10,556	$	9,989	$	567		6	%

N/M means not meaningful.

Noninterest income was $40.1 million for the first nine months of 2019, compared to $29.7 million for the comparable period of 2018, an increase of $10.3 million or 35%, mostly due to the $7.4 million gain on the equity investment sale in second quarter 2019 previously noted in the "Overview" section. Noninterest income excluding net asset gains grew $3.6 million or 13% between the comparable nine-month periods, predominantly on stellar net mortgage income.

Trust services fee income and brokerage fee income combined were up $0.6 million or 6%, consistent with the growth in assets under management and including the transfer of some trust accounts into brokerage accounts.

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, fair value marks on the mortgage interest rate lock commitments and forward commitments, offsetting MSR amortization, MSR valuation changes, if any, and to a smaller degree some related income. Net mortgage income increased $2.5 million or 54% between the comparable nine-month periods, predominantly from higher gains on sale (including 38% more volume sold into the secondary market aided by the current refinance boom and better pricing), higher MSR gains (reflective of greater volume and changes in MSR capitalization assumptions in mid-2018), and increased net servicing fees on the growing portfolio of mortgage loans serviced for others, partially offset by unfavorable changes in the fair value of the mortgage-related derivatives. See also "Lending-Related Commitments."

Service charges on deposits accounts were minimally changed at $3.6 million for both nine-month periods. The change in the 2019 deposit base had minimal impact on service charges since most of the deposit growth in 2019 occurred in time deposits and the increase to the earnings credit rate in mid-2018 mostly offset the growth in transaction deposits.

Card interchange income grew $0.7 million or 18% due to higher volume and activity.

BOLI income was down $0.1 million between the comparable nine-month periods, attributable to the difference in BOLI death benefits received in each period (down $0.2 million), partly offset by income on the higher average balances largely from $5 million additional BOLI purchased in 2019.

Other income of $4.3 million for the nine months ended September 30, 2019 was minimally changed (up less than 1%) from the comparable 2018 period as the fee earned on a customer loan interest rate swap in 2019 was substantially offset by lower income from the smaller equity interest in UFS, LLC given the previously noted sale.

The $8.0 million net asset gains in the first nine months of 2019 were comprised primarily of the $7.4 million gain on the equity investment sale in second quarter 2019 and $0.9 million of favorable fair value marks on equity securities, partially offset by losses of $0.3 million on the disposal and write-down of fixed assets, an OREO property, and an other investment. The $1.3 million net asset gains in the first nine months of 2018 were primarily attributable to $0.6 million of net gains on the sale of fixed assets and OREO, and a $0.7 million fair value mark on equity securities.

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Noninterest Expense

Table 5: Noninterest Expense

	Three Months Ended September 30,									Nine Months Ended September 30,
($ in thousands)	2019		2018		Change			% Change		2019		2018		Change			% Change
Personnel	$	12,914	$	12,983	$	(69	)	(1	)%	$	40,809	$	38,149	$	2,660		7	%
Occupancy, equipment and office	3,454		3,660		(206		)	(6	)	10,961		10,901		60			1
Business development and marketing	1,428		1,334		94			7		4,288		4,139		149			4
Data processing	2,515		2,375		140			6		7,220		7,094		126			2
Intangibles amortization	914		1,054		(140		)	(13	)	2,936		3,336		(400		)	(12	)
Other expense	1,662		1,638		24			1		5,159		4,518		641			14
Total noninterest expense	$	22,887	$	23,044	$	(157	)	(1	)%	$	71,373	$	68,137	$	3,236		5	%
Non-personnel expenses	$	9,973	$	10,061	$	(88	)	(1	)%	$	30,564	$	29,988	$	576		2	%
Average full-time equivalent employees	568		567		1			—	%	557		554		3			1	%

Noninterest expense was $71.4 million, an increase of $3.2 million or 5% over the first nine months of 2018. Personnel costs increased $2.7 million, and non-personnel expenses combined increased $0.6 million or 2% over the first nine months of 2018.

Personnel expense was $40.8 million for the first nine months of 2019, an increase of $2.7 million or 7% over the comparable period in 2018. As previously noted in the "Overview" section, $2.75 million of the increase in personnel expense was attributable to retirement-related compensation actions in second quarter 2019, including a discretionary profit sharing contribution of $1.05 million to the 401k plan and a $1.7 million contribution to the nonqualified deferred compensation plan. Consistent with our philosophy of aligning outcomes to customers, shareholders, and employees, the board approved these retirement-related compensation actions to benefit all employees following the recognition of the gain on the equity investment sale as previously noted. Personnel expense was also impacted by merit increases between the periods (though on a minimally changed workforce, with average full-time equivalents up less than 1%), lower equity and cash incentives (mostly timing in nature), and lower health and other benefit costs.

Occupancy, equipment and office expense was $11.0 million for the first nine months of 2019, up $0.1 million or 1% compared to the first nine months of 2018, with 2019 including higher expense for software and technology solutions to drive operational efficiency and product or service enhancements. Both periods also included accelerated depreciation or impairment charges given new branches or branch facility upgrades totaling $0.3 million in 2019 and $0.4 million in 2018.

Business development and marketing expense was $4.3 million, up $0.1 million or 4%, between the comparable nine-month periods, largely due to the timing and extent of donations, marketing campaigns, promotions, and media.

Data processing expense was $7.2 million, up $0.1 million or 2% between the comparable nine-month periods, with volume-based increases in core processing charges partially offset by savings in data communication and ancillary processing charges.

Intangibles amortization decreased $0.4 million between the comparable nine-month periods from declining amortization on the aging intangibles of previous acquisitions. Other expense was $5.2 million, up $0.6 million or 14% between the comparable nine-month periods, due primarily to a fraud loss contingency matter (with $0.5 million recognized in fourth quarter 2018 and $0.6 million recognized in the year-to-date 2019 period).

Income Taxes

Income tax expense was $10.8 million (effective tax rate of 20.2%) for the first nine months of 2019, compared to $9.4 million (effective tax rate of 23.7%) for the comparable period of 2018. The lower effective tax rate was due to the favorable tax treatment of the equity investment sale and the tax benefit on stock-based compensation.

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Income Statement Analysis – Three Months Ended September 30, 2019 versus Three Months Ended September 30, 2018

Net income was $13.5 million for the three months ended September 30, 2019, an increase of $2.7 million or 25% over $10.9 million for the three months ended September 30, 2018. Earnings per diluted common share was $1.40 for third quarter 2019, 28% higher than $1.09 for third quarter 2018. The increase in net income was principally due to $2.2 million higher net interest income, $1.7 million higher noninterest income (led by net mortgage income), and controlled expenses.

Tax-equivalent net interest income was $29.4 million for third quarter 2019, comprised of net interest income of $29.2 million ($2.2 million or 8% over third quarter 2018, driven mostly by positive volume and rate variances), and a tax-equivalent adjustment of $0.3 million (relatively unchanged from third quarter 2018). Tax-equivalent interest income increased $2.8 million between the third quarter periods, with $1.4 million from improved yields across most interest-earning assets though led by loans (with a 22 bps increase in the interest-earning asset yield) and $1.4 million from stronger volumes (led by average loans which grew $84 million or 4% over third quarter 2018). Interest expense increased $0.5 million over third quarter 2018, all due to rising rates (the cost of funds increased 13 bps between the comparable third quarter periods). For additional information regarding average balances and net interest income, see “Income Statement Analysis — Net Interest Income.”

Asset quality remained exceptional. For third quarter 2019, provision for loan losses was $0.4 million (covering $0.4 million of net charge-offs), compared to provision for loan losses of $0.3 million (covering $0.2 million of net charge-offs) for third quarter 2018.

Noninterest income was $12.3 million for third quarter 2019, an increase of $1.7 million or 16% over third quarter 2018, largely due to stellar net mortgage income. Net mortgage income of $3.7 million for third quarter 2019 was up $1.8 million or 95% over third quarter 2018 on higher sales volume (mostly due to the current refinance boom), higher MSR gains and a larger servicing portfolio, partially offset by unfavorable changes in the fair value of the mortgage-related derivatives. Trust services fee income and brokerage fee income combined was up $0.3 million or 10%, consistent with the growth in assets under management and including the transfer of some trust accounts into brokerage accounts. Card interchange income grew $0.3 million or 17% on higher volume and activity, while BOLI income was down $0.5 million due to a death benefit in third quarter 2018. Other income decreased $0.3 million given the smaller equity interest in UFS, LLC in 2019. Net asset gains of $0.3 million for third quarter 2019 and $0.1 million for third quarter 2018 were both attributable to fair value marks on equity securities. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”

Noninterest expense was $22.9 million for third quarter 2019, a decrease of $0.2 million or 1% from third quarter 2018, including a $0.1 million decrease in personnel expense and a $0.1 million decrease in non-personnel expenses. Personnel expense declined due to lower overall benefit costs, partially offset by high salary expense from merit increases between the periods. Non-personnel expenses combined decreased $0.1 million largely due to occupancy, equipment, and office (down $0.2 million or 6%, attributable to accelerated depreciation for branch facility upgrades in third quarter 2018) and intangibles amortization (down $0.1 million from declining amortization on the aging intangibles of previous acquisitions), partially offset by higher data processing (up $0.1 million or 6% on the higher volume of accounts and activity). For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

Income tax expense for third quarter 2019 was $4.6 million, with an effective tax rate of 25.3%, compared to income tax expense of $3.3 million and an effective tax rate of 23.0% for third quarter 2018. The higher income tax expense and effective tax rate for 2019 was due to higher income before taxes, while third quarter 2018 benefited from a BOLI death benefit.

BALANCE SHEET ANALYSIS

At September 30, 2019, assets were $3.1 billion, minimally changed (up 0.3%) from December 31, 2018, including a $77 million (4%) increase in loans (fully attributable to commercial loans), and a $19 million increase in securities AFS (mostly due to fair value changes from an unrealized loss of $8 million at December 31, 2018 to an unrealized gain of $6 million at September 30, 2019, as well as 2019 purchases), substantially offset by a decrease in cash and cash equivalents. Deposits of $2.6 billion and borrowings of $57 million at September 30, 2019, decreased $30 million and $20 million, respectively, from year-end 2018, contributing to the decrease in cash and cash equivalents. Total stockholders’ equity was $428 million, an increase of $41 million from December 31, 2018, with earnings and net fair value investment changes partially offset by stock repurchases.

Compared to September 30, 2018, assets were $3.1 billion, up $105 million or 3%, including a $99 million or 5% increase in loans (fully attributable to strong commercial loan growth). Deposits were $2.6 billion, an increase of $62 million or 2%, largely due to growth in noninterest-bearing demand deposits. Compared to September 30, 2018, stockholders’ equity increased $51 million, primarily due to net income, stock issuances, and net fair value investment changes partially offset by stock repurchases over the year.

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Loans

Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan. The Company concentrates on 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, 2019, 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, 2019				December 31, 2018				September 30, 2018
(in thousands)	Amount		% of Total		Amount		% of Total		Amount		% of Total
Commercial & industrial	$	763,742	34	%	$	684,920	32	%	$	665,754	31	%
Owner-occupied CRE	456,508		20		441,353		20		449,151		21
AG production	36,050		2		35,625		2		35,727		2
Commercial	1,256,300		56		1,161,898		54		1,150,632		54
AG real estate	58,591		3		53,444		2		52,378		2
CRE investment	336,442		15		343,652		16		331,312		16
Construction & land development	61,810		3		80,599		4		86,533		4
Commercial real estate	456,843		21		477,695		22		470,223		22
Commercial-based loans	1,713,143		77		1,639,593		76		1,620,855		76
Residential construction	41,496		2		30,926		1		30,295		1
Residential first mortgage	343,400		15		357,841		17		357,163		17
Residential junior mortgage	116,179		5		111,328		5		109,692		5
Residential real estate	501,075		22		500,095		23		497,150		23
Retail & other	28,713		1		26,493		1		25,452		1
Retail-based loans	529,788		23		526,588		24		522,602		24
Total loans	$	2,242,931	100	%	$	2,166,181	100	%	$	2,143,457	100	%

Broadly, the loan portfolio at September 30, 2019, was 77% commercial-based and 23% 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 $1.7 billion increased $74 million or 4% since December 31, 2018, primarily due to growth in commercial and industrial loans. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and represented 34% of the total portfolio at September 30, 2019.

Residential real estate loans were relatively unchanged from year-end 2018, and represented 22% of total loans at September 30, 2019. Residential first mortgage loans include conventional first-lien home mortgages, while 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, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market with servicing rights retained. Nicolet's mortgage loans are typically of high quality and have historically had low net charge-off rates.

Retail and other loans (up $2 million from year-end 2018) represented approximately 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate.

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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 summarized under “BALANCE SHEET ANALYSIS — Loans.” A detailed discussion of the loan portfolio credit risk can be found in the "Loans" section in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's 2018 Annual Report on Form 10-K. There have been no material changes in the credit risk of the Company's loan portfolio since December 31, 2018. Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and ongoing review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.

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 segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Assessing these numerous factors involves significant judgment; therefore, management considers the ALLL a critical accounting policy.

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 analysis. For determining the appropriateness of the ALLL, management defines 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 are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. The look-back period on which the average historical loss rates are determined is a rolling 20-quarter (5 year) average. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment. Management 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, 2019, the ALLL was $13.6 million compared to $13.2 million at December 31, 2018 and $13.0 million at September 30, 2018. The components of the ALLL are detailed further in Table 7 below. Annualized net charge-offs as a percent of average loans were 0.03% for the first nine months of 2019, compared to 0.06% for the first nine months of 2018 and 0.05% for the entire 2018 year.

The ratio of the ALLL as a percentage of period-end loans was 0.61% at September 30, 2019, unchanged from 0.61% at both December 31, 2018 and September 30, 2018, respectively. 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. Remaining outstanding acquired loans were $592 million (26% of total loans) and $681 million (31% of total loans) at September 30, 2019 and December 31, 2018, respectively. At September 30, 2019, the $13.6 million ALLL was comprised of $1.6 million for acquired loans (0.26% of acquired loans) and $12.1 million for originated loans (0.73% of originated loans). In comparison, at December 31, 2018, the $13.2 million ALLL was comprised of $1.7 million for acquired loans (0.25% of acquired loans) and $11.4 million for originated loans (0.77% of originated loans).

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Table 7: Allowance for Loan Losses

	Nine Months Ended						Year Ended
(in thousands)	September 30, 2019			September 30, 2018			December 31, 2018
Allowance for loan losses:
Balance at beginning of period	$	13,153		$	12,653		$	12,653
Provision for loan losses	900			1,360			1,600
Charge-offs	(629		)	(1,110		)	(1,213		)
Recoveries	196			89			113
Net (charge-offs) recoveries	(433		)	(1,021		)	(1,100		)
Balance at end of period	$	13,620		$	12,992		$	13,153
Net loan (charge-offs) recoveries:
Commercial & industrial	$	31		$	(713	)	$	(770	)
Owner-occupied CRE	(11		)	(52		)	(60		)
AG production	—			—			—
AG real estate	—			—			—
CRE investment	—			(37		)	(37		)
Construction & land development	—			—			—
Residential construction	(226		)	—			—
Residential first mortgage	36			(82		)	(80		)
Residential junior mortgage	(48		)	31			35
Retail & other	(215		)	(168		)	(188		)
Total net (charge-offs) recoveries	$	(433	)	$	(1,021	)	$	(1,100	)
Ratios:
ALLL to total loans	0.61		%	0.61		%	0.61		%
Net charge-offs to average loans, annualized	0.03		%	0.06		%	0.05		%

Nonperforming Assets

As part of its overall credit risk management process, management is committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized. 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 were $9.2 million (consisting of $5.1 million originated loans and $4.2 million acquired loans) at September 30, 2019 compared to $5.5 million at December 31, 2018 (consisting of $1.4 million originated loans and $4.1 million acquired loans). Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $10.6 million at September 30, 2019 compared to $5.9 million at December 31, 2018. OREO was $1.3 million at September 30, 2019 and $0.4 million at December 31, 2018. Nonperforming assets as a percent of total assets were 0.34% at September 30, 2019 compared to 0.19% at December 31, 2018.

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 $26.8 million (1.2% of loans) and $21.9 million (1.0% of loans) at September 30, 2019 and December 31, 2018, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the

39

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, 2019			December 31, 2018			September 30, 2018
Nonperforming loans:
Commercial & industrial	$	2,279		$	2,816		$	5,803
Owner-occupied CRE	2,302			673			474
AG production	1,251			—			—
AG real estate	846			164			175
CRE investment	1,111			210			1,381
Construction & land development	—			80			80
Residential construction	—			1			28
Residential first mortgage	865			1,265			1,973
Residential junior mortgage	576			262			268
Retail & other	8			—			—
Total nonaccrual loans	9,238			5,471			10,182
Accruing loans past due 90 days or more	—			—			—
Total nonperforming loans	$	9,238		$	5,471		$	10,182
OREO:
Commercial real estate owned	$	525		$	420		$	505
Residential real estate owned	—			—			51
Bank property real estate owned	800			—			725
Total OREO	1,325			420			1,281
Total nonperforming assets	$	10,563		$	5,891		$	11,463
Performing troubled debt restructurings	$	459		$	—		$	—
Ratios:
Nonperforming loans to total loans	0.41		%	0.25		%	0.48		%
Nonperforming assets to total loans plus OREO	0.47		%	0.27		%	0.53		%
Nonperforming assets to total assets	0.34		%	0.19		%	0.38		%
ALLL to nonperforming loans	147.4		%	240.4		%	127.6		%

Deposits

Deposits represent Nicolet’s largest source of funds. The deposit composition is presented in Table 9 below.

Total deposits were $2.6 billion at September 30, 2019, $30 million or 1% lower than December 31, 2018, reflecting the usual cyclical decline. Notably, the decrease in total deposits since year-end 2018 was largely due to money market and interest-bearing demand combined (down $84 million or 7%), partially offset by growth in savings and noninterest-bearing demand accounts.

Compared to September 30, 2018, total deposits were up $62 million or 2%. Notably, the increase in total deposits since September 30, 2018 was largely due to noninterest-bearing demand accounts (up $118 million or 18%) and growth in savings accounts, partially offset by reductions in money market and interest-bearing demand (down $96 million or 8%).

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Table 9: Period End Deposit Composition

	September 30, 2019				December 31, 2018				September 30, 2018
(in thousands)	Amount		% of Total		Amount		% of Total		Amount		% of Total
Noninterest-bearing demand	$	782,968	30	%	$	753,065	29	%	$	664,788	26	%
Money market and interest-bearing demand	1,079,233		42	%	1,163,369		45	%	1,174,912		47	%
Savings	329,122		13	%	294,068		11	%	291,058		12	%
Time	393,124		15	%	403,636		15	%	391,398		15	%
Total deposits	$	2,584,447	100	%	$	2,614,138	100	%	$	2,522,156	100	%
Brokered transaction accounts	$	38,078	1	%	$	62,021	2	%	$	45,894	2	%
Brokered time deposits	15,450		1	%	19,130		1	%	31,056		1	%
Total brokered deposits	$	53,528	2	%	$	81,151	3	%	$	76,950	3	%
Customer transaction accounts	$	2,153,245	83	%	$	2,148,481	82	%	$	2,084,864	83	%
Customer time deposits	377,674		15	%	384,506		15	%	360,342		14	%
Total customer deposits (core)	$	2,530,919	98	%	$	2,532,987	97	%	$	2,445,206	97	%

Lending-Related Commitments

As of September 30, 2019 and December 31, 2018, Nicolet had the following off-balance sheet lending-related commitments.

Table 10: Commitments

(in thousands)	September 30, 2019		December 31, 2018
Commitments to extend credit	$	718,772	$	721,098
Financial standby letters of credit	10,791		8,571
Performance standby letters of credit	9,344		7,094

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 $100.1 million and $47.9 million, respectively, at September 30, 2019. In comparison, interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans held for sale represented $18.2 million and $6.0 million, respectively, at December 31, 2018. The net fair value of these interest rate lock commitments and forward commitments combined was a loss of $451,000 at September 30, 2019 compared to a gain of $162,000 at December 31, 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 service debt, invest in subsidiaries, repurchase common stock, pay dividends to shareholders (if any), 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 or other wholesale funding. All securities AFS and equity securities (included in other investments) are reported at fair value on the consolidated balance sheet. At September 30, 2019, approximately 32% of the $419 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, 2019, consist of a $10 million available and unused line of credit at the holding company, $175 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $185 million, and borrowing capacity in the brokered deposit market.

Cash and cash equivalents at September 30, 2019 and December 31, 2018 were $144 million and $250 million, respectively. The decrease in cash and cash equivalents since year-end 2018 was largely attributable to loan growth, a reduction in deposits, and common stock purchases, partially offset by earnings. Nicolet’s liquidity resources were sufficient as of September 30, 2019 to fund loans, accommodate deposit cycles and trends, and to meet other cash needs as necessary.

Management is committed to the parent Company being a source of strength to the Bank and its other subsidiaries, and therefore, regularly evaluates capital and liquidity positions of the parent Company in light of current and projected needs, growth or strategies. The parent Company uses cash for normal expenses, debt service requirements, and when opportune, for common stock repurchases or investment in other strategic actions such as mergers or acquisitions. Dividends from the Bank and, to a lesser extent, stock

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option exercises, represent significant sources of cash flows for the parent Company. 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, 2019, the parent Company had $62 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, 2019 and December 31, 2018, the projected changes in net interest income over a one-year time horizon, versus the baseline, are presented in Table 11 below. 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, 2019		December 31, 2018
200 bps decrease in interest rates	(2.3	)%	(0.6	)%
100 bps decrease in interest rates	(1.2	)%	—	%
100 bps increase in interest rates	1.0	%	(0.1	)%
200 bps increase in interest rates	2.1	%	—	%

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 shareholder return.

Nicolet’s intent is to maintain capital levels for the Company and the Bank at amounts in excess of the regulatory well-capitalized thresholds. At September 30, 2019, 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

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in strategic growth. A summary of Nicolet’s and the Bank’s regulatory capital amounts and ratios, as well as selected capital metrics are presented in the following table.

Table 12: Capital

	At or for the Nine Months Ended			At or for the Year Ended
($ in thousands)	September 30, 2019			December 31, 2018
Company Stock Repurchases: *
Common stock repurchased during the period (dollars)	$	15,318		$	22,178
Common stock repurchased during the period (full shares)	263,053			408,071
Company Risk-Based Capital:
Total risk-based capital	$	360,697		$	326,235
Tier 1 risk-based capital	335,093			301,125
Common equity Tier 1 capital	305,058			271,435
Total capital ratio	13.5		%	12.9		%
Tier 1 capital ratio	12.6		%	11.9		%
Common equity tier 1 capital ratio	11.4		%	10.7		%
Tier 1 leverage ratio	11.3		%	10.4		%
Bank Risk-Based Capital:
Total risk-based capital	$	288,080		$	274,492
Tier 1 risk-based capital	274,460			261,339
Common equity Tier 1 capital	274,460			261,339
Total capital ratio	10.8		%	10.8		%
Tier 1 capital ratio	10.3		%	10.3		%
Common equity tier 1 capital ratio	10.3		%	10.3		%
Tier 1 leverage ratio	9.2		%	9.1		%
* Reflects common stock repurchased under board of director authorizations for the common stock repurchase program.

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 2019, $15.3 million was utilized to repurchase and cancel 263,053 shares of common stock pursuant to our common stock repurchase program. At September 30, 2019, there remained $24.4 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 2018 Annual Report on Form 10-K. There have been no changes in the Company’s application of critical accounting policies since December 31, 2018.

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 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

43

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 is 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, and continues to make progress on implementing the new standard. Based on our analysis, we believe the standard may potentially have a material impact on the financial statements and we expect more volatility in the credit loss estimate over economic cycles. Nicolet estimates a 40-60% increase to its aggregate reserve levels upon adoption of the current expected credit losses standard on January 1, 2020; however, this estimate is based on current economic conditions, forecasts and our existing loan portfolio at September 30, 2019, and the estimate is likely to change between now and adoption. The Company has been running parallel assessments since the beginning of 2019, which includes expanding the loan segmentation from our current ten categories to better evaluate loans with similar loss characteristics and probabilities over the life of the loan. Results of various assumptions have been monitored and refined over the past two years toward a final adoption method.

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, 2018.

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

Following are Nicolet’s monthly common stock purchases during the third quarter of 2019.

	Total Number of Shares Purchased (a)	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 (b)
	(#)	($)		(#)	(#)
Period
July 1 – July 31, 2019	5,057	$	63.98	1,853	604,100
August 1 – August 31, 2019	7,447	$	61.99	7,447	596,700
September 1 – September 30, 2019	2,267	$	67.81	—	596,700
Total	14,771	$	63.57	9,300	596,700

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(a) During third quarter 2019, the Company repurchased 84 common shares for minimum tax withholding settlements on restricted stock and repurchased 5,387 common shares to satisfy the exercise price and / or tax withholding requirements of stock options, respectively. These purchases do not count against the maximum number of shares that may yet be purchased under the board of directors' authorization.

(b) During third quarter 2019, Nicolet utilized $0.6 million to repurchase and cancel approximately 9,300 shares of common stock pursuant to our common stock repurchase program. At September 30, 2019, approximately $24.4 million remained available under this common stock repurchase program.

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
2.1	Agreement and Plan of Merger Between Nicolet Bankshares, Inc. and Choice Bancorp, Inc. dated June 26, 2019(1)
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, 2019, formatted in eXtensible Business Reporting Language: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Unaudited Consolidated Financial Statements.

(1) Incorporated by reference to Exhibit 2.1 in the Registrant's Current Report on Form 8-K, filed on June 27, 2019.

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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.
October 31, 2019	/s/ Robert B. Atwell
	Robert B. Atwell
	Chairman, President and Chief Executive Officer
October 31, 2019	/s/ Ann K. Lawson
	Ann K. Lawson
	Chief Financial Officer

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