NICOLET BANKSHARES INC - Quarter Report: 2014 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2014

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

For the transition period from_________to__________

Commission file number 333-90052

NICOLET BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

WISCONSIN (State or other jurisdiction of incorporation or organization)	47-0871001 (I.R.S. Employer Identification No.)

111 North Washington Street Green Bay, Wisconsin 54301 (920) 430-1400 (Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company S

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

As of October 31, 2014 there were 4,103,573 shares of $0.01 par value common stock outstanding.

Nicolet Bankshares, Inc.

TABLE OF CONTENTS


PART I	FINANCIAL INFORMATION		PAGE

	Item 1.	Financial Statements:

		Consolidated Balance Sheets September 30, 2014 (unaudited) and December 31, 2013	3

		Consolidated Statements of Income Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited)	4

		Consolidated Statements of Comprehensive Income Three Months and Nine Months Ended September 30, 2014 and 2013 (unaudited)	5

		Consolidated Statement of Changes in Stockholders’ Equity Nine Months Ended September 30, 2014 (unaudited)	6

		Consolidated Statements of Cash Flows Nine Months Ended September 30, 2014 and 2013 (unaudited)	7

		Notes to Unaudited Consolidated Financial Statements	8-26

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27-51

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	52

	Item 4.	Controls and Procedures	52

PART II	OTHER INFORMATION

	Item 1.	Legal Proceedings	52

	Item 1A.	Risk Factors	52

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52

	Item 3.	Defaults Upon Senior Securities	52

	Item 4.	Mine Safety Disclosures	52

	Item 5.	Other Information	52

	Item 6.	Exhibits	53

		Signatures	53-57

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share data)

	September 30, 2014 (Unaudited)			December 31, 2013 (Audited)
Assets
Cash and due from banks	$	30,168		$	26,556
Interest-earning deposits		36,631			119,364
Federal funds sold		421			1,058
Cash and cash equivalents		67,220			146,978
Certificates of deposit in other banks		8,638			1,960
Securities available for sale (“AFS”)		150,649			127,515
Other investments		8,056			7,982
Loans held for sale		2,570			1,486
Loans		865,085			847,358
Allowance for loan losses		(10,052	)		(9,232	)
Loans, net		855,033			838,126
Premises and equipment, net		31,378			29,845
Bank owned life insurance		27,230			23,796
Accrued interest receivable and other assets		18,846			21,115
Total assets	$	1,169,620		$	1,198,803
Liabilities and Stockholders’ Equity
Liabilities:
Demand	$	195,048		$	171,321
Money market and NOW accounts		445,069			492,499
Savings		119,901			97,601
Time		251,491			273,413
Total deposits		1,011,509			1,034,834
Short-term borrowings		-			7,116
Notes payable		22,238			32,422
Junior subordinated debentures		12,278			12,128
Accrued interest payable and other liabilities		13,886			7,424
Total liabilities		1,059,911			1,093,924

Stockholders’ Equity:
Preferred equity		24,400			24,400
Common stock		41			42
Additional paid-in capital		46,683			49,616
Retained earnings		37,488			30,138
Accumulated other comprehensive income (“AOCI”)		1,064			666
Total Nicolet Bankshares, Inc. stockholders’ equity		109,676			104,862
Noncontrolling interest		33			17
Total stockholders’ equity and noncontrolling interest		109,709			104,879
Total liabilities, noncontrolling interest and stockholders’ equity	$	1,169,620		$	1,198,803
Preferred shares authorized (no par value)		10,000,000			10,000,000
Preferred shares issued		24,400			24,400
Common shares authorized (par value $0.01 per share)		30,000,000			30,000,000
Common shares outstanding		4,097,801			4,241,044
Common shares issued		4,147,245			4,303,407

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

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

	Three Months Ended September 30,					Nine Months Ended September 30,
	2014		2013			2014		2013
Interest income:
Loans, including loan fees	$	11,945	$	12,856		$	34,568	$	29,465
Investment securities:
Taxable		379		309			1,212		714
Non-taxable		208		195			551		555
Other interest income		91		77			354		222
Total interest income		12,623		13,437			36,685		30,956
Interest expense:
Money market and NOW accounts		544		525			1,709		1,502
Savings and time deposits		790		618			2,271		1,667
Short-term borrowings		2		11			9		18
Junior subordinated debentures		220		221			655		510
Notes payable		174		259			672		886
Total interest expense		1,730		1,634			5,316		4,583
Net interest income		10,893		11,803			31,369		26,373
Provision for loan losses		675		1,975			2,025		3,925
Net interest income after provision for loan losses		10,218		9,828			29,344		22,448
Noninterest income:
Service charges on deposit accounts		564		510			1,602		1,264
Trust services fee income		1,179		1,060			3,403		2,936
Mortgage income		505		353			1,151		1,939
Brokerage fee income		152		114			478		331
Bank owned life insurance		250		224			684		605
Rent income		292		204			880		728
Investment advisory fees		104		82			316		244
Gain on sale or writedown of assets, net		140		1,333			448		1,382
Bargain purchase gain		-		1,480			-		11,915
Other		459		382			1,323		920
Total noninterest income		3,645		5,742			10,285		22,264
Noninterest expense:
Salaries and employee benefits		5,366		5,333			16,045		14,447
Occupancy, equipment and office		1,735		1,822			5,370		4,392
Business development and marketing		548		573			1,620		1,471
Data processing		816		724			2,345		1,719
FDIC assessments		160		240			547		480
Core deposit intangible amortization		284		342			934		776
Other		614		1,190			1,734		2,865
Total noninterest expense		9,523		10,224			28,595		26,150

Income before income tax expense		4,340		5,346			11,034		18,562
Income tax expense		1,552		2,421			3,425		3,387
Net income		2,788		2,925			7,609		15,175
Less: net income (loss) attributable to noncontrolling interest		23		(22	)		76		16
Net income attributable to Nicolet Bankshares, Inc.		2,765		2,947			7,533		15,159
Less: preferred stock dividends		61		305			183		915
Net income available to common shareholders	$	2,704	$	2,642		$	7,350	$	14,244

Basic earnings per common share	$	0.66	$	0.62		$	1.75	$	3.66
Diluted earnings per common share	$	0.63	$	0.62		$	1.70	$	3.65
Weighted average common shares outstanding:
Basic		4,118,792		4,228,386			4,190,830		3,889,751
Diluted		4,319,975		4,238,009			4,313,298		3,900,289

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Net income	$	2,788		$	2,925		$	7,609		$	15,175
Other comprehensive income (loss), net of tax:
Securities available for sale:
Net unrealized holding gains (losses) arising during the period		(51	)		(475	)		994			(1,604	)
Less: reclassification adjustment for net gains realized in net income		-			(442	)		(341	)		(203	)
Net unrealized gains (losses) on securities before tax expense		(51	)		(917	)		653			(1,807	)
Income tax (expense) benefit		19			357			(255	)		704

Total other comprehensive income (loss)		(32	)		(560	)		398			(1,103	)

Comprehensive income	$	2,756		$	2,365		$	8,007		$	14,072

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

(In thousands) (Unaudited)

	Nicolet Bankshares, Inc. Stockholders’ Equity
	Preferred Equity		Common Stock			Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income		Noncontrolling Interest			Total
Balance December 31, 2013	$	24,400	$	42		$	49,616		$	30,138		$	666	$	17		$	104,879
Comprehensive income:
Net income		-		-			-			7,533			-		76			7,609
Other comprehensive income		-		-			-			-			398		-			398
Stock compensation expense		-		-			459			-			-		-			459
Exercise of stock options		-		-			380			-			-		-			380
Issuance of common stock		-		-			225			-			-		-			225
Purchase and retirement of common stock		-		(1	)		(3,997	)		-			-		-			(3,998	)
Preferred stock dividends		-		-			-			(183	)		-		-			(183	)
Repayment from noncontrolling interest		-		-			-			-			-		(60	)		(60	)
Balance, September 30, 2014	$	24,400	$	41		$	46,683		$	37,488		$	1,064	$	33		$	109,709

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)


	Nine Months Ended September 30,
	2014			2013
Cash Flows From Operating Activities:
Net income	$	7,609		$	15,175
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		2,793			3,149
Provision for loan losses		2,025			3,925
Increase in cash surrender value of life insurance		(684	)		(605	)
Stock compensation expense		459			480
Gain on sale or writedown of assets, net		(448	)		(1,382	)
Gain on sale of loans held for sale, net		(1,151	)		(1,939	)
Proceeds from sale of loans held for sale		55,652			120,246
Origination of loans held for sale		(55,585	)		(114,317	)
Bargain purchase gain		-			(11,915	)
Net change in:
Accrued interest receivable and other assets		295			2,585
Accrued interest payable and other liabilities		(639	)		(31	)
Net cash provided by operating activities		10,326			15,371
Cash Flows From Investing Activities:
Net increase in certificates of deposit in other banks		(6,678	)		-
Net increase in loans		(19,175	)		(39,992	)
Purchases of securities AFS		(33,650	)		(9,608	)
Proceeds from sales of securities AFS		4,821			44,833
Proceeds from calls and maturities of securities AFS		12,387			14,485
Purchase of other investments		(74	)		(797	)
Purchase of premises and equipment		(4,112	)		(2,115	)
Proceeds from sales of premises and equipment		10			15
Proceeds from sales of other real estate and other assets		3,268			2,887
Purchase of bank owned life insurance		(2,750	)		-
Net cash received in business combination		-			37,622
Net cash provided (used) by investing activities		(45,953	)		47,330
Cash Flows From Financing Activities:
Net decrease in deposits		(23,195	)		(43,780	)
Net change in short-term borrowings		(7,116	)		(12,447	)
Proceeds from notes payable		-			5,000
Repayments of notes payable		(10,184	)		(45,867	)
Purchase and retirement of common stock		(3,998	)		(63	)
Stock issuance costs		-			(401	)
Proceeds from issuance of common stock, net		225			3,123
Proceeds from exercise of common stock options		380			206
Noncontrolling interest in joint venture		(60	)		(60	)
Cash dividends paid on preferred stock		(183	)		(915	)
Net cash used by financing activities		(44,131	)		(95,204	)
Net decrease in cash and cash equivalents		(79,758	)		(32,503	)
Cash and cash equivalents:
Beginning	$	146,978		$	82,003
Ending	$	67,220		$	49,500
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	5,562		$	4,759
Cash paid for taxes		3,535			2,013
Transfer of loans and bank premises to other real estate owned		1,291			3,097
Acquisitions:
Fair value of assets acquired		-			483,446
Fair value of liabilities assumed		-			462,269
Net assets acquired		-			21,177

See accompanying notes to unaudited consolidated financial statements.

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

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

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

Critical Accounting Policies and Estimates

Preparation of 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, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the assessment of deferred tax assets and liabilities, and the valuation of loans acquired in the 2013 acquisitions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking regulations, and changes to deferred tax estimates within the first twelve months after acquisition as allowed by purchase accounting guidelines. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.

There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Recent Accounting Developments Adopted

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

Note 2 – Acquisitions

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

Note 2 – Acquisitions, continued

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

The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition is consistent with its growth plans to build a community bank of sufficient size to flourish in various economic environments, serve its expanded customer base with a wide variety of products and services, and effectively and efficiently meet growing regulatory compliance and capital requirements. The Company believes it is well-positioned to achieve stronger financial performance and enhance shareholder value through synergies of the combined operations.

Pursuant to the terms of the Merger Agreement, the outstanding shares of Mid-Wisconsin common stock, other than dissenting shares as defined in the merger agreement, were converted into the right to receive 0.3727 shares of Company common stock (and in lieu of any fractional share of Company common stock, $16.50 in cash) per share of Mid-Wisconsin common stock or, for record holders of 200 or fewer shares of Mid-Wisconsin common stock, $6.15 in cash per share of Mid-Wisconsin common stock. As a result, the total value of the consideration to Mid-Wisconsin shareholders was $10.2 million, consisting of $0.5 million in cash and 589,159 shares of the Company’s common stock. The Company’s common stock was valued at $16.50 per share, which was the value assigned in the merger agreement and considered to be the fair value of the stock on the date of the acquisition. Concurrently with the merger, the Company also closed a private placement of 174,016 shares of its common stock at an offering price of $16.50 per share, for an aggregate of $2.9 million in proceeds. Approximately $0.4 million in direct stock issuance costs for the merger and private placement were incurred and charged against additional paid in capital. Also as a condition of the merger, Mid-Wisconsin redeemed by the closing of the merger its preferred stock (issued to the Department of U.S. Treasury (“UST”) as part of its participation in the federal government’s Capital Purchase Program (“CPP”) with par value of $10.5 million) plus all accrued and unpaid dividends thereon.

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

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

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

	Nine Months Ended September 30, 2013
(in thousands)
Total revenues, net of interest expense	$	46,538
Net income		13,347

Note 3 – Earnings per Common Share

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2014		2013		2014		2013
(In thousands except per share data)
Net income, net of noncontrolling interest	$	2,765	$	2,947	$	7,533	$	15,159
Less: preferred stock dividends		61		305		183		915
Net income available to common shareholders	$	2,704	$	2,642	$	7,350	$	14,244
Weighted average common shares outstanding		4,119		4,228		4,191		3,890
Effect of dilutive stock instruments		201		10		122		10
Diluted weighted average common shares outstanding		4,320		4,238		4,313		3,900
Basic earnings per common share*	$	0.66	$	0.62	$	1.75	$	3.66
Diluted earnings per common share*	$	0.63	$	0.62	$	1.70	$	3.65

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

Options to purchase approximately 0.4 million and 0.5 million shares were outstanding at September 30, 2014 and 2013, respectively, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

Note 4 – Stock-based Compensation

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

Stock Options	Weighted- Average Fair Value of Options Granted		Option Shares Outstanding			Weighted- Average Exercise Price		Exercisable Shares
Balance – December 31, 2012				825,532		$	17.70		548,623
Granted		-		-			-
Exercise of stock options				(23,625	)		12.96
Forfeited				(8,750	)		15.78
Balance – December 31, 2013				793,157			17.86		600,846
Granted		-		-			-
Exercise of stock options				(23,715	)		16.04
Forfeited				(6,750	)		16.80
Balance – September 30, 2014				762,692		$	17.92		607,743

Note 4 – Stock-based Compensation, continued

Options outstanding at September 30, 2014 are exercisable at option prices ranging from $16.50 to $26.00. There are 323,118 options outstanding in the range from $16.50 - $17.00, 393,574 options outstanding in the range from $17.01 - $22.00, and 46,000 options outstanding in the range from $22.01 - $26.00. At September 30, 2014, the exercisable options have a weighted average remaining contractual life of approximately 3 years and a weighted average exercise price of $18.24.

Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The total intrinsic value of options exercised in the first nine months of 2014, and full year of 2013 was approximately $66,000, and $80,000, respectively.

Restricted Stock	Weighted- Average Grant Date Fair Value		Restricted Shares Outstanding
Balance – December 31, 2012	$	16.50		54,475
Granted		16.51		26,506
Vested*		16.50		(18,258	)
Forfeited		16.50		(360	)
Balance – December 31, 2013		16.50		62,363
Granted		-		-
Vested *		16.50		(12,919	)
Forfeited		-		-
Balance – September 30, 2014	$	16.50		49,444

*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly 2,519 shares were surrendered during the nine months ended September 30, 2014 and 5,606 shares were surrendered during the twelve months ended December 31, 2013.

The Company recognized approximately $459,000 and $480,000 of stock-based employee compensation expense during the nine months ended September 30, 2014 and 2013, respectively, associated with its stock equity awards. As of September 30, 2014, there was approximately $1.1 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the weighted average remaining vesting period of approximately four years.

Note 5- Securities Available for Sale

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

	September 30, 2014
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government sponsored enterprises	$	1,027	$	4	$	2	$	1,029
State, county and municipals		82,429		1,033		274		83,188
Mortgage-backed securities		64,206		581		718		64,069
Corporate debt securities		220		-		-		220
Equity securities		1,022		1,121		-		2,143
	$	148,904	$	2,739	$	994	$	150,649

	December 31, 2013
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Values
U.S. government sponsored enterprises	$	2,062	$	3	$	8	$	2,057
State, county and municipals		54,594		1,058		613		55,039
Mortgage-backed securities		68,642		585		1,348		67,879
Corporate debt securities		220		-		-		220
Equity securities		905		1,415		-		2,320
	$	126,423	$	3,061	$	1,969	$	127,515

Note 5- Securities Available for Sale, continued

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

	September 30, 2014
	Less than 12 months				12 months or more				Total
(in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. government sponsored enterprises	$	142	$	2	$	-	$	-	$	142	$	2
State, county and municipals		16,698		49		10,644		225		27,342		274
Mortgage-backed securities		3,082		12		26,912		706		29,994		718
	$	19,922	$	63	$	37,556	$	931	$	57,478	$	994

	December 31, 2013
	Less than 12 months				12 months or more				Total
(in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. government sponsored enterprises	$	511	$	8	$	-	$	-	$	511	$	8
State, county and municipals		17,697		613		-		-		17,697		613
Mortgage-backed securities		36,687		1,240		2,920		108		39,607		1,348
	$	54,895	$	1,861	$	2,920	$	108	$	57,815	$	1,969

At September 30, 2014 we had $1 million of gross unrealized losses related to 96 securities. As of September 30, 2014, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired. The unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the nine-month period ending September 30, 2014 or the year ended December 31, 2013.

The amortized cost and fair values of securities available for sale at September 30, 2014 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair values of securities are estimated based on financial models or prices paid for the same or similar securities. It is possible interest rates could change considerably, resulting in a material change in estimated fair value.

	September 30, 2014
(in thousands)	Amortized Cost		Fair Value
Due in less than one year	$	4,522	$	4,555
Due in one year through five years		69,728		70,482
Due after five years through ten years		8,642		8,607
Due after ten years		784		793
		83,676		84,437
Mortgage-backed securities		64,206		64,069
Equity securities		1,022		2,143
Securities available for sale	$	148,904	$	150,649

Proceeds from sales of securities available for sale during the first nine months of 2014 and 2013 were approximately $4.8 million and $44.8 million, respectively. Gross gains of approximately $0.3 million and $0.5 million were realized on sales of securities during the first nine months of 2014 and 2013, respectively. There were no losses recognized during the first nine months of 2014 and gross losses of $0.3 million were recognized during the first nine months of 2013.

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

The loan composition as of September 30, 2014 and December 31, 2013 is summarized as follows.

	Total
	September 30, 2014						December 31, 2013
(in thousands)	Amount			% of Total			Amount			% of Total
Commercial & industrial	$	282,357			32.6	%	$	253,674			29.9	%
Owner-occupied commercial real estate (“CRE”)		179,166			20.7			187,476			22.1
Agricultural (“AG”) production		14,632			1.7			14,256			1.7
AG real estate		42,195			4.9			37,057			4.4
CRE investment		77,067			8.9			90,295			10.7
Construction & land development		42,462			4.9			42,881			5.1
Residential construction		11,260			1.3			12,535			1.5
Residential first mortgage		157,730			18.2			154,403			18.2
Residential junior mortgage		52,523			6.1			49,363			5.8
Retail & other		5,693			0.7			5,418			0.6
Loans		865,085			100.0	%		847,358			100.0	%
Less allowance for loan losses		10,052						9,232
Loans, net	$	855,033					$	838,126
Allowance for loan losses to loans		1.16	%					1.09	%

	Originated
	September 30, 2014					December 31, 2013
(in thousands)	Amount		% of Total			Amount		% of Total
Commercial & industrial	$	259,705		38.6	%	$	227,572		36.5	%
Owner-occupied CRE		131,321		19.5			127,759		20.5
AG production		4,882		0.7			3,230		0.5
AG real estate		19,134		2.8			13,596		2.2
CRE investment		50,004		7.4			60,390		9.7
Construction & land development		31,941		4.7			30,277		4.9
Residential construction		11,260		1.7			12,475		2.0
Residential first mortgage		116,279		17.3			104,180		16.7
Residential junior mortgage		43,923		6.5			39,207		6.3
Retail & other		5,107		0.8			4,192		0.7
Loans	$	673,556		100.0	%	$	622,878		100.0	%

	Acquired
	September 30, 2014					December 31, 2013
(in thousands)	Amount		% of Total			Amount		% of Total
Commercial & industrial	$	22,652		11.8	%	$	26,102		11.6	%
Owner-occupied CRE		47,845		25.0			59,717		26.6
AG production		9,750		5.1			11,026		4.9
AG real estate		23,061		12.0			23,461		10.5
CRE investment		27,063		14.1			29,905		13.3
Construction & land development		10,521		5.5			12,604		5.6
Residential construction		-		-			60		0.1
Residential first mortgage		41,451		21.7			50,223		22.4
Residential junior mortgage		8,600		4.5			10,156		4.5
Retail & other		586		0.3			1,226		0.5
Loans	$	191,529		100.0	%	$	224,480		100.0	%

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

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

The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors. Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category. Management allocates the ALLL by pools of risk within each loan portfolio. No ALLL has been recorded on acquired loans since acquisition or at September 30, 2014 since the remaining pool discounts exceed the required amount calculated based on the actual charge off experience in the acquired loan portfolio.

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

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the nine months ended September 30, 2014:


	TOTAL – Nine Months Ended September 30, 2014
(in thousands) ALLL:	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
Beginning balance	$	1,798		$	766		$	18		$	59		$	505		$	4,970		$	229		$	544		$	321		$	22		$	9,232
Provision		2,318			1,057			36			213			121			(2,445	)		(73	)		610			129			59			2,025
Charge-offs		(567	)		(468	)		-			-			-			(12	)		-			(191	)		(18	)		(35	)		(1,291	)
Recoveries		50			15			-			-			12			-			-			1			1			7			86
Net charge-offs		(517	)		(453	)		-			-			12			(12	)		-			(190	)		(17	)		(28	)		(1,205	)
Ending balance	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052
As percent of ALLL		35.8	%		13.6	%		0.5	%		2.7	%		6.3	%		25.0	%		1.6	%		9.6	%		4.3	%		0.6	%		100	%

ALLL:
Individually evaluated	$	238		$	-		$	-		$	-		$	-		$	389		$	-		$	-		$	-		$	-		$	627
Collectively evaluated		3,361			1,370			54			272			638			2,124			156			964			433			53			9,425
Ending balance	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052

Loans:
Individually evaluated	$	353		$	1,604		$	62		$	394		$	1,740		$	4,778		$	-		$	1,495		$	156		$	-		$	10,582
Collectively evaluated		282,004			177,562			14,570			41,801			75,327			37,684			11,260			156,235			52,367			5,693			854,503
Total loans	$	282,357		$	179,166		$	14,632		$	42,195		$	77,067		$	42,462		$	11,260		$	157,730		$	52,523		$	5,693		$	865,085

Less ALLL	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052
Net loans	$	278,758		$	177,796		$	14,578		$	41,923		$	76,429		$	39,949		$	11,104		$	156,766		$	52,090		$	5,640		$	855,033

	Originated – Nine Months Ended September 30, 2014
(in thousands) ALLL:	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
Beginning balance	$	1,798		$	766		$	18		$	59		$	505		$	4,970		$	229		$	544		$	321		$	22		$	9,232
Provision		2,261			1,050			36			213			121			(2,457	)		(73	)		457			112			59			1,779
Charge-offs		(510	)		(452	)		-			-			-			-			-			(38	)		-			(35	)		(1,035	)
Recoveries		50			6			-			-			12			-			-			1			-			7			76
Net charge-offs		(460	)		(446	)		-			-			12			-			-			(37	)		-			(28	)		(959	)
Ending balance	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052
As percent of ALLL		35.8	%		13.6	%		0.5	%		2.7	%		6.3	%		25.0	%		1.6	%		9.6	%		4.3	%		0.6	%		100	%

ALLL:
Individually evaluated	$	238		$	-		$	-		$	-		$	-		$	389		$	-		$	-		$	-		$	-		$	627
Collectively evaluated		3,361			1,370			54			272			638			2,124			156			964			433			53			9,425
Ending balance	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052

Loans:
Individually evaluated	$	347		$	830		$	-		$	-		$	-		$	3,999		$	-		$	201		$	-		$	-		$	5,377
Collectively evaluated		259,358			130,491			4,882			19,134			50,004			27,942			11,260			116,078			43,923			5,107			668,179
Total loans	$	259,705		$	131,321		$	4,882		$	19,134		$	50,004		$	31,941		$	11,260		$	116,279		$	43,923		$	5,107		$	673,556

Less ALLL	$	3,599		$	1,370		$	54		$	272		$	638		$	2,513		$	156		$	964		$	433		$	53		$	10,052
Net loans	$	256,106		$	129,951		$	4,828		$	18,862		$	49,366		$	29,428		$	11,104		$	115,315		$	43,490		$	5,054		$	663,504

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

	Acquired – Nine Months Ended September 30, 2014
(in thousands) ALLL:	Commercial & industrial			Owner- occupied CRE			AG production		AG real estate		CRE investment		Construction & land development			Residential construction		Residential first mortgage			Residential junior mortgage			Retail & other		Total
Provision	$	57		$	7		$	-	$	-	$	-	$	12		$	-	$	153		$	17		$	-	$	246
Charge-offs		(57	)		(16	)		-		-		-		(12	)		-		(153	)		(18	)		-		(256	)
Recoveries		-			9			-		-		-		-			-		-			1			-		10
Loans:
Individually evaluated	$	6		$	774		$	62	$	394	$	1,740	$	779		$	-	$	1,294		$	156		$	-	$	5,205
Collectively evaluated		22,646			47,071			9,688		22,667		25,323		9,742			-		40,157			8,444			586		186,324
Total loans	$	22,652		$	47,845		$	9,750	$	23,061	$	27,063	$	10,521		$	-	$	41,451		$	8,600		$	586	$	191,529

The following table presents the balance and activity in the ALLL by portfolio segment at or for the nine months ended September 30, 2013.

	TOTAL – Nine Months Ended September 30, 2013
(in thousands) ALLL:	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
Beginning balance	$	1,969		$	1,069		$	-		$	-		$	337		$	2,580		$	137		$	685		$	312		$	31		$	7,120
Provision		194			(398	)		8			-			642			3,498			62			(168	)		50			37			3,925
Charge-offs		(474	)		(113	)		-			-			(798	)		(319	)		-			(86	)		(142	)		(46	)		(1,978	)
Recoveries		27			83			-			-			-			-			-			8			1			1			120
Net charge-offs		(447	)		(30	)		-			-			(798	)		(319	)		-			(78	)		(141	)		(45	)		(1,858	)
Ending balance	$	1,716		$	641		$	8		$	-		$	181		$	5,759		$	199		$	439		$	221		$	23		$	9,187
As percent of ALLL		18.7	%		7.0	%		0.1	%		-	%		2.0	%		62.5	%		2.2	%		4.8	%		2.4	%		0.3	%		100	%

ALLL:
Individually evaluated	$	-		$	-		$	-		$	-		$	-		$	3,230		$	-		$	-		$	-		$	-		$	3,230
Collectively evaluated		1,716			641			8			-			181			2,529			199			439			221			23			5,957
Ending balance	$	1,716		$	641		$	8		$	-		$	181		$	5,759		$	199		$	439		$	221		$	23		$	9,187

Loans:
Originated loans individually evaluated	$	-		$	-		$	-		$	-		$	857		$	8,213		$	-		$	371		$	-		$	-		$	9,441
Acquired loans individually evaluated		101			5,634			13			444			5,592			1,220			-			2,216			232			-			15,452
Collectively evaluated		251,489			198,081			14,058			37,294			100,314			29,324			12,831			147,530			49,286			6,832			847,039
Total loans	$	251,590		$	203,715		$	14,071		$	37,738		$	106,763		$	38,757		$	12,831		$	150,117		$	49,518		$	6,832		$	871,932

Less ALLL	$	1,716		$	641		$	8		$	-		$	181		$	5,759		$	199		$	439		$	221		$	23		$	9,187
Net loans	$	249,874		$	203,074		$	14,063		$	37,738		$	106,582		$	32,998		$	12,632		$	149,678		$	49,297		$	6,809		$	862,745

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

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of September 30, 2014 and December 31, 2013.

(in thousands)	September 30, 2014		% to Total			December 31, 2013		% to Total
Commercial & industrial	$	548		8.0	%	$	68		0.7	%
Owner-occupied CRE		1,487		21.7			1,087		10.6
AG production		23		0.3			11		0.1
AG real estate		394		5.8			448		4.3
CRE investment		1,433		20.9			4,631		45.1
Construction & land development		943		13.8			1,265		12.3
Residential construction		-		-			-		-
Residential first mortgage		1,845		26.9			2,365		23.0
Residential junior mortgage		178		2.6			262		2.6
Retail & other		-		-			129		1.3
Nonaccrual loans - Total	$	6,851		100.0	%	$	10,266		100.0	%

			Originated
(in thousands)	September 30, 2014		% to Total			December 31, 2013		% to Total
Commercial & industrial	$	542		26.2	%	$	67		8.9	%
Owner-occupied CRE		830		40.2			-		-
AG production		-		-			-		-
AG real estate		-		-			-		-
CRE investment		-		-			40		5.3
Construction & land development		165		8.0			-		-
Residential construction		-		-			-		-
Residential first mortgage		494		23.9			442		58.9
Residential junior mortgage		35		1.7			73		9.7
Retail & other		-		-			129		17.2
Nonaccrual loans - Originated	$	2,066		100.0	%	$	751		100.0	%

			Acquired
(in thousands)	September 30, 2014		% to Total			December 31, 2013		% to Total
Commercial & industrial	$	6		0.1	%	$	1		0.1	%
Owner-occupied CRE		657		13.7			1,087		11.4
AG production		23		0.5			11		0.1
AG real estate		394		8.2			448		4.7
CRE investment		1,433		30.0			4,591		48.2
Construction & land development		778		16.3			1,265		13.3
Residential construction		-		-			-		-
Residential first mortgage		1,351		28.2			1,923		20.2
Residential junior mortgage		143		3.0			189		2.0
Retail & other		-		-			-		-
Nonaccrual loans - Acquired	$	4,785		100.0	%	$	9,515		100.0	%

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

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

	September 30, 2014
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or non-accrual			Current			Total
Commercial & industrial	$	714		$	548		$	281,095		$	282,357
Owner-occupied CRE		62			1,487			177,617			179,166
AG production		22			23			14,587			14,632
AG real estate		119			394			41,682			42,195
CRE investment		441			1,433			75,193			77,067
Construction & land development		-			943			41,519			42,462
Residential construction		-			-			11,260			11,260
Residential first mortgage		173			1,845			155,712			157,730
Residential junior mortgage		-			178			52,345			52,523
Retail & other		-			-			5,693			5,693
Total loans	$	1,531		$	6,851		$	856,703		$	865,085
As a percent of total loans		0.2	%		0.8	%		99.0	%		100.0	%

	December 31, 2013
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	-		$	68		$	253,606		$	253,674
Owner-occupied CRE		1,247			1,087			185,142			187,476
AG production		-			11			14,245			14,256
AG real estate		-			448			36,609			37,057
CRE investment		491			4,631			85,173			90,295
Construction & land development		-			1,265			41,616			42,881
Residential construction		-			-			12,535			12,535
Residential first mortgage		387			2,365			151,651			154,403
Residential junior mortgage		12			262			49,089			49,363
Retail & other		12			129			5,277			5,418
Total loans	$	2,149		$	10,266		$	834,943		$	847,358
As a percent of total loans		0.3	%		1.2	%		98.5	%		100.0	%

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

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

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

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

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

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

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

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

The following tables present total loans by loan grade as of September 30, 2014 and December 31, 2013:

	September 30, 2014
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	268,593		$	6,713		$	1,806		$	5,245		$	-	$	-	$	282,357
Owner-occupied CRE		169,711			3,295			2,932			3,228			-		-		179,166
AG production		14,124			145			-			363			-		-		14,632
AG real estate		31,729			9,689			60			717			-		-		42,195
CRE investment		73,201			1,888			-			1,978			-		-		77,067
Construction & land development		32,740			1,040			118			8,564			-		-		42,462
Residential construction		10,706			-			-			554			-		-		11,260
Residential first mortgage		154,504			1,011			191			2,024			-		-		157,730
Residential junior mortgage		52,053			42			-			428			-		-		52,523
Retail & other		5,685			8			-			-			-		-		5,693
Total loans	$	813,046		$	23,831		$	5,107		$	23,101		$	-	$	-	$	865,085
Percent of total		94.0	%		2.8	%		0.6	%		2.6	%		-		-		100	%

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

Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. For determining the adequacy of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, plus additional loans with impairment risk characteristics. Management instituted the nonaccrual scope criteria in the second quarter of 2013, particularly in response to the higher volume of smaller nonaccrual loans acquired in the 2013 acquisitions. At the time an individual loan goes into nonaccrual status, however, management evaluates the loan for impairment and possible charge-off regardless of loan size.

In determining the appropriateness of the ALLL, management includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans are individually assessed and are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

Loans that are determined not to be impaired are collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments are also provided for certain current environmental and qualitative factors. An internal loan review function rates loans using a grading system based on nine different categories. Loans with grades of seven or higher (“classified loans”) represent loans with a greater risk of loss and may be assigned allocations for loss based on specific review of the weaknesses observed in the individual credits if classified as impaired. Classified loans are constantly monitored by the loan review function to ensure early identification of any deterioration.

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

The following tables present impaired loans as of September 30, 2014 and December 31, 2013. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. PCI loans acquired in the 2013 acquisitions were initially recorded at a fair value of $16.7 million on their respective acquisition dates, net of an initial $12.2 million non-accretable mark and a zero accretable mark. At September 30, 2014, $4.8 million of the $16.7 million remain in impaired loans. Included in the September 30, 2014 and December 31, 2013 impaired loans is one troubled debt restructuring totaling $3.8 million described below under “Troubled Debt Restructurings.”


	Total Impaired Loans – September 30, 2014
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial*	$	353	$	353	$	238	$	178	$	22
Owner-occupied CRE		1,604		2,801		-		1,345		189
AG production		62		130		-		36		8
AG real estate		394		462		-		419		31
CRE investment		1,740		4,703		-		3,124		197
Construction & land development*		4,778		5,320		389		7,079		110
Residential construction		-		-		-		-		-
Residential first mortgage		1,495		3,256		-		1,602		152
Residential junior mortgage		156		526		-		164		17
Retail & Other		-		24		-		-		2
Total	$	10,582	$	17,575	$	627	$	13,947	$	728

	Originated – September 30, 2014
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial*	$	347	$	347	$	238	$	174	$	19
Owner-occupied CRE		830		830		-		415		52
AG production		-		-		-		-		-
AG real estate		-		-		-		-		-
CRE investment		-		-		-		-		-
Construction & land development*		3,999		3,999		389		6,108		34
Residential construction		-		-		-		-		-
Residential first mortgage		201		201		-		101		4
Residential junior mortgage		-		-		-		-		-
Retail & Other		-		-		-		-		-
Total	$	5,377	$	5,377	$	627	$	6,798	$	109

	Acquired – September 30, 2014
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	6	$	6	$	-	$	4	$	3
Owner-occupied CRE		774		1,971		-		930		137
AG production		62		130		-		36		8
AG real estate		394		462		-		419		31
CRE investment		1,740		4,703		-		3,124		197
Construction & land development		779		1,321		-		971		76
Residential construction		-		-		-		-		-
Residential first mortgage		1,294		3,055		-		1,501		148
Residential junior mortgage		156		526		-		164		17
Retail & Other		-		24		-		-		2
Total	$	5,205	$	12,198	$	-	$	7,149	$	619

*Two commercial and industrial loans with a combined balance of $347,000 had a specific reserve of $238,000. One construction and land development loan with a balance of $3.8 million had a specific reserve of $389,000. No other loans had a related allowance at September 30, 2014 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.

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


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


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

	Acquired – December 31, 2013
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	1	$	140	$	-	$	1	$	3
Owner-occupied CRE		1,086		4,151		-		1,268		169
AG production		9		76		-		11		5
AG real estate		443		558		-		443		9
CRE investment		4,507		9,056		-		4,592		451
Construction & land development		1,162		2,363		-		1,191		135
Residential construction		-		-		-		-		-
Residential first mortgage		1,708		4,177		-		1,827		215
Residential junior mortgage		172		703		-		198		26
Retail & other		-		36		-		-		3
Total	$	9,088	$	21,260	$	-	$	9,531	$	1,016

**One loan with a balance of $3.9 million and a reserve of $3.2 million is included within the construction and land development category. No other loans had a related allowance at December 31, 2013 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.

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

Troubled Debt Restructurings

At September 30, 2014, there were five loans classified as troubled debt restructurings totaling $4.2 million. One loan had a premodification balance of $3.9 million and at September 30, 2014, had a balance of $3.8 million, was in compliance with its modified terms, was not past due, and was included in impaired loans with a specific reserve allocation of approximately $389,000. This loan is performing but is disclosed as impaired as a result of its classification as a troubled debt restructuring. The remaining four loans had a combined premodification balance of $438,000 and a combined outstanding balance of $389,000 at September 30, 2014. There were no other loans which were modified and classified as troubled debt restructurings at September 30, 2014. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of September 30, 2014. Loans which were considered troubled debt restructurings by Mid-Wisconsin prior to the acquisition were not required to be classified as troubled debt restructurings in the Company’s financial statements unless or until such loans would subsequently meet criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

Note 7- Notes Payable

The Company had the following long-term notes payable:

(in thousands)	September 30, 2014		December 31, 2013
Joint venture note	$	9,738	$	9,922
Federal Home Loan Bank (“FHLB”) advances		12,500		22,500
Notes payable	$	22,238	$	32,422

At the completion of the construction of the Company’s headquarters building in 2005 and as part of a joint venture investment related to the building, the Company and the other joint venture partners guaranteed a joint venture note to finance certain costs of the building. This note is secured by the building, bears a fixed rate of 5.81% and requires monthly principal and interest payments until its maturity on June 1, 2016.

The Company’s FHLB advances are all fixed rate, require interest-only monthly payments, and have maturities through February 2018. The weighted average rate of FHLB advances was 0.69% at September 30, 2014 and 1.85% at December 31, 2013. The FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled approximately $93.8 million and $85.9 million at September 30, 2014 and December 31, 2013, respectively.

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

Maturing in	(in thousands)
2014	$	1,064
2015		5,762
2016		14,412
2017		-
2018		1,000
	$	22,238

Note 8 - Junior Subordinated Debentures

The Company’s carrying value of junior subordinated debentures was $12.3 million at September 30, 2014 and $12.1 million at December 31, 2013. In July 2004 Nicolet Bankshares Statutory Trust I (the “Statutory Trust”), issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) that qualify as Tier I capital under Federal Reserve Board guidelines. All of the common securities of the Statutory Trust are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by the Statutory Trust to purchase $6.2 million of junior subordinated debentures of the Company, which pay an 8% fixed rate. Interest on these debentures is current. The debentures may be redeemed in part or in full, on or after July 15, 2009 at par plus any accrued but unpaid interest. The maturity date of the debenture, if not redeemed, is July 15, 2034.

As part of the Mid-Wisconsin acquisition, the Company assumed $10.3 million of junior subordinated debentures related to $10.0 million of issued trust preferred securities. The trust preferred securities and the debentures mature on December 15, 2035 and have a floating rate of the three-month LIBOR plus 1.43% adjusted quarterly. Interest on these debentures is current. The debentures may be called at par in part or in full, on or after December 15, 2010 or within 120 days of certain events. At acquisition in April 2013 the debentures were recorded at a fair value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At September 30, 2014, the carrying value of these junior debentures was $6.1 million, and the $5.8 million carrying value of related trust preferred securities qualifies as Tier 1 capital.

Note 9 - Fair Value Measurements

As provided for by accounting standards, the Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are: Level 1 - quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date; Level 2 - inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety; this assessment of the significance of an input requires management judgment.

Disclosure of the fair value of financial instruments, whether recognized or not recognized in the balance sheet, is required for those instruments for which it is practicable to estimate that value, with the exception of certain financial instruments and all nonfinancial instruments as provided for by the accounting standards. For financial instruments recognized at fair value in the consolidated balance sheets, the fair value disclosure requirements also apply.

Fair value (i.e. the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement versus an entity-specific measurement.

Note 9 - Fair Value Measurements, continued

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. One security classified as Level 3 was called at its par value of $0.3 million during the third quarter of 2014. There were no other changes in Level 3 values to report during the first nine months of 2014.


			Fair Value Measurements Using
Measured at Fair Value on a Recurring Basis:	Total		Level 1		Level 2		Level 3
(in thousands)
U.S. government sponsored enterprises	$	1,029	$	-	$	1,029	$	-
State, county and municipals		83,188		-		82,612		576
Mortgage-backed securities		64,069		-		64,069		-
Corporate debt securities		220		-		-		220
Equity securities		2,143		2,143		-		-
Securities AFS, September 30, 2014	$	150,649	$	2,143	$	147,710	$	796

(in thousands)
U.S. government sponsored enterprises	$	2,057	$	-	$	2,057	$	-
State, county and municipals		55,039		-		54,162		877
Mortgage-backed securities		67,879		-		67,879		-
Corporate debt securities		220		-		-		220
Equity securities		2,320		2,320		-		-
Securities AFS, December 31, 2013	$	127,515	$	2,320	$	124,098	$	1,097

The following is a description of the valuation methodologies used by the Company for the items noted in the tables above. Where quoted market prices on securities exchanges are available, the investment is classified as Level 1. Level 1 investments primarily include exchange-traded equity securities available for sale. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include mortgage-related securities and obligations of state, county and municipals. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include auction rate securities available for sale (for which there has been no liquid market since 2008) and corporate debt securities. At September 30, 2014 and December 31, 2013, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on receipt of par from refinances for the auction rate securities and the internal analysis on the corporate debt securities.

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

Measured at Fair Value on a Nonrecurring Basis
			Fair Value Measurements Using
(in thousands)	Total		Level 1		Level 2		Level 3
September 30, 2014:
Impaired loans	$	9,955	$	-	$	-	$	9,955
OREO		963		-		-		963
December 31, 2013:
Impaired loans	$	14,101	$	-	$	-	$	14,101
OREO		1,987		-		-		1,987

The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell.

Note 9 - Fair Value Measurements, continued

The Company is required under accounting guidance to report the fair value of all financial instruments in the consolidated balance sheets, including those financial instruments carried at cost. The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2014 and December 31, 2013 are shown below.

	September 30, 2014
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	67,220	$	67,220	$	67,220	$	-	$	-
Certificates of deposit in other banks		8,638		8,667		-		8,667		-
Securities AFS		150,649		150,649		2,143		147,710		796
Other investments		8,056		8,056		-		5,915		2,141
Loans held for sale		2,570		2,570		2,570		-		-
Loans, net		855,033		857,897		-		-		857,897
Bank owned life insurance		27,230		27,230		27,230		-		-

Financial liabilities:
Deposits	$	1,011,509	$	1,013,271	$	-	$	-	$	1,013,271
Notes payable		22,238		25,216		-		25,216		-
Junior subordinated debentures		12,278		12,273		-		-		12,273

	December 31, 2013
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	146,978	$	146,978	$	146,978	$	-	$	-
Certificates of deposit in other banks		1,960		1,983		-		1,983		-
Securities AFS		127,515		127,515		2,320		124,098		1,097
Other investments		7,982		7,982		-		5,841		2,141
Loans held for sale		1,486		1,486		1,486		-		-
Loans, net		838,126		842,758		-		-		842,758
Bank owned life insurance		23,796		23,796		23,796		-		-

Financial liabilities:
Deposits	$	1,034,834	$	1,036,564	$	-	$	-	$	1,036,564
Short-term borrowings		7,116		7,116		7,116		-		-
Notes payable		32,422		32,548		-		32,548		-
Junior subordinated debentures		12,128		12,704		-		-		12,704

Not all the financial instruments listed in the table above are subject to the disclosure provisions of ASC 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, loans held for sale, bank owned life insurance, nonmaturing deposits, and short-term borrowings. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.

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

Securities AFS: Fair values for securities are based on quoted market prices on securities exchanges, when available, which is considered a Level 1 measurement. If quoted market prices are not available, fair value is generally determined using pricing models widely used in the industry, quoted market prices of securities with similar characteristics, or discounted cash flows, which is considered a Level 2 measurement, and Level 3 was deemed appropriate for auction rate securities (for which there has been no liquid market since 2008) and corporate debt securities which include trust preferred security instruments. The corporate debt securities were acquired in the Mid-Wisconsin acquisition and valued based on a discounted cash flow analysis and the underlying credit quality of the issuer. The fair value approximates the cost at acquisition. For other investments, the carrying amount of Federal Reserve Bank, Bankers Bank, Farmer Mac, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.

Note 9 - Fair Value Measurements, continued

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

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

Notes payable: The fair value of the Federal Home Loan Bank advances is obtained from the Federal Home Loan Bank which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of remaining notes payable are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and credit quality which represents a Level 2 measurement.

Junior subordinated debentures: The fair values of junior subordinated debentures are estimated based on an evaluation of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.

Off-balance-sheet instruments: The estimated fair value of letters of credit at September 30, 2014 and December 31, 2013 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at September 30, 2014 and December 31, 2013.

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

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

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

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

At September 30, 2014, total assets were $1.2 billion and net income for the nine months ended September 30, 2014 was $7.5 million. When comparing 2014 results to prior year periods, the timing of Nicolet’s 2013 acquisitions impacts the 2013 financial results and comparisons to 2014. These acquisitions (collectively referred to as the “2013 acquisitions”) consisted of the predominantly stock-for-stock acquisition of Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”), which was consummated on April 26, 2013, and the FDIC-assisted transaction to acquire Bank of Wausau, which was effective August 9, 2013. The transactions were accounted for under the acquisition method of accounting, and thus, the results of operations of the acquired entities prior to their respective consummation dates were not included in the accompanying consolidated financial statements. The eleven banking branches of Mid-Wisconsin and the one branch of Bank of Wausau opened as Nicolet National Bank branches on April 29 and August 10, 2013, respectively. At acquisition, the Mid-Wisconsin transaction increased total assets by $435 million, total liabilities by $415 million, and common equity by approximately $9.3 million, and resulted in a BPG of $10.4 million during the second quarter of 2013. In the third quarter of 2013, a $0.9 million negative adjustment was recorded to that BPG relative to a change in estimate of a now settled legal action. The 2013 income statement also included approximately $1.7 million (approximately $0.1 million and $1.6 million in the first and second quarters, respectively, of 2013) of pre-tax, non-recurring merger related expenses tied to preparation for, consummation of and integration of Mid-Wisconsin into Nicolet. On a smaller scale, the Bank of Wausau transaction increased total assets by $47 million at acquisition (of which $18 million of cash was used during the month of September 2013 to immediately redeem rate-sensitive certificates of deposit), and resulted in a pre-tax BPG of $2.4 million and approximately $0.2 million of pre-tax, non-recurring merger related expenses recorded in the third quarter of 2013. Finally, acquisition accounting requires assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition, which impacted various ratios, but most notably asset quality measures (as loans are recorded directly at their estimated fair value and no addition to the allowance for loan losses is recorded at consummation), average balances in 2013, and taxes. Therefore, the 2014 results include both acquisitions fully, while the nine months ended September 30, 2013, includes approximately five months of Mid-Wisconsin and two months of Bank of Wausau. For additional details, see “Note 2 – Acquisitions” and “Note 6 – Loans, Allowance for Loan Losses, and Credit Quality” in the Notes to the Unaudited Consolidated Financial Statements, and “--Income Taxes” within this document.

On November 28, 2012, Nicolet entered into a merger agreement with Mid-Wisconsin and subsequently filed a Registration Statement on Form S-4 (Regis. No. 333-186401) (the “Registration Statement”) with the Securities and Exchange Commission (the “SEC”) under the provisions of the Securities Act of 1933, as amended (the “Securities Act”). On March 26, 2013, the Registration Statement became effective and Nicolet became a public reporting company under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). On October 21, 2014, the SEC declared effective Nicolet’s Registration Statement on Form S-3, which registered an aggregate of $50 million of preferred stock, common stock, debt securities, warrants, rights, or units for potential future offer and sale, with the net proceeds of such issuances to be used for general corporate purposes, which may include one or more of the following: capital expenditures, repayment or refinancing of indebtedness or other securities from time to time, working capital or to make acquisitions. The specific terms of any issuance of securities under such registration statement will be set forth in a prospectus supplement in accordance with the provisions of the Securities Act.

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


	●	operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder, as well as the rules by the Federal bank regulatory agencies to implement the Basel III capital accord;
	●	economic, political and competitive forces affecting Nicolet’s banking and wealth management businesses;
	●	changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;
	●	potential difficulties in integrating the operations of Nicolet with those of acquired entities, if any;
	●	compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement; and
	●	the risk that Nicolet’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

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

Critical Accounting Policies

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

Business Combinations and Valuation of Loans Acquired in Business Combinations

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

In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.

In determining the Day 1 Fair Values of acquired loans, management calculates a non-accretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The non-accretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to the accretable and non-accretable differences, which would have a positive impact on interest income.

The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.

Allowance for Loan Losses

The ALLL is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the ALLL. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. A provision for loan losses, which is a charge against earnings, is recorded to bring the ALLL to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.

The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at September 30, 2014. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination.

Income taxes

The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.

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

Performance Summary

Nicolet reported net income of $7.5 million for the nine months ended September 30, 2014, compared to $15.2 million for the first nine months of 2013. After $183,000 of preferred stock dividends, the first nine months of 2014 net income available to common shareholders was $7.4 million, or $1.70 per diluted common share. Comparatively, after $915,000 of preferred stock dividends, the first nine months of 2013 net income available to common shareholders was $14.2 million, or $3.65 per diluted common share. Beginning in the fourth quarter of 2013, given growth in qualifying small business loans, Nicolet qualified for a 1% annual dividend rate on its preferred stock issued to the U.S. Treasury related to its participation in the Small Business Lending Fund (“SBLF”), compared to the previous 5% annual rate, resulting in the $732,000 reduction in preferred stock dividends between the first nine months of 2014 and 2013. Income statement results and average balances for the first nine months of 2014 fully include the 2013 acquisitions, while, as noted previously, the first nine months of 2013 included approximately five months of the Mid-Wisconsin acquisition and two months of the Bank of Wausau acquisition, as well as the related $11.9 million of BPG and pre-tax non-recurring expenses of approximately $1.9 million.

●

Net interest income was $31.4 million for the first nine months of 2014, an increase of $5.0 million or 19% over the first nine months of 2013. The improvement was predominantly volume related, given the timing of the 2013 acquisitions. On a tax-equivalent basis, the net interest margin for the first nine months of 2014 was 3.91%, down 18 basis points (“bps”) from 4.09% for the comparable 2013 period. Between the comparable nine-month periods, the earning asset yield fell 23 bps to 4.57%, while the cost of interest bearing liabilities improved by 6 bps to 0.79%, resulting in a 17 bps decrease in the interest rate spread between the comparable nine-month periods.

●

Loans were $865 million at September 30, 2014, up $18 million or 2% over $847 million at December 31, 2013, but down $7 million or 1% from $872 million at September 30, 2013. Between the comparative nine-month periods, average loans grew 19% (or approximately 3% organically, excluding the $272 million of loans added at the Mid-Wisconsin acquisition and the $12 million of loans added at the Bank of Wausau acquisition), to $855 million for 2014 yielding 5.36%, compared to $720 million for 2013 yielding 5.43%. While the loan yields for both periods include favorable purchase accounting accretion on acquired loans, the third quarter of 2013 included the resolution of two significant acquired loans with combined discounts of $1 million.

●

Total deposits were $1.01 billion at September 30, 2014, down $23 million or 2% from $1.03 billion at December 31, 2013 (following a customary pattern of deposit decline historically following year ends through the first nine months of the year), and up $51 million or 5% over $960 million in total deposits a year ago. Between the comparative nine-month periods, average total deposits grew 31% (or approximately 8% organically, excluding the $346 million of deposits from the Mid-Wisconsin acquisition and the $24 million of net deposits from the Bank of Wausau acquisition), to $1.02 billion for the first nine months of 2014, with interest-bearing deposits costing 0.63%, compared to $777 million for the same period in 2013, with interest-bearing deposits costing 0.65%.

●

Asset quality measures were strong at September 30, 2014. Nonperforming assets were $7.8 million at September 30, 2014, down 36% from year end 2013 and down 63% from a year ago. Nonperforming assets represented 0.67%, 1.02% and 1.88% of total assets at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. The allowance for loan losses was $10.1 million or 1.16% of loans at September 30, 2014, compared to $9.2 million or 1.09%, respectively at year end 2013, and $9.2 million or 1.05%, respectively at September 30, 2013. The provision for loan losses was $2.0 million with net charge offs of $1.2 million for the first nine months of 2014, versus provision of $3.9 million with $1.9 million of net charge offs for the comparable 2013 period.

●

Noninterest income was $10.3 million for the first nine months of 2014 (including $0.4 million net gain on sales or writedowns of assets) compared to $22.3 million for the first nine months of 2013 (including $13.3 million of BPG and net gain on sale of assets, combined). Removing these net gains, noninterest income was up $0.9 million or 10% between the nine-month periods. Notable increases over prior year, largely due to increased business from the expanded size of the Company, were in service charges (up $0.3 million or 27%), trust fee income (up $0.5 million or 16%), brokerage fee income (up $0.1 million or 44%) and other income (up $0.4 million or 44%, mostly attributable to income from higher debit card volumes). Mortgage income was down $0.8 million or 41% between the nine-month periods, resulting from a significantly more robust mortgage market a year ago. Production was strong until the start of third quarter 2013, when production slowed dramatically largely in response to rising mortgage rates, and remains sluggish in 2014.

●

Noninterest expense was $28.6 million for the first nine months of 2014, up $2.4 million or 9% over the first nine months of 2013; however, excluding $1.9 million of non-recurring merger-based expenses incurred in the 2013 period (of which approximately $1 million was in personnel and $0.9 million was in other expense), expenses were up 18%. The increase in most noninterest expense line items is predominantly due to the larger operating base from the 2013 acquisitions being fully included in 2014 and only partially included in the first nine months of 2013. In addition, between the nine-month periods, salaries and benefits were up $1.6 million or 11% (or up 19% excluding the 2013 merger-based expense, given the larger workforce and merit increases between the years), occupancy was up $0.6 million or 25% (given the larger operating base and a harsher winter), office expense was up $0.4 million or 19% (given the larger operating base, as well as continued integration on systems and phones), processing costs were up $0.6 million or 36% (mostly commensurate with growth in the number of accounts), and core deposit intangible amortization increased $0.2 million or 20%, attributable to the Mid-Wisconsin merger. Other expense was down $1.1 million, mostly due to the 2013 period including $0.9 million of non-recurring merger-based expenses in legal, audit, and consulting.

Net Interest Income

Nicolet’s earnings are substantially dependent on net interest income. Net interest income is the primary source of Nicolet’s revenue and is the difference between interest income earned on interest earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.

Comparison of the nine months ending September 30, 2014 versus 2013

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $31.4 million in the first nine months of 2014, 19% higher than $26.4 million in the first nine months of 2013. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $541,000 and $444,000 for the first nine months of 2014 and 2013, respectively, resulting in taxable equivalent net interest income of $31.9 million and $26.8 million, respectively.

Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.

Tables 1 through 5 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.

Table 1: Year-To-Date Net Interest Income Analysis


	For the Nine Months Ended September 30,
	2014							2013
(in thousands)	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
ASSETS
Earning assets
Loans, including loan fees (1)(2)	$	855,052	$	34,662		5.36	%	$	719,717	$	29,550		5.43	%
Investment securities
Taxable		84,747		1,212		1.91	%		70,492		714		1.35	%
Tax-exempt (2)		47,923		998		2.78	%		30,991		914		3.93	%
Other interest-earning assets		89,727		354		0.53	%		44,384		222		0.67	%
Total interest-earning assets		1,077,449	$	37,226		4.57	%		865,584	$	31,400		4.80	%
Cash and due from banks		38,657							15,107
Other assets		66,006							59,964
Total assets	$	1,182,112						$	940,655
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	106,958	$	198		0.25	%	$	73,353	$	155		0.28	%
Interest-bearing demand		206,228		1,141		0.74	%		146,614		905		0.83	%
MMA		263,592		549		0.28	%		209,583		571		0.36	%
Core CDs and IRAs		228,945		1,737		1.01	%		181,859		1,313		0.97	%
Brokered deposits		40,235		355		1.18	%		39,023		225		0.77	%
Total interest-bearing deposits		845,958		3,980		0.63	%		650,432		3,169		0.65	%
Other interest-bearing liabilities		48,325		1,336		3.64	%		64,932		1,414		2.87	%
Total interest-bearing liabilities		894,283		5,316		0.79	%		715,364		4,583		0.85	%
Noninterest-bearing demand		171,701							126,420
Other liabilities		8,445							6,970
Total equity		107,683							91,901
Total liabilities and stockholders’ equity	$	1,182,112						$	940,655
Net interest income and rate spread			$	31,910		3.78	%			$	26,817		3.95	%
Net interest margin						3.91	%						4.09	%

(1) Nonaccrual loans are included in the daily average loan balances outstanding.

(2)	The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

Table 2: Year-To-Date Volume/Rate Variance

Comparison of the nine months ended September 30, 2014 versus the nine months ended September 30, 2013 follows:
	Increase (decrease) Due to Changes in
(in thousands)	Volume			Rate			Net
Earning assets

Loans	$	5,473		$	(361	)	$	5,112
Investment securities
Taxable		190			308			498
Tax-exempt		404			(320	)		84
Other interest-earning assets		113			19			132

Total interest-earning assets	$	6,180		$	(354	)	$	5,826

Interest-bearing liabilities
Savings deposits	$	64		$	(21	)	$	43
Interest-bearing demand		338			(102	)		236
MMA		129			(151	)		(22	)
Core CDs and IRAs		354			70			424
Brokered deposits		7			123			130

Total interest-bearing deposits		892			(81	)		811
Other interest-bearing liabilities		(99	)		21			(78	)

Total interest-bearing liabilities		793			(60	)		733
Net interest income	$	5,387		$	(294	)	$	5,093

Table 3: Quarterly Net Interest Income Analysis


	For the Three Months Ended September 30,
	2014							2013
(in thousands)	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
ASSETS
Earning assets
Loans, including loan fees (1)(2)	$	862,960	$	11,976		5.46	%	$	854,404	$	12,892		5.93	%
Investment securities
Taxable		80,951		379		1.87	%		93,943		309		1.32	%
Tax-exempt (2)		60,483		390		2.57	%		35,125		329		3.75	%
Other interest-earning assets		43,536		91		0.84	%		32,852		77		0.94	%
Total interest-earning assets		1,047,930	$	12,836		4.82	%		1,016,324	$	13,607		5.26	%
Cash and due from banks		44,550							26,019
Other assets		67,991							70,179
Total assets	$	1,160,471						$	1,112,522
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	113,065	$	70		0.25	%	$	92,123	$	57		0.25	%
Interest-bearing demand		206,764		392		0.75	%		168,685		315		0.74	%
MMA		243,408		152		0.25	%		232,778		200		0.34	%
Core CDs and IRAs		223,740		611		1.09	%		232,658		462		0.79	%
Brokered deposits		33,080		109		1.30	%		45,780		109		0.94	%
Total interest-bearing deposits		820,057		1,334		0.65	%		772,024		1,143		0.59	%
Other interest-bearing liabilities		37,708		396		4.11	%		71,332		491		2.69	%
Total interest-bearing liabilities		857,765		1,730		0.80	%		843,356		1,634		0.77	%
Noninterest-bearing demand		184,535							158,353
Other liabilities		9,328							7,592
Total equity		108,843							103,221
Total liabilities and stockholders’ equity	$	1,160,471						$	1,112,522
Net interest income and rate spread			$	11,106		4.02	%			$	11,973		4.49	%
Net interest margin						4.17	%						4.63	%

(1) Nonaccrual loans are included in the daily average loan balances outstanding.

(2)	The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

Table 4: Quarterly Volume/Rate Variance

Comparison of the three months ended September 30, 2014 versus the three months ended September 30, 2013 follows:
	Increase (decrease) Due to Changes in
(in thousands)	Volume			Rate			Net
Earning assets
Loans	$	83		$	(999	)	$	(916	)
Investment securities
Taxable		(37	)		107			70
Tax-exempt		186			(125	)		61
Other interest-earning assets		11			3			14
Total interest-earning assets	$	243		$	(1,014	)	$	(771	)

Interest-bearing liabilities
Savings deposits	$	12		$	1		$	13
Interest-bearing demand		74			3			77
MMA		9			(57	)		(48	)
Core CDs and IRAs		(21	)		170			149
Brokered deposits		(35	)		35			-
Total interest-bearing deposits		39			152			191
Other interest-bearing liabilities		(52	)		(43	)		(95	)
Total interest-bearing liabilities		(13	)		109			96
Net interest income	$	256		$	(1,123	)	$	(867	)

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

	Nine Months Ended September 30,
	2014								2013
(in thousands)	Average Balance		% of Earning Assets			Yield/Rate			Average Balance		% of Earning Assets			Yield/Rate
Total loans	$	855,052		79.4	%		5.36	%	$	719,717		83.1	%		5.43	%

Securities and other earning assets		222,397		20.6	%		1.54	%		145,867		16.9	%		1.69	%
Total interest-earning assets	$	1,077,449		100	%		4.57	%	$	865,584		100	%		4.80	%

Interest-bearing liabilities	$	894,283		83.0	%		0.79	%	$	715,364		82.6	%		0.85	%

Noninterest-bearing funds, net		183,166		17.0	%					150,220		17.4	%
Total funds sources	$	1,077,449		100	%		0.66	%	$	865,584		100	%		0.70	%
Interest rate spread							3.78	%							3.95	%
Contribution from net free funds							0.13	%							0.14	%
Net interest margin							3.91	%							4.09	%

Taxable-equivalent net interest income was $31.9 million for the first nine months of 2014, an increase of $5.1 million or 19% over the same period in 2013. The increase in taxable-equivalent net interest income was predominantly volume related, given the timing of the acquisitions. Taxable equivalent interest income increased $5.8 million (or 19%) between the nine-month periods driven by loans, including $5.5 million more interest income from higher loan volumes offset by $0.4 million from lower loan yields. Interest expense increased only $0.7 million (or 16%) between the periods driven mainly by interest-bearing deposits, including $0.9 million more interest expense from higher volumes, offset by $0.1 million less interest expense from lower deposit rates.

The taxable-equivalent net interest margin was 3.91% for the nine months of 2014, down 18 bps versus the first nine months of 2013, with a favorable decrease in the cost of funds to 0.79% (down 6 bps), offset by a lower earning asset yield of 4.57% (down 23 bps) and a 1 bp decrease in net free funds. The cost of funds between the nine-month periods benefited mostly from a lower rate structure acquired with the 2013 acquisitions, rate reductions made across product lines though mostly in commercial deposit products, and a continuing high mix of funds in lower-costing interest-bearing deposits. In general, there has been and will be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds. Additionally, while both 2013 and 2014 periods are experiencing favorable income from purchase-accounting accretion on acquired loans, particularly where such loans pay or resolve at better than their carrying values, such favorable interest flow can be sporadic and will likely diminish over time.

The earning asset yield was influenced mainly by loans, representing only 79% of average earning assets and yielding 5.36% for first nine months of 2014, compared to 83% and 5.43%, respectively, for the first nine months of 2013. The 7 bps decline in loan yield between the nine-month periods was largely due to two acquired loans which were fully resolved at approximately $1 million above their carrying values during the third quarter of 2013. The 23 bps decline in earning asset yield was also affected by a higher mix of non-loan earning assets, which earn much less than loans. Non-loan earning assets represented 21% of average earning assets and yielded 1.54%, versus 17% and 1.69%, respectively for the comparable nine-month period in 2013. A higher proportion of low-earning cash was the main reason for the 15 bps decline in the non-loan yield between the nine-month periods.

Nicolet’s cost of funds continued its favorable decline during the low-rate environment, at 0.79% for the first nine months of 2014, 6 bps lower than the first nine months of 2013. The average cost of interest-bearing deposits (which represent over 90% of average interest-bearing liabilities for both periods), was 0.63% for the first nine months of 2014, down 2 bps versus the first nine months of 2013, with favorable rate variances in all deposit categories except core CDs and brokered deposits. Lower-costing transactional deposits (savings, checking and MMA) saw rate declines in response to reductions made across products between the years, while such balances continued to rise. Core time deposit rates increased marginally (from 0.97% to 1.01%), and the average balance increased to $229 million from $182 million. Average brokered deposit balances increased nominally for the comparable nine-month periods but their cost increased from 0.77% in 2013 to 1.18% in 2014, as longer-termed funding replaced maturing shorter-term instruments. Average other interest-bearing liabilities (comprised of short- and long-term borrowings) declined $17 million and cost 77 bps more between the nine-month periods as maturing advances were not renewed in the lower-rate environment.

Average interest-earning assets were $1.1 billion for the first nine months of 2014, $212 million or 24% higher than the first nine months of 2013, led by a $135 million increase in average loans (to $855 million or 79% of interest earning assets) and a $77 million increase in all other interest-earning assets combined (to $222 million or 21% of earning assets), both heavily influenced by the size and timing of the 2013 acquisitions, and a higher level of low-earning cash balances.

Average interest-bearing liabilities were $894 million, up $179 million or 25% over the first nine months of 2013, led by a $196 million increase in interest-bearing deposits (to $846 million or 95% of average interest-bearing liabilities), and a $17 million decrease in average other interest-bearing liabilities (to $48 million), all heavily influenced by the size and timing of the acquisitions in 2013 and the growth in deposits offsetting the need for wholesale funding.

Provision for Loan Losses

The provision for loan losses for the nine months ended September 30, 2014 and 2013 was $2.0 million and $3.9 million, respectively, exceeding net charge offs of $1.2 million and $1.9 million, respectively. Asset quality trends remained relatively strong with continued resolutions of problem loans. The ALLL was $10.1 million (1.16% of loans) at September 30, 2014, compared to $9.2 million (1.09% of loans) at December 31, 2013 and $9.2 million (1.05% of loans) at September 30, 2013. The ALLL to loans ratio was impacted most after each of the 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $284 million of loans into the denominator. As events occur in the acquired loan portfolios, an ALLL will be established for this pool of assets as appropriate. Growth in the ALLL to loans ratio is mostly a result of the provision for loan losses exceeding net charge offs.

Nonperforming loans continue to improve. Nonperforming loans had been declining prior to the 2013 acquisitions. Shortly after the acquisitions, nonperforming loans increased to a high of $17.4 million (or 2.0% of loans) at September 30, 2013, but have since declined to $6.9 million (or 0.79% of loans) at September 30, 2014. Of the $16.7 million nonaccrual loans initially acquired in the 2013 acquisitions, $4.8 million remain which is included in the $6.9 million of nonaccruals at September 30, 2014.

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

Noninterest Income

Table 6: Noninterest Income

	For the three months ended September 30,										For the nine months ended September 30,
	2014		2013		$ Change			% Change			2014		2013		$ Change			% Change
(in thousands)
Service charges on deposit accounts	$	564	$	510	$	54			10.6	%	$	1,602	$	1,264	$	338			26.7	%
Trust services fee income		1,179		1,060		119			11.2			3,403		2,936		467			15.9
Mortgage income		505		353		152			43.1			1,151		1,939		(788	)		(40.6	)
Brokerage fee income		152		114		38			33.3			478		331		147			44.4
Bank owned life insurance (“BOLI”)		250		224		26			11.6			684		605		79			13.1
Rent income		292		204		88			43.1			880		728		152			20.9
Investment advisory fees		104		82		22			26.8			316		244		72			29.5
Gain on sale or writedown of assets, net		140		1,333		(1,193	)		N/M	*		448		1,382		(934	)		N/M	*
BPG		-		1,480		(1,480	)		N/M	*		-		11,915		(11,915	)		N/M	*
Other		459		382		77			20.2			1,323		920		403			43.8
Total noninterest income	$	3,645	$	5,742	$	(2,097	)		(36.5	)%	$	10,285	$	22,264	$	(11,979	)		(53.8	)%
Noninterest income without BPG and net gains	$	3,505	$	2,929	$	576			19.7	%	$	9,837	$	8,967	$	870			9.7	%

*N/M means not meaningful.

Comparison of the nine months ending September 30, 2014 versus 2013

Noninterest income was $10.3 million for the first nine months of 2014 (including $0.4 million of net gain on sales of assets), compared to $22.3 million for the first nine months of 2013 (including $13.3 million of combined BPG and net gain on sale of assets). Removing these net gains, noninterest income was up $0.9 million or 9.7% between the nine-month periods.

The BPGs were calculated as the net difference in the fair value of the net assets acquired less the consideration paid, resulting in a $9.5 million BPG for Mid-Wisconsin and a $2.4 million BPG for Bank of Wausau. See Note 2 of the notes to the unaudited consolidated financial statements for details of the acquisition accounting. Net gain on sale or writedown of assets was $0.5 million and $1.4 million for the nine months of 2014 and 2013, respectively. The 2014 activity consisted of a $0.3 million gain on the sale of an equity security holding, an $0.8 million net gain on sales of OREO, and a $0.6 million write-down of an acquired former branch building moved to OREO in second quarter 2014. The 2013 activity consisted of $1.2 million of net gains on sales of OREO and $0.2 million net gain on sales of investments.

Service charges on deposit accounts were $1.6 million for the first nine months of 2014, up $0.3 million (or 26.7%) over the comparable period of 2013. The increase resulted from greater service charges on deposits given higher deposit balances and number of accounts and from higher non-sufficient funds fees.

Trust service fees increased to $3.4 million for the first nine months of 2014, up $0.5 million (or 15.9%) over the comparable 2013 period. In addition to the larger base of customers acquired through the Mid-Wisconsin merger, there was continued market improvement over last year on assets under management, on which fees are based. Similarly, brokerage fees were $0.5 million, up $0.1 million or 44.4% over the first nine months of 2013, from increased legacy business, market improvements and to a lesser degree from the merger.

Mortgage income represents net gains received from the sale of residential real estate loans service-released into the secondary market and to a small degree, some related income. Residential refinancing activity and new purchase activity remained steady for the first half of 2013; however, mortgage production slowed considerably during the last half of 2013 and into 2014, largely in response to rising mortgage rates and certain mortgage regulation changes. As a result, mortgage income in the first nine months of 2014 was $1.2 million compared to $1.9 million for the first nine months of 2013. While business has picked up, levels still trail 2013. The change between nine-month periods was not significantly impacted by the acquisitions.

The remaining income categories included modest increases compared to the first nine months of 2013. BOLI income was $0.7 million for the first nine months of 2014, up $0.1 million (or 13.1%) from the comparable period in 2013, as a result of the $4.3 million increase of BOLI acquired in the Mid-Wisconsin transaction, and an additional $2.8 million of BOLI purchased in June 2014, bringing the average BOLI investment to $25.1 million, up 17.3%. Rent income, investment advisory fees and other noninterest income combined were $2.5 million for the first nine months of 2014 compared to $1.9 million for the comparable 2013 period, with the majority of the increase due to ancillary fees tied to deposit-related products, most particularly debit card, check cashing and wire fee income.

Noninterest Expense

Table 7: Noninterest Expense

	For the three months ended September 30,										For the nine months ended September 30,
	2014		2013		$ Change			% Change			2014		2013		$ Change			% Change
(in thousands)
Salaries and employee benefits	$	5,366	$	5,333	$	33			0.6	%	$	16,045	$	14,447	$	1,598			11.1	%
Occupancy, equipment and office		1,735		1,822		(87	)		(4.8	)		5,370		4,392		978			22.3
Business development and marketing		548		573		(25	)		(4.4	)		1,620		1,471		149			10.1
Data processing		816		724		92			12.7			2,345		1,719		626			36.4
FDIC assessments		160		240		(80	)		(33.3	)		547		480		67			14.0
Core deposit intangible amortization		284		342		(58	)		(17.0	)		934		776		158			20.4
Other		614		1,190		(576	)		(48.4	)		1,734		2,865		(1,131	)		(39.5	)
Total noninterest expense	$	9,523	$	10,224	$	(701	)		(6.9	)%	$	28,595	$	26,150	$	2,445			9.3	%

Comparison of the nine months ending September 30, 2014 versus 2013

Total noninterest expense was $28.6 million for the first nine months of 2014, up $2.4 million, or 9% over the first nine months of 2013; however, excluding the $1.9 million of non-recurring merger-based expenses (of which approximately $1 million was in personnel and $0.9 million was in other expense) incurred in the 2013 period, expenses were up 18%. The increase in almost all expense line items is predominately due to the larger operating base from the 2013 acquisitions being fully included in 2014 and only partially included in 2013.

Salaries and employee benefits expense was $16.0 million for the first nine months of 2014, up $1.6 million or 11% (or up 19% excluding the 2013 non-recurring merger-based expense) compared to the first nine months of 2013. The increase was partially attributable to the larger workforce following the acquisition and was also impacted by merit increases between the years, higher health insurance premiums, and increased 401k expense. Average full time equivalent employees for the first nine months of 2014 were 280, up 13% from 247 for the comparable 2013 period.

Occupancy, equipment and office expense increased $1.0 million to $5.4 million for the first nine months of 2014 compared to 2013. This 22% increase is in line with the addition of 12 branches from the acquisitions, which more than doubled the physical facilities and related expenses. Utilities, rent, snowplowing, and other occupancy expenses increased proportionately in conjunction with the acquisitions; however, a harsher 2014 winter, continued integration on systems and phones, and postage resulted in higher expense between the nine-month periods.

Business development and marketing expense increased $0.1 million between the comparable nine-month periods. This 10% increase includes a greater focus on growth in new markets, including television costs, and higher expense on promotional materials.

Data processing expenses, which are primarily volume-based, rose $0.6 million or 36% between the nine-month periods, in line with the increase in number of accounts and continued integration of systems. FDIC assessments increased by $0.1 million, mainly given the increase in assets (on which the assessments are based) between the nine-month periods but at a more favorable rate in 2014. Core deposit intangible amortization increased $0.2 million, attributable to the core deposit intangible recorded with the Mid-Wisconsin acquisition.

Other expense decreased $1.1 million (or 39.5%) to $1.7 million for the first nine months of 2014. The first nine months of 2013 carried approximately $0.9 million non-recurring merger-based expenses (mainly consulting and legal fees); without these direct costs, other expense decreased modestly by $0.2 million.

Income Taxes

For both nine-month periods ending September 30, 2014 and 2013, income tax expense was $3.4 million. Tax expense for 2014 includes a $0.5 million tax benefit recorded to the deferred tax asset in the second quarter due to the increased ability to utilize net operating losses under the Internal Revenue Code section 382 following the one-year evaluation period related to the acquisition. Tax expense for the first nine months of 2013 was influenced by the $9.5 million BPG related to the Mid-Wisconsin acquisition, which was a tax free transaction. The effective tax rate was 31% for the first nine months of 2014 compared to 18% for the same nine-month period in 2013. GAAP requires that deferred income taxes be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. No valuation allowance was determined to be necessary as of September 30, 2014 or December 31, 2013.

Comparison of the three months ending September 30, 2014 versus 2013

Nicolet reported net income of $2.8 million for the three months ended September 30, 2014, compared to $2.9 million for the comparable period of 2013. Net income available to common shareholders for the third quarter of 2014 was $2.7 million, or $0.63 per diluted common share, compared to net income available to common shareholders of $2.6 million, or $.62 per diluted common share, for the third quarter of 2013. Income statement results and average balances for third quarter 2013 include approximately two months of activity from Bank of Wausau, while those for the third quarter of 2014 include fully the results of the Bank of Wausau acquisition.

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $10.9 million in the third quarter of 2014 versus $11.8 million in the third quarter of 2013. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $213,000 and $170,000 for the three months ended September 30, 2014 and 2013, respectively, resulting in taxable equivalent net interest income of $11.1 million and $12.0 million, respectively. Taxable equivalent net interest income for third quarter 2014 was down $0.9 million or 7% versus third quarter 2013, with $1.1 million of the decrease due to rate variances (predominately in loans, with the 2013 quarter carrying the favorable resolution of two acquired loans at $1 million greater than their estimated fair values) offset with a $0.2 million increase from favorable volume variances (especially in earning assets).

The earning asset yield was 4.82% for third quarter 2014, 44 bps lower than third quarter 2013, mainly due to a decline in the yield on loans (as explained above) and also influenced by a higher percentage of average non-loan earning assets (21% for third quarter 2014 versus 17% of earning assets for third quarter 2013) which earn less than loan assets.

Between the third quarter periods, the cost of funds increased 3 bps to 0.80% in 2014 versus 2013. The increase in cost of funds was driven mainly by the 2014 quarter carrying a 96% mix of interest-bearing deposits costing 0.65% compared to a 92% mix and 0.59% cost, respectively, for the comparable 2013 quarter. In addition, a portion of brokered deposits and other wholesale funds matured between the quarters and those renewed were generally at extended maturities, for interest rate risk considerations, at higher rates. Core CDs and IRAs cost more between the third quarter periods, largely from the conclusion in February 2014 of a favorable fair value mark on acquired CDs.

Noninterest income was $3.6 million for third quarter 2014, down $2.1 million from $5.7 million for the third quarter 2013. Noninterest income without BPG and net gains was up $0.6 million or 20%, largely due to mortgage income (up $0.2 million given higher production), and trust and brokerage fees (up $0.2 million combined given increased business and market improvements). Net gain on sale or writedown of assets for third quarter 2014 consisted of a $0.1 million net gain on OREO resolutions, while third quarter 2013 included $0.9 million of net gains on OREO sales, and $0.4 million net gains on sales of investments. The BPG in third quarter 2013 consisted of a pre-tax BPG of $2.4 million on the Bank of Wausau transaction and a $0.9 million negative adjustment to the Mid-Wisconsin BPG for a change in estimate on a now settled legal action.

Noninterest expense was $9.5 million for the third quarter of 2014, down $0.7 million from third quarter 2013; however, excluding the $0.2 million of non-recurring merger-based expenses incurred in third quarter 2013, noninterest expense was down $0.5 million or 5%. Salaries and employee benefits were essentially flat between the third quarter periods with merit and other year-over-year increases offset by a slight reduction in full time equivalent employees. FDIC assessments were down 33% given lower assets and a more favorable rate than third quarter last year. Other expenses (including legal, consulting and audit expense) decreased $0.6 million between the third quarter periods, partially due to the above-noted merger costs in the 2013 period and decreases in foreclosure and OREO carrying costs between periods with properties being sold for gains later in 2013 and during 2014.

The provision for loan losses for the three months ended September 30, 2014 and 2013 was $0.7 million and $2.0 million respectively. Net charge offs for the quarter ending September 30, 2014 were $0.3 million compared to $0.4 million for the same period in 2013. At September 30, 2014, the ALLL was $10.1 million (or 1.16% of total loans) compared to $9.2 million (or 1.05% of total loans) at September 30, 2013.

Income tax expense was $1.6 million and $2.4 million for the third quarters of 2014 and 2013, respectively. The effective tax rates were 36% for third quarter 2014 and 45% for third quarter 2013 (mainly due to the taxable nature of the Bank of Wausau BPG).

BALANCE SHEET ANALYSIS

Loans

Nicolet services a diverse customer base throughout Northeast and Central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, agriculture, wholesaling, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.

Nicolet’s primary lending function is to make commercial loans, consisting of commercial and industrial business loans, agricultural production, and owner-occupied commercial real estate loans; CRE loans, consisting of commercial investment real estate loans, agricultural real estate, and construction and land development loans; residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and to a lesser degree residential construction loans; and retail and other loans.

Total loans were $865 million at September 30, 2014 compared to $847 million at December 31, 2013. This $18 million increase represented 2% growth in the first nine months of 2014 but reflected a $7 million decrease or 1% decline from the balance at September 30, 2013. On average, loans were $855 million and $720 million for the first nine months of 2014 and 2013, respectively, up 19%. Excluding the $284 million of loans added at acquisition ($272 million from Mid-Wisconsin and $12 million from Bank of Wausau), average organic loan growth was approximately 3% between the nine-month periods.

Table 8: Period End Loan Composition

	September 30, 2014					December 31, 2013					September 30, 2013
	Amount		% of Total			Amount		% of Total			Amount		% of Total
Commercial & industrial	$	282,357		32.6	%	$	253,674		29.9	%	$	251,590		28.9	%
Owner-occupied CRE		179,166		20.7			187,476		22.1			203,715		23.4
AG production		14,632		1.7			14,256		1.7			14,071		1.6
AG real estate		42,195		4.9			37,057		4.4			37,738		4.3
CRE investment		77,067		8.9			90,295		10.7			106,763		12.2
Construction & land development		42,462		4.9			42,881		5.1			38,757		4.4
Residential construction		11,260		1.3			12,535		1.5			12,831		1.5
Residential first mortgage		157,730		18.2			154,403		18.2			150,117		17.2
Residential junior mortgage		52,523		6.1			49,363		5.8			49,518		5.7
Retail & other		5,693		0.7			5,418		0.6			6,832		0.8
Total loans	$	865,085		100	%	$	847,358		100	%	$	871,932		100	%

Broadly, commercial-based loans (i.e. commercial, AG, CRE and construction loans combined) versus retail-based loans (i.e. residential real estate and other retail loans) were unchanged at 74% commercial-based and 26% retail-based at September 30, 2014 and December 31, 2013. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively as well as the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.

Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans increased $29 million since year end 2013. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 32.6% of the total portfolio at September 30, 2014, up from 29.9% at December 31, 2013.

Owner-occupied CRE loans declined to 20.7% of loans at September 30, 2014 from 22.1% at December 31, 2013 and primarily consist of loans within a diverse range of industries secured by business real estate that is occupied by borrowers (i.e. who operate their businesses out of the underlying collateral) and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.

Agricultural production and agricultural real estate loans combined consist of loans secured by farmland and related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. In total, agricultural loans increased $6 million since year end 2013, representing 6.6% of total loans at September 30, 2014, versus 6.1% at December 31, 2013.

The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. The balance of these loans declined $13 million since year end 2013, declining as a percent of loans from 10.7% to 8.9% at September 30, 2014.

Loans in the construction and land development portfolio represent 4.9% of total loans at September 30, 2014 and such loans provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis. Lending on originated loans in this category declined steadily both in total dollars and as a percentage of the portfolio over the past several years, with the 2013 increase attributable to the 2013 acquisitions. Since December 31, 2013, balances have decreased only $0.4 million and have declined slightly as a percent of loans.

On a combined basis, Nicolet’s residential real estate loans represent 25.6% of total loans at September 30, 2014, up 0.1% from December 31, 2013. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. Across the industry, home equities generally involve loans that are in second or junior lien positions, but Nicolet has secured many such loans in a first lien position, further mitigating the portfolio risks. Nicolet has not experienced significant losses in its residential real estate loans; however, if market values in the residential real estate markets decline, particularly in Nicolet’s market area, rising loan-to-value ratios could cause an increase in the provision for loan losses. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge off rates. While mortgage loans normally hold terms of 30 years, Nicolet’s portfolio mortgages have an average contractual life of less than 15 years.

Loans in the retail and other classification represent less than 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions. The loan balances in this portfolio remained relatively unchanged from December 31, 2013 to September 30, 2014.

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.

The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2014, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.

Allowance for Loan and Lease Losses

In addition to the discussion that follows, see also Note 1, “Basis of Presentation,” and Note 6, “Loans, Allowance for Loan Losses and Credit Quality,” in the notes to the unaudited consolidated financial statements.

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

The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged off against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Nicolet’s methodology reflects guidance by regulatory agencies to all financial institutions.

Management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Loans measured for impairment include nonaccrual loans, non-performing troubled debt-restructurings (“restructured loans”), or other loans determined to be impaired by management. Second, Nicolet’s management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. Beginning in the first quarter of 2014, management extended the look-back period on which the average historical loss rates are determined, from a prior three-year period to a rolling 20-quarter (5 year) average, as a means of capturing more of a full credit cycle now that recent period loss levels are stabilizing. Contrarily, the three-year average (used by the Company’s methodology during 2009-2013) was considered more appropriate for the severe and prolonged economic downturn particularly evidenced by higher net charge off levels in 2008 through 2011. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment.

Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.

Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.

At September 30, 2014, the ALLL was $10.1 million compared to $9.2 million at December 31, 2013. The nine-month increase was a result of a 2014 provision of $2.0 million offset by 2014 net charge offs of $1.2 million. Comparatively, the provision for loan losses in the first nine months of 2013 was $3.9 million and net charge offs were $1.9 million. Annualized net charge offs as a percent of average loans were 0.19% in the first nine months of 2014 compared to 0.35% for the first nine months of 2013 and 0.54% for the entire 2013 year. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. The level of the provision for loan losses is directly correlated to the assessment of the adequacy of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.

The ratio of the ALLL as a percentage of period-end loans was 1.16% at September 30, 2014 compared to 1.09% at December 31, 2013 and 1.05% at September 30, 2013. The ALLL to loans ratio was impacted most after each of the 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $284 million to the denominator. As events occur in the acquired loan portfolios, an ALLL will be established for this pool of assets as appropriate.

The largest portions of the ALLL were allocated to construction and land development loans and commercial & industrial loans combined, representing 60.8% and 73.3% of the ALLL at September 30, 2014 and December 31, 2013, respectively. The decreased allocation to these categories since December 31, 2013 was the result of changes to allowance allocations as additional qualitative factors are refined, creating a more ratable distribution of the provision across categories.

Table 9: Loan Loss Experience

	For the nine months ended						Year ended
(in thousands)	September 30, 2014			September 30, 2013			December 31, 2013
Allowance for loan losses (ALLL):
Balance at beginning of period	$	9,232		$	7,120		$	7,120
Provision for loan losses		2,025			3,925			6,200
Charge-offs		1,291			1,978			4,238
Recoveries		(86	)		(120	)		(150	)
Net charge-offs		1,205			1,858			4,088
Balance at end of period	$	10,052		$	9,187		$	9,232

Net loan charge-offs (recoveries):
Commercial & industrial	$	517		$	447		$	534
Owner-occupied CRE		453			30			1,851
Agricultural production		-			-			-
Agricultural real estate		-			-			-
CRE investment		(12	)		798			992
Construction & land development		12			319			304
Residential construction		-			-			-
Residential first mortgage		190			78			148
Residential junior mortgage		17			141			189
Retail & other		28			45			70
Total net loans charged-off	$	1,205		$	1,858		$	4,088

ALLL to total loans		1.16	%		1.05	%		1.09	%
ALLL to net charge-offs		834	%		494	%		226	%
Net charge-offs to average loans, annualized		0.19	%		0.35	%		0.54	%

The allocation of the ALLL is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 10 for September 30, 2014 and December 31, 2013.

Table 10: Allocation of the Allowance for Loan Losses

(in thousands)	September 30, 2014			% of Loan Type to Total Loans			December 31, 2013			% of Loan Type to Total Loans
ALLL allocation
Commercial & industrial	$	3,599			32.6	%	$	1,798			29.9	%
Owner-occupied CRE		1,370			20.7			766			22.1
Agricultural production		54			1.7			18			1.7
Agricultural real estate		272			4.9			59			4.4
CRE investment		638			8.9			505			10.7
Construction & land development		2,513			4.9			4,970			5.1
Residential construction		156			1.3			229			1.5
Residential first mortgage		964			18.2			544			18.2
Residential junior mortgage		433			6.1			321			5.8
Retail & other		53			0.7			22			0.6
Total ALLL	$	10,052			100	%	$	9,232			100	%

ALLL category as a percent of total ALLL:
Commercial & industrial		35.8	%					19.5	%
Owner-occupied CRE		13.6						8.3
Agricultural production		0.5						0.2
Agricultural real estate		2.7						0.6
CRE investment		6.3						5.5
Construction & land development		25.0						53.8
Residential construction		1.6						2.5
Residential first mortgage		9.6						5.9
Residential junior mortgage		4.3						3.5
Retail & other		0.6						0.2
Total ALLL		100	%					100	%

Impaired Loans and Nonperforming Assets

As part of its overall credit risk management process, Nicolet’s management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans were $6.9 million (consisting of $2.1 million originated loans and $4.8 million acquired loans) at September 30, 2014 compared to $10.3 million at December 31, 2013 (consisting of $0.8 million originated loans and $9.5 million acquired loans). Nonperforming assets (which include nonperforming loans and OREO) were $7.8 million at September 30, 2014 compared to $12.3 million at December 31, 2013. OREO decreased from $2.0 million at year end 2013 to $1.0 million at September 30, 2014. OREO at September 30, 2014 included an acquired branch which was moved from active to inactive status and written to a fair value of $0.2 million. Nonperforming assets as a percent of total assets were 0.67% at September 30, 2014 compared to 1.02% at December 31, 2013.

The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $16.3 million (1.9% of loans) and $18.7 million (2.2% of loans) at September 30, 2014 and December 31, 2013, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.

Table 11: Nonperforming Assets

(in thousands)	September 30, 2014			December 31, 2013			September 30, 2013
Nonaccrual loans:
Commercial & industrial	$	548		$	68		$	115
Owner-occupied CRE		1,487			1,087			5,521
AG production		23			11			15
AG real estate		394			448			451
CRE investment		1,433			4,631			6,447
Construction & land development		943			1,265			1,310
Residential construction		—			—			—
Residential first mortgage		1,845			2,365			3,112
Residential junior mortgage		178			262			322
Retail & other		—			129			129
Total nonaccrual loans		6,851			10,266			17,422
Accruing loans past due 90 days or more		—			—			—
Total nonperforming loans	$	6,851		$	10,266		$	17,422
CRE investment	$	352		$	935		$	874
Owner-occupied CRE		256			—			552
Construction & land development		38			854			1,963
Residential real estate owned		117			198			471
Bank property real estate owned		200			—			—
OREO		963			1,987			3,860
Total nonperforming assets	$	7,814		$	12,253		$	21,282
Total restructured loans accruing	$	3,834		$	3,862		$	3,862
Ratios
Nonperforming loans to total loans		0.79	%		1.21	%		2.00	%
Nonperforming assets to total loans plus OREO		0.90	%		1.44	%		2.43	%
Nonperforming assets to total assets		0.67	%		1.02	%		1.88	%
ALLL to nonperforming loans		146.7	%		89.9	%		43.1	%
ALLL to total loans		1.16	%		1.09	%		1.05	%

Table 12: Investment Securities Portfolio

	September 30, 2014							December 31, 2013

(in thousands)	Amortized Cost		Fair Value		% of Total			Amortized Cost		Fair Value		% of Total
U.S. Government sponsored enterprises	$	1,027	$	1,029		1	%	$	2,062	$	2,057		2	%
State, county and municipals		82,429		83,188		55	%		54,594		55,039		43	%
Mortgage-backed securities		64,206		64,069		43	%		68,642		67,879		53	%
Corporate debt securities		220		220		-			220		220		-
Equity securities		1,022		2,143		1	%		905		2,320		2	%
Total	$	148,904	$	150,649		100	%	$	126,423	$	127,515		100	%

At September 30, 2014 the total carrying value of investment securities was $151 million, up from $128 million at December 31, 2013, and represented 12.9% and 10.6% of total assets at September 30, 2014 and December 31, 2013, respectively. At September 30, 2014, the securities portfolio did not contain securities of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of shareholders’ equity.

In addition to securities available for sale, Nicolet had other investments of $8.1 million at September 30, 2014 and $8.0 million at December 31, 2013, consisting of capital stock in the Federal Reserve and the FHLB (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System), and the Federal Agricultural Mortgage Corporation, as well as equity investments in other privately-traded companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus, not liquid, have no ready market or quoted market value, and are carried at cost. The remaining investments have no quoted market prices, and are carried at cost less other than temporary impairment (“OTTI”) charges, if any. Nicolet’s management evaluates all these other investments periodically for impairment, considering financial condition and other available relevant information. There were no OTTI charges recorded in 2013 or year to date 2014.

Table 13: Investment Securities Portfolio Maturity Distribution


	As of September 30, 2014
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years				Mortgage- related and Equity Securities					Total Amortized Cost				Total Fair Value Amount
	Amount			Yield		Amount			Yield		Amount			Yield		Amount		Yield		Amount			Yield		Amount		Yield		Total Fair Value Amount
(in thousands)
U.S. government sponsored enterprises	$	505		2.8	%	$	144		1.5	%	$	378		2.0	%	$	—	—	%	$	—		—	%	$	1,027	2.3	%	$	1,029
State and county municipals (1)		4,017		3.2			69,584		2.5			8,264		3.2			564	4.4			—		—			82,429	2.6			83,188
Corporate debt securities		—		—			—		—			—		—			220	2.0			—		—			220	2.0			220
Mortgage-backed securities		—		—			—		—			—		—			—	—			64,206		3.3			64,206	3.3			64,069
Equity securities		—		—			—		—			—		—			—	—			1,022		6.2			1,022	6.2			2,143
Total amortized cost	$	4,522		3.2	%	$	69,728		2.5	%	$	8,642		3.1	%	$	784	3.7	%	$	65,228		3.3	%	$	148,904	2.9	%	$	150,649
Total fair value and carrying value	$	4,555				$	70,482				$	8,607				$	793			$	66,212								$	150,649
As a percent of total fair value		3	%				47	%				6	%				-				44	%

(1)	The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.

Deposits

Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Included in total deposits in Table 14 are brokered deposits of $33 million at September 30, 2014 and $50 million at December 31, 2013.

Table 14: Deposits


	September 30, 2014				December 31, 2013
(in thousands)	Amount		% of Total		Amount		% of Total
Demand	$	195,048	19.3	%	$	171,321	16.6	%
Money market and NOW accounts		445,069	44.0	%		492,499	47.6	%
Savings		119,901	11.8	%		97,601	9.4	%
Time		251,491	24.9	%		273,413	26.4	%
Total deposits	$	1,011,509	100	%	$	1,034,834	100	%

Total deposits were $1.01 billion at September 30, 2014, with no significant change since December 31, 2013. On average for the first nine months of 2014, total deposits were $1.02 billion, up 31% versus $777 million for the comparable 2013 period. Excluding the $370 million of deposits added at acquisition ($346 million from Mid-Wisconsin and $24 million of net deposits from Bank of Wausau given the quick redemption of $18 million of rate-sensitive certificates of deposit), average organic deposit growth was approximately 8% between the nine-month periods.

Table 15: Average Deposits


	For the nine months ended
	September 30, 2014				September 30, 2013
(in thousands)	Amount		% of Total		Amount		% of Total
Demand	$	171,701	16.9	%	$	126,420	16.3	%
Money market and NOW accounts		474,655	46.6	%		356,197	45.9	%
Savings		106,958	10.5	%		73,353	9.4	%
Time		264,345	26.0	%		220,882	28.4	%
Total	$	1,017,659	100	%	$	776,852	100	%

Table 16: Maturity Distribution of Certificates of Deposit


(in thousands)	September 30, 2014
3 months or less	$	38,799
Over 3 months through 6 months		33,392
Over 6 months through 12 months		51,574
Over 12 months		127,726

Total	$	251,491

Other Funding Sources

Other funding sources, which include short-term and long-term borrowings (notes payable and junior subordinated debentures), were $35 million and $52 million at September 30, 2014 and December 31, 2013, respectively. Short-term borrowings, consisting mainly of customer repurchase agreements maturing in less than three months, totaled $7 million at December 31, 2013. There were no short-term borrowings outstanding at September 30, 2014. Long-term borrowings include a joint venture note and FHLB advances, totaling $22 million and $32 million at September 30, 2014 and December 31, 2013, respectively. Junior subordinated debentures are another long-term funding source totaling $12 million at September 30, 2014 and December 31, 2013. Junior subordinated debentures of $6.2 million were issued in July 2004 in connection with the issuance of $6.0 million of trust preferred securities. Acquired junior subordinated debentures of $10.3 million issued in connection with $10.0 million of trust preferred securities were assumed in the Mid-Wisconsin merger and initially recorded at the fair market value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. Further information regarding these junior subordinated debentures is located in “Note 8 – Junior Subordinated Debentures” in the notes to the unaudited consolidated financial statements.

Off-Balance Sheet Obligations

As of September 30, 2014 and December 31, 2013, Nicolet had the following commitments that did not appear on its balance sheet:

Table 17: Commitments


	September 30,		December 31,
	2014		2013
(in thousands)
Commitments to extend credit — Fixed and variable rate	$	265,917	$	234,930
Standby and irrevocable letters of credit-fixed rate		6,728		6,371

Liquidity and Interest Rate Sensitivity

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

Funds are available from a number of basic banking activity sources including but not limited to the core deposit base, the repayment and maturity of loans, investment securities calls, maturities, and sales, and funds obtained through brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. Approximately $51 million of the $151 million investment securities portfolio on hand at September 30, 2014 was pledged to secure public deposits, short-term borrowings, repurchase agreements, and for other purposes as required by law. Other funding sources available include short-term borrowings, federal funds purchased, and long-term borrowings.

Cash and cash equivalents at September 30, 2014 and December 31, 2013 were approximately $67 million and $147 million, respectively. The increased cash and cash equivalents at year end 2013 was predominantly due to strong customer deposit growth outpacing the loan demand. These levels have declined through the first nine months of 2014 as is typical of Nicolet’s historical deposit behaviors. Nicolet’s liquidity resources were sufficient as of September 30, 2014 to fund loans and to meet other cash needs as necessary.

Interest Rate Sensitivity Gap Analysis

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

At December 31, 2013, the one year cumulative gap was $85 million with a cumulative ratio of rate sensitive assets to rate sensitive liabilities of 114% representing a slightly asset sensitive position. At December 31, 2013 the cumulative one year gap to total assets ratio was 7% which was within Nicolet’s established guidelines of not greater than +25% or -25% of total assets. During the first nine months of 2014, interest bearing cash equivalents declined in conjunction with Nicolet’s cyclical decline in deposits. The one year cumulative gap at September 30, 2014 increased to $103 million and represented a cumulative ratio of rate sensitive assets to rate sensitive liabilities of 121%, versus 114% at year-end 2013. At September 30, 2014 the cumulative one year gap to total assets ratio was 9% which was within Nicolet’s established guidelines of not greater than +25% or -25% of total assets.

In order to limit exposure to interest rate risk, management monitors the liquidity and gap analysis on a monthly basis and may adjust pricing, term and product offerings when necessary to stay within applicable guidelines and maximize the effectiveness of asset/liability management.

Along with the static gap analysis, Nicolet’s management also estimates the effect a gradual change and a sudden change in interest rates could have on expected net interest income through income simulation. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, and 300 bps or decreasing 100, 200 and 300 bps. All rates are increased or decreased parallel to the change in prime rate. The simulation assumes a static mix of assets and liabilities. As a result of the simulation, over a 12-month time period ending September 30, 2014, net interest income was estimated to decrease 1.7% if rates increase 100 bps in an immediate shock scenario, and was estimated to decrease 2.9% in a 100 bps declining rate environment assumption. These results are in line with Nicolet’s interest rate sensitivity position under a static balance sheet, including relatively short (though extending) loan maturities and level of variable rate loans with interest floors; as rates remain low, asset maturities extend, and deposit maturities contract, pressuring the position to become more liability-sensitive. These results are based solely on the modeled changes in the market rates and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve, changes in spreads between key market rates, or changes in consumer or business behavior. These results also do not include any management action to mitigate potential income variances within the modeled process. The simulation results are one indicator of interest rate risk, and actual net interest income is largely impacted by the allocation of assets, liabilities and product mix. Management continually reviews its interest rate risk position through the Asset/Liability Committee process, and such Committee reports to the full board of directors on a monthly basis.

Capital

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

The SBLF is a U.S. Treasury program made available to community banks, designed to boost lending to small businesses by providing participating banks with capital and liquidity. In particular, the SBLF program targets commercial, industrial, owner-occupied real-estate and agricultural-based lending to qualifying small businesses, which include businesses with less than $50 million in revenue, and promotes outreach to women-owned, veteran-owned and minority-owned businesses.

For participating banks, the annual dividend rate upon funding and for the following nine full calendar quarters was 5%, unless there was growth in qualifying small business loans outstanding over a baseline which could reduce the rate to as low as 1% (as determined under the terms of the Securities Purchase Agreement (the “Agreement”)), adjusted quarterly. The dividend rate fixes for the tenth full quarter after funding through the end of the first four and one-half years based on the amount of qualifying small business loans at that time per the terms of the Agreement. The dividend rate is then fixed at 9% after four and one-half years if the preferred stock is not repurchased or redeemed. On September 1, 2011, under the SBLF, Nicolet received $24.4 million from the Treasury for the issuance of 24,400 shares of Non-Cumulative Perpetual Preferred Stock, Series C, with $1,000 per share liquidation value (the “Series C Preferred Stock”). Nicolet paid an annual dividend rate of 5% from funding through September 30, 2013, paid 1% for the quarter ended December 31, 2013 (i.e. the ninth full quarter after funding) and has qualified beginning in the first quarter of 2014 for the 1% fixed annual dividend rate for the remainder of the first four and one-half years. Nicolet does not have current plans to repay its SBLF funding. Under the terms of the Agreement, Nicolet is required to provide various information, certifications, and reporting to the Treasury. At September 30, 2014, Nicolet believes it was in compliance with the requirements set by the Treasury in the Agreement. The Series C Preferred Stock qualifies as Tier 1 capital for regulatory purposes.

On April 26, 2013, through a private placement, the Company raised $2.9 million in capital, issuing 174,016 shares of common stock.

On April 26, 2013, in its acquisition of Mid-Wisconsin, the Company issued 589,159 shares of its common stock at a value of $9.7 million. The $0.4 million of incurred issuance costs was charged against additional paid in capital. As a result of this merger, Nicolet became an SEC-reporting company and listed its common stock on the Over-the-Counter markets under the trading symbol of “NCBS.”

On January 21, 2014, Nicolet’s board of directors approved a resolution authorizing a stock repurchase program whereby Nicolet may utilize up to $6 million to purchase up to 350,000 shares of its outstanding common stock from time to time in the open market or block transactions as market conditions warrant or in private transactions. During the first nine months of 2014, $4.0 million was used to repurchase 187,543 shares at a weighted average price of $21.07 per share including commissions.

A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of September 30, 2014 and December 31, 2013 are presented in the following table.

Table 19: Capital


	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions (2)
(in thousands)	Amount		Ratio (1)		Amount		Ratio (1)		Amount		Ratio (1)
As of September 30, 2014:
Nicolet
Total capital	$	125,384	14.2	%	$	70,485	8.0	%		N/A	N/A
Tier I capital		115,332	13.1			35,243	4.0			N/A	N/A
Leverage		115,332	10.0			46,139	4.0			N/A	N/A

Nicolet National Bank
Total capital	$	117,386	13.5	%	$	69,464	8.0	%	$	86,830	10.0	%
Tier I capital		107,334	12.4			34,732	4.0			52,098	6.0
Leverage		107,334	9.4			45,650	4.0			57,062	5.0

As of December 31, 2013:
Nicolet
Total capital	$	119,050	13.8	%	$	69,075	8.0	%		N/A	N/A
Tier I capital		109,817	12.7			34,538	4.0			N/A	N/A
Leverage		109,817	9.5			46,322	4.0			N/A	N/A

Nicolet National Bank
Total capital	$	111,343	13.1	%	$	68,110	8.0	%	$	85,138	10.0	%
Tier I capital		102,111	12.0			34,055	4.0			51,083	6.0
Leverage		102,111	8.9			43,858	4.0			57,323	5.0

(1)

The total capital ratio is defined as tier1 capital plus tier 2 capital divided by total risk-weighted assets. The tier 1 capital ratio is defined as tier1 capital divided by total risk-weighted assets. The leverage ratio is defined as tier1 capital divided by the most recent quarter’s average total assets, adjusted in accordance with regulatory guidelines.

(2)	Prompt corrective action provisions are not applicable at the bank holding company level.

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to Nicolet and Nicolet National Bank. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Federal Reserve. The final rules implement the “Basel III” regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act.

The final rules include new risk-based capital and leverage ratios that will be phased in from 2015 to 2019. The rules include a new minimum common equity Tier 1 capital to risk-weighted assets (“CET1”) ratio of 4.5% and a CET1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Tier 2 risk-based capital requirements. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for Nicolet on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers.

The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The final rules provide that depository holding companies with less than $15 billion in total assets as of December 31, 2009, such as Nicolet, may permanently include trust preferred securities and certain other non-qualifying instruments issued and included in Tier 1 or Tier 2 capital before May 19, 2010 in additional Tier 1 (subject to a maximum of 25% of Tier 1 capital) or Tier 2 capital until maturity or redemption.

The final rules also set forth certain changes for the calculation of risk-weighted assets that the Company will be required to implement beginning January 1, 2015. Based on Nicolet’s current capital composition and levels, management does not presently anticipate that the final rules present a material risk to Nicolet’s financial condition or results of operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable for smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

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

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

Not applicable for smaller reporting company.

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

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Effective November 6, 2014, Nicolet National Bank and Nicolet entered into an employment agreement with Ann K. Lawson, Chief Financial Officer of Nicolet and Nicolet National Bank, regarding her employment. Under the terms of the agreement, Ms. Lawson receives a fixed annual base salary of $190,000 (which may be increased annually by the Board of Directors), plus benefits, and annual bonus compensation pursuant to any incentive compensation program as may be adopted from time to time by the Board of Directors. Ms. Lawson’s agreement automatically renews for an additional day each day after November 6, 2014, so that it always has a three-year term, unless any of the parties to the agreement give notice of intent not to renew the agreement, which will cause the agreement to terminate on the third anniversary of the 30th day following the date of notice. Nicolet and Nicolet National Bank are obligated to pay Ms. Lawson her base salary and reimbursement of health insurance costs under terminating events, as defined per the agreement, which include: maximum 6 months of base salary if Ms. Lawson becomes disabled; maximum 12 months of base salary and reimbursement of health insurance costs if Ms. Lawson is involuntarily terminated without cause; maximum 12 months of base salary and reimbursement of health insurance costs if employment is terminated by Ms. Lawson for cause; and one and one-half times base salary and bonus and 12 months reimbursement of health insurance costs if Ms. Lawson terminates her employment for cause within six months of a change of control. The agreement also provides various other benefits and subjects Ms. Lawson to non-compete and other restrictive covenants for a twelve month period following certain employment termination events.

ITEM 6. EXHIBITS

The following exhibits are filed herewith:


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

*Indicates information that is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

SIGNATURES

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


		NICOLET BANKSHARES, INC.

November 7, 2014		/s/ Robert B. Atwell
		Robert B. Atwell
		Chairman, President and Chief Executive Officer

November 7, 2014		/s/ Ann K. Lawson
		Ann K. Lawson
		Chief Financial Officer