NICOLET BANKSHARES INC - Quarter Report: 2018 June (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 June 30, 2018

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

For the transition period from to

Commission file number: 001-37700

NICOLET BANKSHARES, INC.

(Exact Name of Registrant as Specified in its Charter)

WISCONSIN

(State or Other Jurisdiction of Incorporation or Organization)

47-0871001

(I.R.S. Employer Identification No.)

111 North Washington Street

Green Bay, Wisconsin

(Address of Principal Executive Offices)

54301

(Zip Code)

(920) 430-1400

(Registrant’s Telephone Number, Including Area Code)

N/A

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

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

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

Large accelerated filer ¨	Accelerated filer x

Non-accelerated filer ¨	Smaller reporting company ¨

Emerging Growth Company x

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

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

As of July 31, 2018 there were 9,644,774 shares of $0.01 par value common stock outstanding.

Nicolet Bankshares, Inc.

TABLE OF CONTENTS

			PAGE
PART I	FINANCIAL INFORMATION

	Item 1.	Financial Statements:

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

		Consolidated Statements of IncomeThree and Six Months Ended June 30, 2018 and 2017 (unaudited)	4

		Consolidated Statements of Comprehensive IncomeThree and Six Months Ended June 30, 2018 and 2017 (unaudited)	5

		Consolidated Statement of Stockholders’ Equity Six Months Ended June 30, 2018 (unaudited)	6

		Consolidated Statements of Cash FlowsSix Months Ended June 30, 2018 and 2017 (unaudited)	7

		Notes to Unaudited Consolidated Financial Statements	8-28

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29-44

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44

	Item 4.	Controls and Procedures	44

PART II	OTHER INFORMATION

	Item 1.	Legal Proceedings	45

	Item 1A.	Risk Factors	45

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45

	Item 3.	Defaults Upon Senior Securities	45

	Item 4.	Mine Safety Disclosures	45

	Item 5.	Other Information	45

	Item 6.	Exhibits	46

		Signatures	47

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS:

NICOLET BANKSHARES, INC.

Consolidated Balance Sheets
(In thousands, except share and per share data)

	June 30, 2018 (Unaudited)			December 31, 2017 (Audited)
Assets
Cash and due from banks	$	62,668		$	86,191
Interest-earning deposits		40,661			68,008
Federal funds sold		740			734
Cash and cash equivalents		104,069			154,933
Certificates of deposit in other banks		1,247			1,746
Securities available for sale (“AFS”), at fair value		401,975			405,153
Other investments		17,749			14,837
Loans held for sale		6,037			4,666
Loans		2,128,624			2,087,925
Allowance for loan losses		(12,875	)		(12,653	)
Loans, net		2,115,749			2,075,272
Premises and equipment, net		46,785			47,151
Bank owned life insurance (“BOLI”)		65,363			64,453
Goodwill and other intangibles, net		126,124			128,406
Accrued interest receivable and other assets		37,053			35,816
Total assets	$	2,922,151		$	2,932,433

Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing demand deposits	$	621,576		$	631,831
Interest-bearing deposits		1,833,960			1,839,233
Total deposits		2,455,536			2,471,064
Short-term borrowings		-			-
Long-term borrowings		77,176			78,046
Accrued interest payable and other liabilities		18,154			18,444
Total liabilities		2,550,866			2,567,554

Stockholders’ Equity:
Common stock		96			98
Additional paid-in capital		254,564			263,835
Retained earnings		122,642			102,391
Accumulated other comprehensive loss		(6,718	)		(2,146	)
Total Nicolet Bankshares, Inc. stockholders’ equity		370,584			364,178
Noncontrolling interest		701			701
Total stockholders’ equity and noncontrolling interest		371,285			364,879
Total liabilities, noncontrolling interest and stockholders’ equity	$	2,922,151		$	2,932,433

Preferred shares authorized (no par value)		10,000,000			10,000,000
Preferred shares issued and outstanding		-			-
Common shares authorized (par value $0.01 per share)		30,000,000			30,000,000
Common shares outstanding		9,642,834			9,818,247
Common shares issued		9,669,350			9,849,167

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Income

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Interest income:
Loans, including loan fees	$	27,193	$	24,673	$	55,647	$	45,768
Investment securities:
Taxable		1,597		1,239		2,939		2,308
Tax-exempt		577		592		1,165		1,157
Other interest income		1,178		376		1,579		730
Total interest income		30,545		26,880		61,330		49,963
Interest expense:
Deposits		3,868		1,665		6,957		2,852
Short-term borrowings		5		51		8		72
Long-term borrowings		869		637		1,688		1,195
Total interest expense		4,742		2,353		8,653		4,119
Net interest income		25,803		24,527		52,677		45,844
Provision for loan losses		510		450		1,020		900
Net interest income after provision for loan losses		25,293		24,077		51,657		44,944
Noninterest income:
Trust services fee income		1,671		1,485		3,277		2,952
Brokerage fee income		1,738		1,433		3,342		2,692
Mortgage income, net		1,528		1,406		2,608		2,248
Service charges on deposit accounts		1,200		1,121		2,390		2,129
Card interchange income		1,358		1,173		2,601		2,153
BOLI income		468		454		910		855
Rent income		340		295		648		567
Asset gains (losses), net		972		772		1,176		766
Other income		964		946		2,111		1,492
Total noninterest income		10,239		9,085		19,063		15,854
Noninterest expense:
Personnel		12,674		10,983		25,166		20,916
Occupancy, equipment and office		3,454		3,223		7,241		6,054
Business development and marketing		1,463		1,317		2,805		2,246
Data processing		2,399		2,207		4,719		4,190
FDIC assessments		282		145		555		377
Intangibles amortization		1,100		1,178		2,282		2,341
Other expense		1,079		1,260		2,325		2,512
Total noninterest expense		22,451		20,313		45,093		38,636
Income before income tax expense		13,081		12,849		25,627		22,162
Income tax expense		3,255		4,440		6,163		7,472
Net income		9,826		8,409		19,464		14,690
Less: Net income attributable to noncontrolling interest		89		81		150		154
Net income attributable to Nicolet Bankshares, Inc.	$	9,737	$	8,328	$	19,314	$	14,536

Earnings per common share:
Basic	$	1.01	$	0.88	$	1.99	$	1.61
Diluted	$	0.98	$	0.83	$	1.93	$	1.53

Weighted average common shares outstanding:
Basic		9,639,098		9,515,745		9,701,888		9,052,590
Diluted		9,969,854		9,991,625		10,032,304		9,521,206

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Net income	$	9,826		$	8,409		$	19,464		$	14,690
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities AFS:
Net unrealized holding gains (losses) arising during the period		(320	)		1,981			(4,978	)		4,851
Reclassification adjustment for net gains included in income		-			2			-			2
Income tax (expense) benefit		86			(746	)		1,343			(1,866	)
Total other comprehensive income (loss)		(234	)		1,237			(3,635	)		2,987
Comprehensive income	$	9,592		$	9,646		$	15,829		$	17,677

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statement of Stockholders’ Equity

(In thousands) (Unaudited)

	Nicolet Bankshares, Inc. Stockholders’ Equity
	Common Stock			Additional Paid-In Capital			Retained Earnings		Accumulated Other Comprehensive Loss			Noncontrolling Interest			Total
Balance December 31, 2017	$	98		$	263,835		$	102,391	$	(2,146	)	$	701		$	364,879
Comprehensive income:
Net income		-			-			19,314		-			150			19,464
Other comprehensive loss		-			-			-		(3,635	)		-			(3,635	)
Stock-based compensation expense		-			2,314			-		-			-			2,314
Exercise of stock options, net		-			962			-		-			-			962
Issuance of common stock		-			108			-		-			-			108
Purchase and retirement of common stock		(2	)		(12,655	)		-		-			-			(12,657	)
Distribution to noncontrolling interest		-			-			-		-			(150	)		(150	)
Adoption of ASU 2016-01 (See Notes 1 and 5)		-			-			937		(937	)		-			-
Balance, June 30, 2018	$	96		$	254,564		$	122,642	$	(6,718	)	$	701		$	371,285

See accompanying notes to unaudited consolidated financial statements.

ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC.

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

	Six Months Ended June 30,
	2018			2017
Cash Flows From Operating Activities:
Net income	$	19,464		$	14,690
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		3,121			3,677
Provision for loan losses		1,020			900
Increase in cash surrender value of life insurance		(910	)		(855	)
Stock-based compensation expense		2,314			919
Asset gains (losses), net		(1,176	)		(766	)
Gain on sale of loans held for sale, net		(2,235	)		(2,005	)
Proceeds from sale of loans held for sale		115,515			94,371
Origination of loans held for sale		(114,926	)		(95,399	)
Net change in:
Accrued interest receivable and other assets		(3,223	)		1,729
Accrued interest payable and other liabilities		1,054			(1,840	)
Net cash provided by operating activities		20,018			15,421
Cash Flows From Investing Activities:
Net increase in loans		(37,458	)		(84,385	)
Net decrease in certificates of deposit in other banks		499			999
Purchases of securities AFS		(33,697	)		(48,436	)
Proceeds from sales of securities AFS		-			10,798
Proceeds from calls and maturities of securities AFS		27,657			25,002
Purchases of other investments		(629	)		(891	)
Proceeds from sales of other investments		386			6,146
Net increase in premises and equipment		(814	)		(1,895	)
Net decrease in other real estate and other assets		1,486			2,791
Net cash received in business combination		-			9,119
Net cash used by investing activities		(42,570	)		(80,752	)
Cash Flows From Financing Activities:
Net increase (decrease) in deposits		(15,449	)		45,074
Proceeds from long-term borrowings		-			10,000
Repayments of long-term borrowings		(1,126	)		(4,297	)
Purchase and retirement of common stock		(12,657	)		(3,895	)
Capitalized issuance costs, net		-			(186	)
Proceeds from issuance of common stock, net		108			114
Proceeds from exercise of stock options, net		962			1,060
Distribution to noncontrolling interest		(150	)		-
Net cash provided (used) by financing activities		(28,312	)		47,870
Net decrease in cash and cash equivalents		(50,864	)		(17,461	)
Cash and cash equivalents:
Beginning		154,933			129,103
Ending *	$	104,069		$	111,642
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	8,574		$	4,083
Cash paid for taxes		5,325			4,521
Transfer of loans and bank premises to other real estate owned		537			828
Capitalized mortgage servicing rights		275			413
Transfer of loans from held for sale to held for investment		-			3,236
Acquisitions:
Fair value of assets acquired	$	-		$	439,000
Fair value of liabilities assumed		-			397,000
Net assets acquired		-			42,000

* Cash and cash equivalents include restricted cash of $6.8 million and $1.7 million at June 30, 2018 and 2017, respectively, for the reserve balance required with the Federal Reserve Bank.

See accompanying notes to unaudited consolidated financial statements.

NICOLET BANKSHARES, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

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

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

Critical Accounting Policies and Estimates

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

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

Recent Accounting Developments Adopted

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

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

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

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

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

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

Operating Segment

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

Reclassifications

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

Note 2 – Acquisition

On April 28, 2017, the Company consummated its merger with First Menasha Bancshares, Inc. (“First Menasha”) pursuant to the Agreement and Plan of Merger by and between the Company and First Menasha dated November 3, 2016, (the “Merger Agreement”), whereby First Menasha was merged with and into the Company, and The First National Bank-Fox Valley, the wholly owned commercial bank subsidiary of First Menasha serving the Fox Valley area of Wisconsin, was merged with and into Nicolet National Bank (the “Bank”). The system integration was completed, and five branches of First Menasha opened on May 1, 2017, as Nicolet National Bank branches, expanding its presence in Calumet and Winnebago Counties, Wisconsin. The Company closed one of its Calumet County locations concurrently with the First Menasha merger.

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

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

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

Note 3 – Earnings per Common Share

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

	Three Months Ended June 30,				Six Months Ended June 30,
(In thousands, except per share data)	2018		2017		2018		2017
Net income attributable to Nicolet Bankshares, Inc.	$	9,737	$	8,328	$	19,314	$	14,536

Weighted average common shares outstanding		9,639		9,516		9,702		9,053
Effect of dilutive common stock awards		331		476		330		468
Diluted weighted average common shares outstanding		9,970		9,992		10,032		9,521

Basic earnings per common share*	$	1.01	$	0.88	$	1.99	$	1.61
Diluted earnings per common share*	$	0.98	$	0.83	$	1.93	$	1.53

*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.

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

Note 4 – Stock-based Compensation

The Company may grant stock options and restricted stock under its stock-based compensation plans to certain officers, employees and directors. At June 30, 2018, approximately 145,000 shares were available for grant under these stock-based compensation plans.

A Black-Scholes model is utilized to estimate the fair value of stock option grants, while the market price of the Company’s stock at the date of grant is used to estimate the value of restricted stock awards. The weighted average assumptions used in the Black-Scholes model for valuing stock option grants for the six months ended June 30, 2018 and 2017, respectively, were as follows.

	Six Months Ended June 30, 2018			Six Months Ended June 30, 2017
Dividend yield		0	%		0	%
Expected volatility		25	%		25	%
Risk-free interest rate		2.48	%		2.13	%
Expected average life		7 years			7 years
Weighted average per share fair value of options	$	17.60		$	15.44

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

Stock Options	Option Shares Outstanding			Weighted Average Exercise Price		Weighted Average Remaining Life (Years)		Aggregate Intrinsic Value (in thousands)
Outstanding – December 31, 2017		1,643,255		$	39.82
Granted		10,000			54.06
Exercise of stock options *		(44,161	)		21.79
Forfeited		(3,500	)		42.32
Outstanding – June 30, 2018		1,605,594		$	40.39		7.8	$	23,805
Exercisable – June 30, 2018		531,506		$	31.48		6.4	$	12,558

* The terms of the stock option agreements permit having a number of shares of stock withheld, the fair market value of which as of the date of exercise is sufficient to satisfy the exercise price and/or tax withholding requirements. No such shares were surrendered to the Company for the six months ended June 30, 2018.

Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The intrinsic value of options exercised for the six months ended June 30, 2018 and 2017 was approximately $1.4 million and $1.8 million, respectively.

Restricted Stock	Weighted Average Grant Date Fair Value		Restricted Shares Outstanding
Outstanding – December 31, 2017	$	34.26		30,920
Granted		56.01		3,000
Vested *		28.89		(7,404	)
Forfeited		-		-
Outstanding – June 30, 2018	$	38.23		26,516

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

The Company recognized approximately $2.3 million and $0.9 million of stock-based compensation expense during the six months ended June 30, 2018 and 2017, respectively, associated with its common stock awards. As of June 30, 2018, there was approximately $14.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the remaining vesting period of approximately four years. The Company recognized a tax benefit of approximately $0.2 million for both the six months ended June 30, 2018 and 2017, respectively, for the tax impact of stock option exercises and vesting of restricted stock.

Note 5 – Securities Available for Sale

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

	June 30, 2018
(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. government agency securities	$	26,986	$	-	$	636	$	26,350
State, county and municipals		170,679		66		3,846		166,899
Mortgage-backed securities		147,420		106		4,276		143,250
Corporate debt securities		66,092		214		830		65,476
Total	$	411,177	$	386	$	9,588	$	401,975

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

* Effective January 1, 2018, the Company adopted ASU 2016-01, which requires equity securities with readily determinable fair values to be measured at fair value with changes in the fair value recognized through net income. Such securities are no longer reflected as securities AFS. As a result of this accounting change, the Company recognized a cumulative-effect adjustment at adoption from accumulated other comprehensive income to retained earnings of approximately $0.9 million in the consolidated statement of stockholders’ equity for the net of tax impact of the unrealized gain on equity securities as of the date of adoption and recognized a gain of approximately $330,000 for the six months ended June 30, 2018, in the consolidated statements of income for the change in fair value on equity securities since adoption. In addition, the approximately $3.1 million current fair value of equity securities is now reflected within other investments on the consolidated balance sheets rather than as securities AFS. Prior periods have not been restated for the impact of this accounting change. See Note 1 for additional information on this new accounting standard.

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

	June 30, 2018
	Less than 12 months				12 months or more				Total
($ in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Number of Securities
U.S. government agency securities	$	-	$	-	$	26,350	$	636	$	26,350	$	636		2
State, county and municipals		104,455		1,934		48,091		1,912		152,546		3,846		449
Mortgage-backed securities		71,975		1,715		61,657		2,561		133,632		4,276		223
Corporate debt securities		47,319		830		-		-		47,319		830		25
Total	$	223,749	$	4,479	$	136,098	$	5,109	$	359,847	$	9,588		699

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

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

The amortized cost and fair value of securities AFS by contractual maturity at June 30, 2018 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties; as this is particularly inherent in mortgage-backed securities, these securities are not included in the maturity categories below.

	June 30, 2018
(in thousands)	Amortized Cost		Fair Value
Due in less than one year	$	16,297	$	16,276
Due in one year through five years		150,725		148,289
Due after five years through ten years		89,470		86,698
Due after ten years		7,265		7,462
		263,757		258,725
Mortgage-backed securities		147,420		143,250
Securities available for sale	$	411,177	$	401,975

Proceeds from the sale of securities AFS were as follows.

	Six Months Ended June 30,
(in thousands)	2018		2017
Gross gains	$	-	$	5
Gross losses		-		(7	)
Gains (losses) on sales of securities AFS, net	$	-	$	(2	)
Proceeds from sales of securities AFS	$	-	$	10,798

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

The loan composition as of June 30, 2018 and December 31, 2017 is summarized as follows.

	June 30, 2018						December 31, 2017
(in thousands)	Amount			% of Total			Amount			% of Total
Commercial & industrial	$	666,249			31.3	%	$	637,337			30.5	%
Owner-occupied commercial real estate (“CRE”)		448,367			21.1			430,043			20.6
Agricultural (“AG”) production		34,016			1.6			35,455			1.7
AG real estate		53,019			2.5			51,778			2.5
CRE investment		333,893			15.7			314,463			15.1
Construction & land development		75,053			3.5			89,660			4.3
Residential construction		28,701			1.4			36,995			1.8
Residential first mortgage		358,537			16.8			363,352			17.4
Residential junior mortgage		106,592			5.0			106,027			5.1
Retail & other		24,197			1.1			22,815			1.0
Loans	$	2,128,624			100.0	%	$	2,087,925			100.0	%
Less allowance for loan losses (“ALLL”)		12,875						12,653
Loans, net	$	2,115,749					$	2,075,272
Allowance for loan losses to loans		0.60	%					0.61	%

	June 30, 2018												December 31, 2017
(in thousands)	Originated Amount			% of Total			Acquired Amount			% of Total			Originated Amount			% of Total			Acquired Amount			% of Total
Commercial & industrial	$	534,454			39.3	%	$	131,795			17.1	%	$	488,600			39.3	%	$	148,737			17.6	%
Owner-occupied CRE		265,155			19.5			183,212			23.8			237,548			19.1			192,495			22.8
AG production		9,841			0.7			24,175			3.1			11,102			0.9			24,353			2.9
AG real estate		29,598			2.2			23,421			3.0			27,831			2.2			23,947			2.8
CRE investment		144,339			10.6			189,554			24.6			113,862			9.2			200,601			23.8
Construction & land development		50,758			3.8			24,295			3.2			56,061			4.5			33,599			4.0
Residential construction		28,358			2.1			343			0.1			33,615			2.7			3,380			0.4
Residential first mortgage		204,794			15.1			153,743			20.0			191,186			15.4			172,166			20.4
Residential junior mortgage		70,391			5.2			36,201			4.7			65,643			5.3			40,384			4.8
Retail & other		20,765			1.5			3,432			0.4			18,254			1.4			4,561			0.5
Loans		1,358,453			100.0	%		770,171			100.0	%		1,243,702			100.0	%		844,223			100.0	%
Less ALLL		10,893						1,982						10,542						2,111
Loans, net	$	1,347,560					$	768,189					$	1,233,160					$	842,112
ALLL to loans		0.80	%					0.26	%					0.85	%					0.25	%

A roll forward of the allowance for loan losses for the six months ended June 30, 2018 and 2017, and the year ended December 31, 2017, respectively, is summarized as follows.

	Six Months Ended						Year Ended
(in thousands)	June 30, 2018			June 30, 2017			December 31, 2017
Beginning balance	$	12,653		$	11,820		$	11,820
Provision for loan losses		1,020			900			2,325
Charge-offs		(877	)		(176	)		(1,604	)
Recoveries		79			47			112
Net charge-offs		(798	)		(129	)		(1,492	)
Ending balance	$	12,875		$	12,591		$	12,653

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

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment at or for the six months ended June 30, 2018:

	TOTAL – Six Months Ended June 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	4,934		$	2,607		$	129		$	296		$	1,388		$	726		$	251		$	1,609		$	488		$	225		$	12,653
Provision		881			199			(17	)		8			34			(236	)		(47	)		57			(45	)		186			1,020
Charge-offs		(594	)		(64	)		-			-			(37	)		-			-			(48	)		-			(134	)		(877	)
Recoveries		30			10			-			-			-			-			-			1			29			9			79
Net charge-offs		(564	)		(54	)		-			-			(37	)		-			-			(47	)		29			(125	)		(798	)
Ending balance	$	5,251		$	2,752		$	112		$	304		$	1,385		$	490		$	204		$	1,619		$	472		$	286		$	12,875
As percent of ALLL		40.7	%		21.4	%		0.9	%		2.4	%		10.8	%		3.8	%		1.6	%		12.6	%		3.7	%		2.1	%		100.0	%

ALLL:
Individually evaluated	$	-		$	-		$	-		$	-		$	-		$	-		$	-		$	-		$	-		$	-		$	-
Collectively evaluated		5,251			2,752			112			304			1,385			490			204			1,619			472			286			12,875
Ending balance	$	5,251		$	2,752		$	112		$	304		$	1,385		$	490		$	204		$	1,619		$	472		$	286		$	12,875

Loans:
Individually evaluated	$	5,713		$	1,685		$	-		$	235		$	2,736		$	522		$	80		$	2,801		$	60		$	12		$	13,844
Collectively evaluated		660,536			446,682			34,016			52,784			331,157			74,531			28,621			355,736			106,532			24,185			2,114,780
Total loans	$	666,249		$	448,367		$	34,016		$	53,019		$	333,893		$	75,053		$	28,701		$	358,537		$	106,592		$	24,197		$	2,128,624

Less ALLL	$	5,251		$	2,752		$	112		$	304		$	1,385		$	490		$	204		$	1,619		$	472		$	286		$	12,875
Net loans	$	660,998		$	445,615		$	33,904		$	52,715		$	332,508		$	74,563		$	28,497		$	356,918		$	106,120		$	23,911		$	2,115,749

As a further breakdown, the June 30, 2018 ALLL is summarized by originated and acquired as follows:

	Originated – Six Months Ended June 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	4,192		$	2,115		$	112		$	235		$	1,154		$	628		$	200		$	1,297		$	409		$	200		$	10,542
Provision		929			232			(13	)		14			14			(214	)		(33	)		83			(37	)		183			1,158
Charge-offs		(594	)		(64	)		-			-			(37	)		-			-			(48	)		-			(131	)		(874	)
Recoveries		29			-			-			-			-			-			-			1			28			9			67
Net charge-offs		(565	)		(64	)		-			-			(37	)		-			-			(47	)		28			(122	)		(807	)
Ending balance	$	4,556		$	2,283		$	99		$	249		$	1,131		$	414		$	167		$	1,333		$	400		$	261		$	10,893
As percent of ALLL		41.8	%		21.0	%		0.9	%		2.3	%		10.4	%		3.8	%		1.5	%		12.2	%		3.7	%		2.4	%		100.0	%

Loans:
Individually evaluated	$	2,373		$	338		$	-		$	-		$	951		$	-		$	-		$	255		$	-		$	-		$	3,917
Collectively evaluated		532,081			264,817			9,841			29,598			143,388			50,758			28,358			204,539			70,391			20,765			1,354,536
Total loans	$	534,454		$	265,155		$	9,841		$	29,598		$	144,339		$	50,758		$	28,358		$	204,794		$	70,391		$	20,765		$	1,358,453

Less ALLL	$	4,556		$	2,283		$	99		$	249		$	1,131		$	414		$	167		$	1,333		$	400		$	261		$	10,893
Net loans	$	529,898		$	262,872		$	9,742		$	29,349		$	143,208		$	50,344		$	28,191		$	203,461		$	69,991		$	20,504		$	1,347,560

	Acquired – Six Months Ended June 30, 2018
(in thousands)	Commercial & industrial			Owner- occupied CRE			AG production			AG real estate			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ALLL:
Beginning balance	$	742		$	492		$	17		$	61		$	234		$	98		$	51		$	312		$	79		$	25		$	2,111
Provision		(48	)		(33	)		(4	)		(6	)		20			(22	)		(14	)		(26	)		(8	)		3			(138	)
Charge-offs		-			-			-			-			-			-			-			-			-			(3	)		(3	)
Recoveries		1			10			-			-			-			-			-			-			1			-			12
Net charge-offs		1			10			-			-			-			-			-			-			1			(3	)		9
Ending balance	$	695		$	469		$	13		$	55		$	254		$	76		$	37		$	286		$	72		$	25		$	1,982
As percent of ALLL		35.1	%		23.7	%		0.7	%		2.8	%		12.8	%		3.8	%		1.9	%		14.4	%		3.6	%		1.2	%		100.0	%

Loans:
Individually evaluated	$	3,340		$	1,347		$	-		$	235		$	1,785		$	522		$	80		$	2,546		$	60		$	12		$	9,927
Collectively evaluated		128,455			181,865			24,175			23,186			187,769			23,773			263			151,197			36,141			3,420			760,244
Total loans	$	131,795		$	183,212		$	24,175		$	23,421		$	189,554		$	24,295		$	343		$	153,743		$	36,201		$	3,432		$	770,171

Less ALLL	$	695		$	469		$	13		$	55		$	254		$	76		$	37		$	286		$	72		$	25		$	1,982
Net loans	$	131,100		$	182,743		$	24,162		$	23,366		$	189,300		$	24,219		$	306		$	153,457		$	36,129		$	3,407		$	768,189

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment at or for the year ended December 31, 2017:

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

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

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

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

As a further breakdown, the December 31, 2017 ALLL is summarized by originated and acquired as follows:

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

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

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

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

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

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


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

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

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of June 30, 2018 and December 31, 2017.

	Total Nonaccrual Loans
(in thousands)	June 30, 2018			% of Total			December 31, 2017			% of Total
Commercial & industrial	$	6,119			56.2	%	$	6,016			46.0	%
Owner-occupied CRE		588			5.4			533			4.1
AG production		66			0.6			-			-
AG real estate		175			1.6			186			1.4
CRE investment		1,487			13.7			4,531			34.6
Construction & land development		-			-			-			-
Residential construction		108			1.0			80			0.6
Residential first mortgage		2,063			19.0			1,587			12.1
Residential junior mortgage		276			2.5			158			1.2
Retail & other		-			-			4			-
Nonaccrual loans	$	10,882			100.0	%	$	13,095			100.0	%
Percent of total loans		0.5	%					0.6	%

	June 30, 2018												December 31, 2017
(in thousands)	Originated Amount			% of Total			Acquired Amount			% of Total			Originated Amount			% of Total			Acquired Amount			% of Total
Commercial & industrial	$	2,608			53.6	%	$	3,511			58.4	%	$	2,296			70.0	%	$	3,720			37.9	%
Owner-occupied CRE		372			7.6			216			3.6			86			2.6			447			4.6
AG production		66			1.4			-			-			-			-			-			-
AG real estate		-			-			175			2.9			-			-			186			1.9
CRE investment		950			19.5			537			8.9			549			16.8			3,982			40.6
Construction & land development		-			-			-			-			-			-			-			-
Residential construction		28			0.6			80			1.3			-			-			80			0.8
Residential first mortgage		826			17.0			1,237			20.6			331			10.1			1,256			12.8
Residential junior mortgage		17			0.3			259			4.3			12			0.4			146			1.4
Retail & other		-			-			-			-			4			0.1			-			-
Nonaccrual loans	$	4,867			100.0	%	$	6,015			100.0	%	$	3,278			100.0	%	$	9,817			100.0	%
Percent of nonaccrual loans		44.7	%					55.3	%					25.0	%					75.0	%

The following tables present past due loans by portfolio segment as of June 30, 2018 and December 31, 2017:

	June 30, 2018
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	-		$	6,119		$	660,130		$	666,249
Owner-occupied CRE		64			588			447,715			448,367
AG production		-			66			33,950			34,016
AG real estate		-			175			52,844			53,019
CRE investment		2			1,487			332,404			333,893
Construction & land development		24			-			75,029			75,053
Residential construction		606			108			27,987			28,701
Residential first mortgage		319			2,063			356,155			358,537
Residential junior mortgage		56			276			106,260			106,592
Retail & other		88			-			24,109			24,197
Total loans	$	1,159		$	10,882		$	2,116,583		$	2,128,624
Percent of total loans		0.1	%		0.5	%		99.4	%		100.0	%

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

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

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

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

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

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

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

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

The following tables present total loans by risk categories as of June 30, 2018 and December 31, 2017:

	June 30, 2018
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Grade 8		Grade 9		Total
Commercial & industrial	$	626,176		$	24,512		$	3,133		$	12,428		$	-	$	-	$	666,249
Owner-occupied CRE		410,885			28,442			2,491			6,549			-		-		448,367
AG production		28,999			3,314			1,324			379			-		-		34,016
AG real estate		46,575			3,501			2,300			643			-		-		53,019
CRE investment		323,229			7,271			1,202			2,191			-		-		333,893
Construction & land development		69,606			5,276			17			154			-		-		75,053
Residential construction		28,593			-			-			108			-		-		28,701
Residential first mortgage		353,793			1,348			662			2,734			-		-		358,537
Residential junior mortgage		106,285			17			-			290			-		-		106,592
Retail & other		24,197			-			-			-			-		-		24,197
Total loans	$	2,018,338		$	73,681		$	11,129		$	25,476		$	-	$	-	$	2,128,624
Percent of total		94.8	%		3.5	%		0.5	%		1.2	%		-		-		100.0	%

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

The following tables present impaired loans as of June 30, 2018 and December 31, 2017.

	Total Impaired Loans – June 30, 2018
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	5,713	$	9,890	$	-	$	6,168	$	318
Owner-occupied CRE		1,685		2,191		-		1,729		73
AG production		-		7		-		-		-
AG real estate		235		294		-		239		13
CRE investment		2,736		4,078		-		2,799		106
Construction & land development		522		522		-		522		10
Residential construction		80		983		-		80		-
Residential first mortgage		2,801		3,329		-		2,839		95
Residential junior mortgage		60		371		-		63		4
Retail & other		12		14		-		12		1
Total	$	13,844	$	21,679	$	-	$	14,451	$	620

Originated impaired loans	$	3,917	$	3,918	$	-	$	4,198	$	112
Acquired impaired loans		9,927		17,761		-		10,253		508
Total	$	13,844	$	21,679	$	-	$	14,451	$	620

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

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

Total purchased credit impaired loans (in aggregate since the Company’s 2013 acquisitions) were initially recorded at a fair value of $43.6 million on their respective acquisition dates, net of an initial $34.4 million non-accretable mark and a zero accretable mark. At June 30, 2018, $9.9 million of the $43.6 million remain in impaired loans.

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

	Six Months Ended						Year Ended
(in thousands)	June 30, 2018			June 30, 2017			December 31, 2017
Balance at beginning of period	$	9,471		$	14,327		$	14,327
Acquired balance, net		-			5,932			8,352
Accretion to loan interest income		(1,580	)		(3,830	)		(7,995	)
Transferred to accretable		(56	)		-			(1,936	)
Disposals of loans		-			(1,104	)		(3,277	)
Balance at end of period	$	7,835		$	15,325		$	9,471

Troubled Debt Restructurings

At June 30, 2018, there were five loans classified as troubled debt restructurings with a current outstanding balance of $0.9 million and pre-modification balance of $2.7 million. In comparison, at December 31, 2017, there were eight loans classified as troubled debt restructurings with an outstanding balance of $5.6 million and pre-modification balance of $6.9 million. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the six months ended June 30, 2018. As of June 30, 2018, there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructurings.

Note 7 – Goodwill and Other Intangibles and Mortgage Servicing Rights

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

	Six Months Ended		Year Ended
(in thousands)	June 30, 2018		December 31, 2017
Goodwill	$	107,366	$	107,366
Core deposit intangibles		14,420		16,477
Customer list intangibles		4,338		4,563
Other intangibles		18,758		21,040
Goodwill and other intangibles, net	$	126,124	$	128,406

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

Other intangible assets: Other intangible assets, consisting of core deposit intangibles (related to branch or bank acquisitions) and customer list intangibles (related to the customer relationships acquired in connection with the 2016 financial advisor business acquisition), are amortized over their estimated finite lives. During 2017, core deposit intangibles increased due to the First Menasha acquisition and customer list intangibles increased due to a modification to the contingent earn-out payment on the financial advisor business acquired in 2016, fixing the previously variable earn-out payment on a portion of the purchase price. See Note 2 for additional information on the First Menasha acquisition.

	Six Months Ended			Year Ended
(in thousands)	June 30, 2018			December 31, 2017
Core deposit intangibles:
Gross carrying amount	$	29,015		$	29,015
Accumulated amortization		(14,595	)		(12,538	)
Net book value	$	14,420		$	16,477
Additions during the period	$	-		$	3,670
Amortization during the period	$	2,057		$	4,294

Customer list intangibles:
Gross carrying amount	$	5,233		$	5,233
Accumulated amortization		(895	)		(670	)
Net book value	$	4,338		$	4,563
Additions during the period	$	-		$	870
Amortization during the period	$	225		$	401

Mortgage servicing rights: Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date, with the amortization recorded in mortgage income, net, in the consolidated statements of income. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets. Activity in the mortgage servicing rights asset for the year ended December 31, 2017 and the six months ended June 30, 2018 was as follows:

	Six Months Ended			Year Ended
(in thousands)	June 30, 2018			December 31, 2017
Mortgage servicing rights (MSR) asset:
MSR asset at beginning of year	$	3,187		$	1,922
Capitalized MSR		275			876
MSR asset acquired		-			874
Amortization during the period		(301	)		(485	)
MSR asset at end of period	$	3,161		$	3,187
Fair value of MSR asset at end of period	$	4,414		$	4,097
Residential mortgage loans serviced for others	$	527,986		$	518,419
Net book value of MSR asset to loans serviced for others		0.60	%		0.61	%

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

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

(in thousands)	Core deposit intangibles		Customer list intangibles		MSR asset
Year ending December 31,
2018 (remaining six months)	$	1,858	$	224	$	299
2019		3,337		449		597
2020		2,657		449		754
2021		2,167		449		342
2022		1,735		449		342
Thereafter		2,666		2,318		827
Total	$	14,420	$	4,338	$	3,161

Note 8 – Short and Long-Term Borrowings

Short-Term Borrowings:

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

Long-Term Borrowings:

The components of long-term borrowings (borrowing with an original maturity greater than one year) at June 30, 2018 and December 31, 2017 were as follows:

(in thousands)	June 30, 2018		December 31, 2017
FHLB advances	$	35,381	$	36,509
Junior subordinated debentures		29,856		29,616
Subordinated notes		11,939		11,921
Total long-term borrowings	$	77,176	$	78,046

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

The following table shows the maturity schedule of the FHLB advances as of June 30, 2018.

Maturing in:	(in thousands)
2018 (remaining six months)	$	-
2019		-
2020		10,000
2021		-
2022		25,381
Total	$	35,381

Junior Subordinated Debentures: The following table shows the breakdown of junior subordinated debentures as of June 30, 2018 and December 31, 2017. Interest on all debentures is current. Any applicable discounts (initially recorded to carry an acquired debenture at its then estimated fair market value) are being accreted to interest expense over the remaining life of the debentures. All the debentures below are currently callable and may be redeemed in part or in full at par plus any accrued but unpaid interest. At June 30, 2018 and December 31, 2017, $28.7 million and $28.5 million, respectively, qualify as Tier 1 capital.

		Junior Subordinated Debentures
(in thousands)	Maturity Date	Par		6/30/2018 Unamortized Discount			6/30/2018 Carrying Value		12/31/2017 Carrying Value
2004 Nicolet Bankshares Statutory Trust⁽¹⁾	7/15/2034	$	6,186	$	-		$	6,186	$	6,186
2005 Mid-Wisconsin Financial Services, Inc.⁽²⁾	12/15/2035		10,310		(3,471	)		6,839		6,739
2006 Baylake Corp.⁽³⁾	9/30/2036		16,598		(4,238	)		12,360		12,242
2004 First Menasha Bancshares, Inc.⁽⁴⁾	3/17/2034		5,155		(684	)		4,471		4,449
Total		$	38,249	$	(8,393	)	$	29,856	$	29,616

⁽¹⁾

The interest rate is 8.00% fixed.

⁽²⁾

The debentures, assumed in April 2013 as the result of an acquisition, have a floating rate of the three-month LIBOR plus 1.43%, adjusted quarterly. The interest rates were 3.77% and 3.02% as of June 30, 2018 and December 31, 2017, respectively.

⁽³⁾

The debentures, assumed in April 2016 as a result of an acquisition, have a floating rate of the three-month LIBOR plus 1.35%, adjusted quarterly. The interest rates were 3.69% and 3.04% as of June 30, 2018 and December 31, 2017, respectively.

⁽⁴⁾

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

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

Note 9 – Fair Value Measurements

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

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

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

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

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

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

Recurring basis fair value measurements:

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

(in thousands)			Fair Value Measurements Using
Measured at Fair Value on a Recurring Basis:	Total		Level 1		Level 2		Level 3
June 30, 2018:
U.S. government agency securities	$	26,350	$	-	$	26,350	$	-
State, county and municipals		166,899		-		166,768		131
Mortgage-backed securities		143,250		-		143,250		-
Corporate debt securities		65,476		-		57,025		8,451
Securities AFS	$	401,975	$	-	$	393,393	$	8,582
Other investments (equity securities) *	$	3,053	$	3,053	$	-	$	-

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

* Effective January 1, 2018, the Company adopted ASU 2016-01, which requires equity securities with readily determinable fair values to be measured at fair value with changes in the fair value recognized through net income. As a result, the approximately $3.1 million current fair value of equity securities is now reflected within other investments on the consolidated balance sheets compared to securities AFS at December 31, 2017. Prior periods have not been restated for the impact of this accounting change. See Note 1 for additional information on this new accounting standard and see Note 5 for additional information on the impact to securities AFS.

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

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

(in thousands)	Six Months Ended			Year Ended
Level 3 Fair Value Measurements:	June 30, 2018			December 31, 2017
Balance at beginning of year	$	9,151		$	9,108
Acquired balance		-			189
Paydowns/Sales/Settlements		(569	)		(146	)
Balance at end of period	$	8,582		$	9,151

Nonrecurring basis fair value measurements:

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

			Fair Value Measurements Using
Measured at Fair Value on a Nonrecurring Basis:	Total		Level 1		Level 2		Level 3
(in thousands)
June 30, 2018:
Impaired loans	$	13,844	$	-	$	-	$	13,844
Other real estate owned (“OREO”)		1,230		-		-		1,230
MSR asset		4,414		-		-		4,414

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

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

Financial instruments:

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

June 30, 2018
(in thousands)	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	104,069	$	104,069	$	104,069	$	-	$	-
Certificates of deposit in other banks		1,247		1,231		-		1,231		-
Securities AFS		401,975		401,975		-		393,393		8,582
Other investments, including equity securities		17,749		17,749		3,053		13,112		1,584
Loans held for sale		6,037		6,092		-		6,092		-
Loans, net		2,115,749		2,099,434		-		-		2,099,434
BOLI		65,363		65,363		65,363		-		-
MSR asset		3,161		4,414		-		-		4,414

Financial liabilities:
Deposits	$	2,455,536	$	2,456,846	$	-	$	-	$	2,456,846
Long-term borrowings		77,176		76,152		-		35,380		40,772

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

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

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

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

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

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

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

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

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

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

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

Note 10 – Revenue Recognition

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

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

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

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

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

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

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

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

Forward-Looking Statements

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

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

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

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

potential difficulties in integrating the operations of Nicolet with those of acquired entities, if any;

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

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

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

Overview

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

The timing of Nicolet’s April 2017 acquisition of First Menasha Bancshares, Inc. (“First Menasha”), at approximately 20% of pre-merger assets at the time of acquisition, impacts financial comparisons to 2017 periods. Certain income statement results, average balances and related ratios for 2018 and the last two quarters of 2017 each include three months of First Menasha operations, versus no contribution of First Menasha in the first quarter 2017 period and two months of contribution in the second quarter of 2017. Given the merger activity, quarterly results included non-recurring other direct merger and integration pre-tax expenses of $0.2 million and $0.3 million in the first and second quarters of 2017, respectively. See Note 2, “Acquisition,” in the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional information on this acquisition.

Performance Summary

Table 1: Earnings Summary and Selected Financial Data

	At or for the Three Months Ended															At or for the Six Months Ended
(In thousands, except per share data)	6/30/2018			3/31/2018			12/31/2017			9/30/2017			6/30/2017			6/30/2018			6/30/2017
Results of operations:
Interest income	$	30,545		$	30,785		$	29,836		$	29,454		$	26,880		$	61,330		$	49,963
Interest expense		4,742			3,911			3,329			3,063			2,353			8,653			4,119
Net interest income		25,803			26,874			26,507			26,391			24,527			52,677			45,844
Provision for loan losses		510			510			450			975			450			1,020			900
Net interest income after provision for loan losses		25,293			26,364			26,057			25,416			24,077			51,657			44,944
Noninterest income		10,239			8,824			8,621			10,164			9,085			19,063			15,854
Noninterest expense		22,451			22,642			21,858			20,862			20,313			45,093			38,636
Income before income tax expense		13,081			12,546			12,820			14,718			12,849			25,627			22,162
Income tax expense		3,255			2,908			3,662			5,133			4,440			6,163			7,472
Net income		9,826			9,638			9,158			9,585			8,409			19,464			14,690
Net income attributable to noncontrolling interest		89			61			55			74			81			150			154
Net income attributable to Nicolet Bankshares, Inc.	$	9,737		$	9,577		$	9,103		$	9,511		$	8,328		$	19,314		$	14,536
Earnings per common share:
Basic	$	1.01		$	0.98		$	0.93		$	0.97		$	0.88		$	1.99		$	1.61
Diluted	$	0.98		$	0.94		$	0.88		$	0.91		$	0.83		$	1.93		$	1.53
Common Shares:
Basic weighted average		9,639			9,765			9,805			9,837			9,516			9,702			9,053
Diluted weighted average		9,970			10,225			10,368			10,409			9,992			10,032			9,521
Outstanding		9,643			9,699			9,818			9,799			9,863			9,643			9,863
Period-End Balances:
Loans	$	2,128,624		$	2,100,597		$	2,087,925		$	2,051,122		$	2,009,964		$	2,128,624		$	2,009,964
Allowance for loan losses		12,875			12,765			12,653			12,610			12,591			12,875			12,591
Investment securities available-for-sale, at fair value		401,975			401,130			405,153			408,217			418,286			401,975			418,286
Goodwill and other intangibles, net		126,124			127,224			128,406			129,588			128,871			126,124			128,871
Total assets		2,922,151			3,223,935			2,932,433			2,845,730			2,825,917			2,922,151			2,825,917
Deposits		2,455,536			2,765,090			2,471,064			2,366,951			2,389,971			2,455,536			2,389,971
Stockholders’ equity		370,584			363,988			364,178			360,426			352,384			370,584			352,384
Book value per common share		38.43			37.53			37.09			36.78			35.73			38.43			35.73
Tangible book value per common share		25.35			24.41			24.01			23.56			22.66			25.35			22.66
Average Balances:
Loans	$	2,117,828		$	2,114,345		$	2,066,974		$	2,035,277		$	1,888,320		$	2,116,096		$	1,744,808
Interest-earning assets		2,742,976			2,584,070			2,531,066			2,505,073			2,336,124			2,663,962			2,183,164
Total assets		3,044,466			2,896,533			2,852,400			2,825,542			2,635,925			2,970,908			2,455,384
Deposits		2,583,112			2,436,103			2,385,821			2,377,229			2,214,865			2,510,013			2,072,752
Interest-bearing liabilities		2,084,361			1,925,443			1,835,375			1,854,340			1,779,366			2,005,341			1,653,770
Goodwill and other intangibles, net		126,646			127,801			128,980			129,158			115,698			127,220			101,599
Stockholders’ equity		364,988			366,002			361,455			358,227			329,201			365,492			304,830
Financial Ratios*:
Return on average assets		1.28	%		1.34	%		1.27	%		1.34	%		1.27	%		1.31	%		1.19	%
Return on average common equity		10.70			10.61			9.99			10.53			10.15			10.66			9.62
Return on average tangible common equity		16.39			16.31			15.53			16.47			15.64			16.35			14.42
Stockholders’ equity to assets		12.68			11.29			12.42			12.67			12.47			12.68			12.47
Average equity to average assets		11.99			12.64			12.67			12.68			12.49			12.30			12.41
Tangible equity to tangible assets		8.74			7.65			8.41			8.50			8.29			8.74			8.29
Net interest margin		3.77			4.20			4.21			4.24			4.27			3.98			4.29
Net loan charge-offs to average loans		0.08			0.08			0.08			0.19			0.01			0.08			0.01
Nonperforming loans to total loans		0.51			0.56			0.63			0.70			0.84			0.51			0.84
Nonperforming assets to total assets		0.41			0.40			0.49			0.55			0.66			0.41			0.66
Effective tax rate		24.88			23.18			28.56			34.88			34.56			24.05			33.72
Selected Items:
Interest income from resolving PCI loans (rounded)	$	100		$	1,500		$	2,100		$	2,100		$	1,600		$	1,600		$	3,800
Tax-equivalent adjustment on net interest income		289			298			584			594			604			587			1,191
Tax expense (benefit) on stock-based compensation		-			(159	)		(1,678	)		(15	)		(64	)		(159	)		(161	)
Tax expense (benefit) of tax reform items		-			-			896			-			-			-			-

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

Net income was $19.3 million for the six months ended June 30, 2018, an increase of $4.8 million or 33% over $14.5 million for the six months ended June 30, 2017. Earnings per diluted common share was $1.93 for the first six months of 2018, 26% higher than $1.53 for the first six months of 2017. Annualized return on average assets for the first six months of 2018 and 2017 was 1.31% and 1.19%, respectively.

At June 30, 2018, assets were $2.9 billion and deposits were $2.5 billion, both decreasing $0.3 billion from March 31, 2018, attributable to a $0.3 billion short-term transaction deposit of a long-standing commercial customer accepted in late March and distributed by mid-June. Assets were minimally changed from December 31, 2017 and grew $0.1 billion or 3% compared to June 30, 2017.

At June 30, 2018, loans were $2.1 billion, 2% higher than December 31, 2017 and 6% higher than June 30, 2017. On an average basis, loans grew $371 million or 21% over the first half of 2017 (largely attributable to the timing of the 2017 acquisition). For additional information regarding loans, see “Balance Sheet Analysis — Loans.”

Total deposits were $2.5 billion at June 30, 2018, down slightly (less than 1%) from December 31, 2017 and grew 3% from June 30, 2017. On an average basis, deposits grew $437 million or 21% over the first half of 2017 (largely attributable to the timing of the 2017 acquisition). For additional information regarding deposits, see “Balance Sheet Analysis – Deposits.”

Net interest income increased $6.8 million or 15% over the first half of 2017, with interest income up $11.4 million on strong loan growth while interest expense increased $4.5 million due to rising rates on a larger deposit base. The interest-earning asset yield and net interest margin for the first six months of 2018 was 4.63% and 3.98%, respectively, compared to 4.67% and 4.29%, respectively, for the comparable period in 2017. The large deposit noted above was a positive contributor to net interest income in 2018 though at a very low net spread, compressing the related margin components for 2018. The inclusion of the large deposit lowered the earning asset yield and net interest margin by approximately 11 bps and 12 bps, respectively. For additional information regarding net interest income, see “Income Statement Analysis — Net Interest Income.”

Noninterest income grew $3.2 million or 20% over the first half of 2017, with all categories up year-over-year. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”

Noninterest expense increased $6.5 million or 17% over the first half of 2017, mostly due to the expanded workforce and larger operating base. Excluding $0.5 million of merger-related expenses from the 2017 period, noninterest expense would have increased $7.0 million or 18%. For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

Income tax expense for the first six months of 2018 benefited from the lower corporate tax rate effective in 2018, due to the passage of the Tax Cuts and Jobs Act in December 2017. Income tax expense included a $0.2 million tax benefit for the tax impact of stock option exercises for both six-month periods. As a result, the effective tax rate was 24.0% for the first half of 2018 and 33.7% for the first half of 2017.

Asset quality remains sound. Nonperforming assets declined to $12 million, representing 0.41% of total assets at June 30, 2018, down favorably from 0.49% at December 31, 2017 and 0.66% at June 30, 2017. For additional information regarding nonperforming assets, see “Balance Sheet Analysis – Nonperforming Assets.”

INCOME STATEMENT ANALYSIS

Net Interest Income

Tax-equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources. The tax-equivalent adjustments bring tax-exempt interest to a level that would yield the same after-tax income by applying the effective Federal corporate tax rates to the underlying assets. Tables 2 and 3 present information to facilitate the review and discussion of selected average balance sheet items, tax-equivalent net interest income, interest rate spread and net interest margin.

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

	For the Six Months Ended June 30,
	2018							2017
(in thousands)	Average Balance		Interest		Average Yield/Rate			Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,116,096	$	55,741		5.25	%	$	1,744,808	$	45,956		5.25	%
Investment securities:
Taxable		251,204		2,939		2.34	%		229,801		2,308		2.01	%
Tax-exempt (2)		153,724		1,658		2.16	%		160,739		2,160		2.69	%
Other interest-earning assets		142,938		1,579		2.20	%		47,816		730		3.05	%
Total interest-earning assets		2,663,962	$	61,917		4.63	%		2,183,164	$	51,154		4.67	%
Other assets, net		306,946							272,220
Total assets	$	2,970,908						$	2,455,384
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	277,927	$	504		0.37	%	$	239,212	$	142		0.12	%
Interest-bearing demand		550,631		2,171		0.79	%		408,011		831		0.41	%
Money market (“MMA”)		678,719		1,918		0.57	%		568,335		544		0.19	%
Core time deposits		310,696		2,009		1.30	%		284,054		973		0.69	%
Brokered deposits		109,158		355		0.66	%		94,647		362		0.77	%
Total interest-bearing deposits		1,927,131		6,957		0.73	%		1,594,259		2,852		0.36	%
Other interest-bearing liabilities		78,210		1,696		4.32	%		59,511		1,267		4.24	%
Total interest-bearing liabilities		2,005,341		8,653		0.87	%		1,653,770		4,119		0.50	%
Noninterest-bearing demand		582,882							478,493
Other liabilities		17,193							18,291
Stockholders’ equity		365,492							304,830
Total liabilities and stockholders’ equity	$	2,970,908						$	2,455,384
Net interest income and rate spread			$	53,264		3.76	%			$	47,035		4.17	%
Tax-equivalent adjustment			$	587						$	1,191
Net interest margin						3.98	%						4.29	%

(1)

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

(2)

The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 21% for 2018 periods and 34% for 2017 periods and adjusted for the disallowance of interest expense.

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

	For the Three Months Ended June 30,
	2018							2017
(in thousands)	Average Balance		Interest		Average Yield/Rate			Average Balance		Interest		Average Yield/Rate
ASSETS
Interest-earning assets
Loans, including loan fees (1)(2)	$	2,117,828	$	27,241		5.10	%	$	1,888,320	$	24,771		5.20	%
Investment securities:
Taxable		257,537		1,597		2.48	%		250,539		1,239		1.98	%
Tax-exempt (2)		151,163		818		2.16	%		162,154		1,098		2.71	%
Other interest-earning assets		216,448		1,178		2.16	%		35,111		376		4.28	%
Total interest-earning assets		2,742,976	$	30,834		4.46	%		2,336,124	$	27,484		4.67	%
Other assets, net		301,490							299,801
Total assets	$	3,044,466						$	2,635,925
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Savings	$	282,656	$	286		0.41	%	$	253,377	$	85		0.13	%
Interest-bearing demand		539,744		1,098		0.82	%		410,555		429		0.42	%
MMA		765,741		1,195		0.63	%		584,078		350		0.24	%
Core time deposits		317,594		1,143		1.44	%		293,068		463		0.63	%
Brokered deposits		100,426		146		0.59	%		165,992		338		0.82	%
Total interest-bearing deposits		2,006,161		3,868		0.77	%		1,707,070		1,665		0.39	%
Other interest-bearing liabilities		78,200		874		4.43	%		72,296		688		3.78	%
Total interest-bearing liabilities		2,084,361		4,742		0.91	%		1,779,366		2,353		0.53	%
Noninterest-bearing demand		576,951							507,795
Other liabilities		18,166							19,563
Stockholders’ equity		364,988							329,201
Total liabilities and stockholders’ equity	$	3,044,466						$	2,635,925
Net interest income and rate spread			$	26,092		3.55	%			$	25,131		4.14	%
Tax-equivalent adjustment			$	289						$	604
Net interest margin						3.77	%						4.27	%

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

	For the Six Months Ended June 30, 2018 Compared to June 30, 2017:									For the Three Months Ended June 30, 2018 Compared to June 30, 2017:
	Increase (Decrease) Due to Changes in									Increase (Decrease) Due to Changes in
(in thousands)	Volume			Rate			Net (1)			Volume			Rate			Net (1)
Interest-earning assets
Loans (2)	$	9,970		$	(185	)	$	9,785		$	3,045		$	(575	)	$	2,470
Investment securities:
Taxable		432			199			631			78			280			358
Tax-exempt (2)		(91	)		(411	)		(502	)		(71	)		(209	)		(280	)
Other interest-earning assets		796			53			849			838			(36	)		802
Total interest-earning assets	$	11,107		$	(344	)	$	10,763		$	3,890		$	(540	)	$	3,350

Interest-bearing liabilities
Savings	$	27		$	335		$	362		$	11		$	190		$	201
Interest-bearing demand		365			975			1,340			167			502			669
MMA		124			1,250			1,374			137			708			845
Core time deposits		99			937			1,036			42			638			680
Brokered deposits		51			(58	)		(7	)		(112	)		(80	)		(192	)
Total interest-bearing deposits		666			3,439			4,105			245			1,958			2,203
Other interest-bearing liabilities		272			157			429			66			120			186
Total interest-bearing liabilities		938			3,596			4,534			311			2,078			2,389
Net interest income	$	10,169		$	(3,940	)	$	6,229		$	3,579		$	(2,618	)	$	961

(1)

The change in interest due to both rate and volume has been allocated in proportion to the relationship of dollar amounts of change in each.

(2)

Tax-equivalent net interest income was $53 million for the first six months of 2018, $6 million or 13% higher than $47 million for the first six months of 2017. Between the comparative six-month periods, the interest rate spread decreased 41 bps due to a higher cost of funds (up 37 bps) and a decrease in the interest-earning asset yield (down 4 bps). The contribution from net free funds increased 10 bps, due mostly to the increase in noninterest-bearing demand deposits and the higher rate environment. As a result, the tax-equivalent net interest margin was 3.98% for the first half of 2018, down 31 bps compared to 4.29% for the first half of 2017.

Between the comparable six-month periods, average interest-earning assets increased $481 million or 22% to $2.7 billion, primarily due to a $371 million or 21% increase in loans (attributable to the acquired balances and organic loan growth) and a $95 million increase in other interest-earning assets (mainly low earning cash due to the large deposit previously noted). Tax-equivalent interest income increased $11 million or 21% to $62 million for the first six months of 2018, while the related interest-earning asset yield decreased 4 bps to 4.63%. Interest income on loans increased $10 million from the first half of 2017, while the related yield was level at 5.25% as the higher yield on new, renewed and variable rate loans in the rising rate environment was substantially offset by $1 million lower aggregate discount accretion income between the periods. Interest income on non-loan earnings assets increased $1 million or 19% from the first half of 2017, while the related yield decreased 14 bps due mostly to the lower corporate effective tax rate for 2018 reducing the benefit (and thus yields) of tax-exempt investment securities and the higher volume of lower interest-earning cash.

Average interest-bearing liabilities were $2.0 billion, an increase of $352 million or 21% compared to the first half of 2017, primarily due to a $333 million or 21% increase in interest-bearing deposits (attributable to the acquired balances and organic deposit growth, including the large customer deposit previously noted). Interest expense was $9 million for the first six months of 2018, up $5 million over the first half of 2017, and the related cost of funds increased 37 bps to 0.87%, driven predominantly by the cost and volume of deposits. Interest expense on deposits increased $4 million from the first half of 2017 and the average cost of interest-bearing deposits increased 37 bps to 0.73%, influenced by increases in select deposit rates from general rate pressures of the federal funds rate changes since the start of 2017. The Federal Reserve raised short-term interest rates by 125 bps since January 1, 2017.

Of note for the first half of 2018, the large customer deposit previously noted was a positive contributor to net interest income, though at a very low net spread, compressing the related margin components for 2018. The inclusion of the large deposit lowered the 2018 earning asset yield and net interest margin by approximately 11 bps and 12 bps, respectively, with no material impact on the cost of funds.

Provision for Loan Losses

The provision for loan losses was $1.0 million for the six months ended June 30, 2018, exceeding net charge-offs of $0.8 million. In comparison, the provision for loan losses for the six months ended June 30, 2017, was $0.9 million, exceeding net charge-offs of $0.1 million. Asset quality trends remained strong with continued resolutions of problem loans. The ALLL was $12.9 million (0.60% of loans) at June 30, 2018, compared to $12.7 million (0.61% of loans) at December 31, 2017 and $12.6 million (0.63% of loans) at June 30, 2017.

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

Noninterest Income

Table 4: Noninterest Income

	For the Three Months Ended June 30,									For the Six Months Ended June 30,
(in thousands)	2018		2017		$ Change		% Change			2018		2017		$ Change		% Change

Trust services fee income	$	1,671	$	1,485	$	186		12.5	%	$	3,277	$	2,952	$	325		11.0	%
Brokerage fee income		1,738		1,433		305		21.3			3,342		2,692		650		24.1
Mortgage income, net		1,528		1,406		122		8.7			2,608		2,248		360		16.0
Service charges on deposit accounts		1,200		1,121		79		7.0			2,390		2,129		261		12.3
Card interchange income		1,358		1,173		185		15.8			2,601		2,153		448		20.8
BOLI income		468		454		14		3.1			910		855		55		6.4
Rent income		340		295		45		15.3			648		567		81		14.3
Other income		964		946		18		1.9			2,111		1,492		619		41.5
Noninterest income without net gains		9,267		8,313		954		11.5			17,887		15,088		2,799		18.6
Asset gains (losses), net		972		772		200		25.9			1,176		766		410		53.5
Total noninterest income	$	10,239	$	9,085	$	1,154		12.7	%	$	19,063	$	15,854	$	3,209		20.2	%

Noninterest income grew $3.2 million or 20% over the first half of 2017, with all categories up year-over-year.

Trust service fees were up $0.3 million or 11% between the comparable six-month periods due to higher assets under management. Between the first half periods, brokerage fees were up $650,000 or 24%, attributable to growth within the financial advisor business.

Mortgage income represents net gains received from the sale of residential real estate loans into the secondary market, capitalized mortgage servicing rights (“MSRs”), servicing fees, offsetting MSR amortization, valuation changes, if any, and to a smaller degree some related income. Net mortgage income increased $0.4 million or 16% between the comparable six-month periods, commensurate with higher secondary mortgage production and increased net servicing fees on the growing portfolio of mortgage loans serviced for others.

Service charges on deposit accounts were $2.4 million for the first six months of 2018, up $0.3 million or 12% over the first six months of 2017, resulting from an increased number of accounts partly from the First Menasha acquisition and an increase to the fee charged on overdrafts implemented during mid-2017. Card interchange income grew $0.4 million or 21% due to higher volume and activity.

BOLI income was up 6% over the first six months of 2017, commensurate with the growth in average BOLI investments. Other noninterest income was $2.1 million, up $0.6 million or 41% over the first half of 2017, mostly attributable to an increase of $0.3 million in income from the equity interest in UFS (a data processing company interest acquired with a 2016 bank merger) and $0.3 million of annual card contract incentives received in first quarter 2018.

The $1.2 million net asset gains in 2018 were primarily attributable to $0.6 million of net gains on the sale of fixed assets, a $0.3 million fair value mark on equity securities, and a $0.2 million gain on the sale of equity securities. The $0.8 million net asset gains in 2017 primarily consisted of a $0.9 million gain on the sale of vacated bank branches, $0.4 million of net losses and write-downs on assets and OREO properties (predominantly the fair market value loss on two closed bank branches transferred to OREO), and a $0.2 million gain on the liquidation of an other investment.

Noninterest Expense

Table 5: Noninterest Expense

	For the Three Months Ended June 30,										For the Six Months Ended June 30,
($ in thousands)	2018		2017		Change			% Change			2018		2017		Change			% Change

Personnel	$	12,674	$	10,983	$	1,691			15.4	%	$	25,166	$	20,916	$	4,250			20.3	%
Occupancy, equipment and office		3,454		3,223		231			7.2			7,241		6,054		1,187			19.6
Business development and marketing		1,463		1,317		146			11.1			2,805		2,246		559			24.9
Data processing		2,399		2,207		192			8.7			4,719		4,190		529			12.6
FDIC assessments		282		145		137			94.5			555		377		178			47.2
Intangibles amortization		1,100		1,178		(78	)		(6.6	)		2,282		2,341		(59	)		(2.5	)
Other expense		1,079		1,260		(181	)		(14.4	)		2,325		2,512		(187	)		(7.4	)
Total noninterest expense	$	22,451	$	20,313	$	2,138			10.5	%	$	45,093	$	38,636	$	6,457			16.7	%

Non-personnel expenses	$	9,777	$	9,330	$	447			4.8	%	$	19,927	$	17,720	$	2,207			12.5	%
Average full-time equivalent employees		552		521		31			6.0			548		505		43			8.5

Personnel expense was $25.2 million for the first half of 2018, up $4.3 million or 20% compared to the first half of 2017, partly due to the expanded workforce resulting from the 2017 acquisition, with average full-time equivalent employees up 9% between the comparable six-month periods. Additionally, the increase results from merit increases between the periods, additional competitive market-based wage increases made more broadly across staff positions starting in early 2018, cash and equity incentives timing, and higher health and other benefits costs.

Occupancy, equipment and office expense was $7.2 million for the first half of 2018, up $1.2 million or 20% compared to 2017, primarily the result of the larger operating base and higher software and technology costs.

Business development and marketing expense increased $0.6 million, or 25%, between the comparable six-month periods, largely due to $0.5 million higher donation expense, as well as the expanded operating base influencing additional marketing, promotions and media.

Data processing expenses, which are primarily volume-based, rose $0.5 million or 13% between the first half periods; however, excluding the $0.2 million of merger-based processing expense from the 2017 period, data processing expense would have increased $0.7 million or 18%, in line with the higher volumes from the 2017 acquisition and organic growth.

Intangible amortization increased due to the addition of core deposit intangibles related to the First Menasha acquisition, offset partly by lower amortization on the aging intangibles of previous acquisitions. Other noninterest expense was down $0.2 million or 7% between the comparable first half periods; however, removing the $0.3 million of merger-based legal expenses from the 2017 period, other noninterest expense would have increased $0.1 million or 3% given the larger operating base offset by certain economies of scale.

Income Taxes

Income tax expense was $6.2 million (effective tax rate of 24.0%) for the first six months of 2018, compared to $7.5 million (effective tax rate of 33.7%) for the comparable period of 2017. The underlying corporate tax rate declined to 21% (beginning in 2018) from 35% (for 2017) as a result of the Tax Cuts and Jobs Act passed in December 2017, impacting the effective tax rates between the years. Additionally, a tax benefit of $159,000 and $161,000 was recorded against income tax expense for the six months ended June 30, 2018 and 2017, respectively, related to the tax impact of stock option exercises and vesting of restricted stock.

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

Net income was $9.7 million for the three months ended June 30, 2018, an increase of $1.4 million or 17% over $8.3 million for the three months ended June 30, 2017. Earnings per diluted common share was $0.98 for second quarter 2018, 18% higher than $0.83 for second quarter 2017. Annualized return on average assets for second quarter 2018 and 2017 was 1.28% and 1.27%, respectively.

Net interest income increased $1.3 million or 5% over second quarter 2017, with interest income up $3.7 million on strong loan growth while interest expense increased $2.4 million due to rising rates on a larger deposit base. The interest-earning asset yield, cost of funds and net interest margin for second quarter 2018 was 4.46%, 0.91% and 3.77%, respectively, compared to 4.67%, 0.53% and 4.27%, respectively, for second quarter 2017. The large deposit previously noted was a positive contributor to net interest income though at a very low net spread, compressing the related margin components for 2018. The inclusion of the large deposit lowered the earning asset yield and net interest margin by approximately 20 bps each in the quarter and lowered the reported cost of funds by approximately 2 bps. For additional information regarding net interest income, see “Income Statement Analysis — Net Interest Income.”

Noninterest income was $10.2 million for second quarter 2018, an increase of $1.2 million or 13% over second quarter 2017. Excluding net gains, noninterest income increased $1.0 million or 11%, largely due to trust and brokerage fees (up $0.5 million or 17% combined), card interchange income (up $0.2 million or 16% on higher volume and activity), and mortgage income (up $0.1 million or 9% on higher production and a larger servicing portfolio). Net asset gains of $1.0 million for second quarter 2018 were attributable to $0.4 million of net gains on the sale of fixed assets, a $0.4 million fair value mark on equity securities, and a $0.2 million gain on the sale of equity securities. Net asset gains of $0.8 million for second quarter 2017 were primarily attributable to a $0.5 million net gain on the sale of a former bank branch and a $0.2 million gain on the sale of investments. For additional information regarding noninterest income, see “Income Statement Analysis — Noninterest Income.”

Noninterest expense was $22.5 million for second quarter 2018, an increase of $2.1 million or 11% over second quarter 2017. Personnel expense increased $1.7 million or 15% from second quarter 2017 partly due to the expanded workforce from the 2017 acquisition (average FTEs increased 6%), as well as merit and competitive wage increases between the periods and higher equity incentives. Data processing increased $0.2 million or 9% between the comparable second quarter periods; however, excluding the $0.1 million of merger-based processing expense from second quarter 2017, data processing expense would have increased $0.3 million or 14%, reflecting the larger operating base. Other noninterest expense decreased $0.2 million or 14% compared to second quarter 2017; however, removing the $0.2 million of merger-based legal expenses from the 2017 period, other noninterest expense would have decreased 3%. All remaining noninterest expense categories on a combined basis were up $0.4 million or 7% over second quarter 2017, attributable to the larger operating base and higher overall costs. For additional information regarding noninterest expense, see “Income Statement Analysis — Noninterest Expense.”

Income tax expense for second quarter 2018 benefited from the lower corporate tax rate effective in 2018, due to the passage of the Tax Cuts and Jobs Act in December 2017. Income tax expense for second quarter 2018 was $3.3 million, with an effective tax rate of 24.9%, compared to income tax expense of $4.4 million and an effective tax rate of 34.6% for second quarter 2017.

BALANCE SHEET ANALYSIS

At June 30, 2018, assets were $2.9 billion and deposits were $2.5 billion, minimally changed from December 31, 2017; however, both decreased $0.3 billion from March 31, 2018, attributable to a $0.3 billion short-term transaction deposit of a long-standing commercial customer accepted in late March and distributed by mid-June. At June 30, 2018, loans were $2.1 billion, up $41 million or 2% over December 31, 2017.

Compared to June 30, 2017, assets increased $96 million or 3%, including an increase of $119 million or 6% in loans. Deposits increased $66 million or 3% over the same period.

Total stockholders’ equity was $371 million, an increase of $6 million from December 31, 2017, with net income and stock issuances partially offset by stock repurchases and net fair value investment changes. Compared to June 30, 2017, stockholders’ equity increased $18 million, primarily due to net income and stock issuances, partially offset by stock repurchases over the year.

Loans

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

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

Table 6: Period End Loan Composition

	June 30, 2018					December 31, 2017					June 30, 2017
(in thousands)	Amount		% of Total			Amount		% of Total			Amount		% of Total
Commercial & industrial	$	666,249		31.3	%	$	637,337		30.5	%	$	589,460		29.3	%
Owner-occupied CRE		448,367		21.1			430,043		20.6			419,066		20.8
AG production		34,016		1.6			35,455		1.7			35,428		1.8
Commercial		1,148,632		54.0			1,102,835		52.8			1,043,954		51.9
AG real estate		53,019		2.5			51,778		2.5			49,977		2.5
CRE investment		333,893		15.7			314,463		15.1			307,572		15.3
Construction & land development		75,053		3.5			89,660		4.3			85,367		4.3
Commercial real estate		461,965		21.7			455,901		21.9			442,916		22.1
Commercial-based loans		1,610,597		75.7			1,558,736		74.7			1,486,870		74.0
Residential construction		28,701		1.4			36,995		1.8			29,325		1.4
Residential first mortgage		358,537		16.8			363,352		17.4			369,007		18.4
Residential junior mortgage		106,592		5.0			106,027		5.1			103,935		5.2
Residential real estate		493,830		23.2			506,374		24.3			502,267		25.0
Retail & other		24,197		1.1			22,815		1.0			20,827		1.0
Retail-based loans		518,027		24.3			529,189		25.3			523,094		26.0
Total loans	$	2,128,624		100.0	%	$	2,087,925		100.0	%	$	2,009,964		100.0	%

Broadly, the loan portfolio at June 30, 2018, is 76% commercial-based and 24% retail-based. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively. In addition, the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis. Credit risk on commercial-based loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

Commercial-based loans of $1.6 billion increased $52 million or 3% since December 31, 2017, primarily due to a $29 million or 5% increase in commercial and industrial and an $18 million or 4% increase in owner-occupied CRE. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 31.3% of the total portfolio at June 30, 2018, up from 30.5% at December 31, 2017.

Commercial real estate loans of $0.5 billion increased $6 million or 1% from year-end 2017, with a shift in mix. CRE investment loans increased $19 million or 6%, while construction and land development loans decreased $15 million or 16%. Lending in the CRE investment and construction and land development categories has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development.

Residential real estate loans declined $13 million or 2% since year-end 2017, and represented 23.2% of total loans at June 30, 2018, compared to 24.3% at year-end 2017. Residential first mortgage loans include conventional first-lien home mortgages and residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. As part of its management of originating residential mortgage loans, Nicolet’s long-term, fixed-rate residential real estate mortgage loans are largely sold in the secondary market with or without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge-off rates.

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

Allowance for Loan Losses

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

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

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

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

At June 30, 2018, the ALLL was $12.9 million compared to $12.7 million at December 31, 2017. The $0.2 million increase was the net result of a $1.0 million provision for loan losses, partially offset by net charge-offs of $0.8 million. Comparatively, the provision for loan losses in the first half of 2017 was $0.9 million and net charge-offs were $0.1 million. Annualized net charge-offs as a percent of average loans were 0.08% in the first six months of 2018 compared to 0.01% for the first six months of 2017 and 0.08% for the entire 2017 year.

The ratio of the ALLL as a percentage of period-end loans was 0.60% at June 30, 2018, compared to 0.61% at December 31, 2017, and 0.63% at June 30, 2017. The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s bank acquisitions, which combined at their acquisition dates (from 2013 to 2017) added no ALLL to the numerator and $1.3 billion of loans into the denominator at their then estimated fair values. Remaining outstanding acquired loans were $770 million and $844 million at June 30, 2018 and December 31, 2017, respectively. The related allowance for acquired loans was $2.0 million, representing 0.26% of acquired loans, at June 30, 2018, compared to an allowance for acquired loans of $2.1 million, representing 0.25% of acquired loans, at December 31, 2017. Originated loans outstanding, the related allowance and the ALLL to loans ratio at June 30, 2018 were $1.4 billion, $10.9 million and 0.80%, respectively, compared to $1.2 billion, $10.5 million and 0.85%, respectively, at December 31, 2017.

Table 7: Allowance for Loan Losses

	For the Six Months Ended						Year Ended
(in thousands)	June 30, 2018			June 30, 2017			December 31, 2017
Allowance for loan losses (ALLL):
Balance at beginning of period	$	12,653		$	11,820		$	11,820
Provision for loan losses		1,020			900			2,325
Charge-offs		877			176			1,604
Recoveries		(79	)		(47	)		(112	)
Net charge-offs		798			129			1,492
Balance at end of period	$	12,875		$	12,591		$	12,653

Net loan charge-offs (recoveries):
Commercial & industrial	$	564		$	110		$	1,404
Owner-occupied CRE		54			(14	)		(30	)
AG production		-			-			-
AG real estate		-			-			-
CRE investment		37			(1	)		(1	)
Construction & land development		-			13			13
Residential construction		-			-			-
Residential first mortgage		47			4			(17	)
Residential junior mortgage		(29	)		(1	)		69
Retail & other		125			18			54
Total net loans charged-off	$	798		$	129		$	1,492

ALLL to total loans		0.60	%		0.63	%		0.61	%
ALLL to net charge-offs		1,613.4	%		9,760.5	%		848.1	%
Net charge-offs to average loans, annualized		0.08	%		0.01	%		0.08	%

Nonperforming Assets

As part of its overall credit risk management process, Nicolet’s management is committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized. See also Note 6, “Loans, Allowance for Loan Losses, and Credit Quality” of the Notes to Unaudited Consolidated Financial Statements under Part I, Item 1, for additional disclosures on credit quality.

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans decreased to $10.9 million (consisting of $4.9 million originated loans and $6.0 million acquired loans) at June 30, 2018 compared to $13.1 million at December 31, 2017 (consisting of $3.3 million originated loans and $9.8 million acquired loans), with the decline primarily attributable to the favorable resolution of a large purchased credit impaired commercial loan. Nonperforming assets (which include nonperforming loans and OREO) were $12.1 million at June 30, 2018 compared to $14.4 million at December 31, 2017. OREO was $1.2 million at June 30, 2018, down slightly from $1.3 million at year-end 2017, the majority of which is closed bank branch property. Nonperforming assets as a percent of total assets were 0.41% at June 30, 2018 compared to 0.49% at December 31, 2017.

The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the appropriate level of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $14.6 million (0.7% of loans) and $13.6 million (0.7% of loans) at June 30, 2018 and December 31, 2017, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.

Table 8: Nonperforming Assets

(in thousands)	June 30, 2018			December 31, 2017			June 30, 2017
Nonperforming loans:
Commercial & industrial	$	6,119		$	6,016		$	4,017
Owner-occupied CRE		588			533			3,266
AG production		66			—			3
AG real estate		175			186			197
CRE investment		1,487			4,531			5,744
Construction & land development		—			—			740
Residential construction		108			80			80
Residential first mortgage		2,063			1,587			2,602
Residential junior mortgage		276			158			252
Retail & other		—			4			—
Total nonaccrual loans		10,882			13,095			16,901
Accruing loans past due 90 days or more		—			—			—
Total nonperforming loans	$	10,882		$	13,095		$	16,901
OREO:
Commercial real estate owned	$	505		$	185		$	165
Residential real estate owned		—			70			90
Bank property real estate owned		725			1,039			1,594
Total OREO		1,230			1,294			1,849
Total nonperforming assets	$	12,112		$	14,389		$	18,750
Performing troubled debt restructurings	$	—		$	—		$	—
Ratios:
Nonperforming loans to total loans		0.51	%		0.63	%		0.84	%
Nonperforming assets to total loans plus OREO		0.57	%		0.69	%		0.93	%
Nonperforming assets to total assets		0.41	%		0.49	%		0.66	%
ALLL to nonperforming loans		118.3	%		96.6	%		74.5	%
ALLL to total loans		0.60	%		0.61	%		0.63	%

Deposits

Deposits represent Nicolet’s largest source of funds. The deposit composition, including brokered deposits within total deposits, was as follows:

Table 9: Deposits

	June 30, 2018					December 31, 2017					June 30, 2017
(in thousands)	Amount		% of Total			Amount		% of Total			Amount		% of Total
Demand	$	621,576		25.3	%	$	631,831		25.6	%	$	573,372		24.0	%
MMA and Interest-bearing demand		1,169,163		47.6	%		1,222,401		49.5	%		1,170,986		49.0	%
Savings		289,156		11.8	%		269,922		10.9	%		265,165		11.1	%
Time		375,641		15.3	%		346,910		14.0	%		380,448		15.9	%
Total deposits	$	2,455,536		100.0	%	$	2,471,064		100.0	%	$	2,389,971		100.0	%

Brokered transaction accounts	$	63,741		2.6	%	$	76,141		3.1	%	$	140,584		5.9	%
Brokered time deposits		37,713		1.5	%		44,645		1.8	%		84,835		3.5	%
Total brokered deposits	$	101,454		4.1	%	$	120,786		4.9	%	$	225,419		9.4	%

Lending-Related Commitments

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

Table 10: Commitments

	June 30,		December 31,
(in thousands)	2018		2017
Commitments to extend credit	$	688,167	$	680,307
Financial standby letters of credit		8,878		8,783
Performance standby letters of credit		8,143		9,080

Interest rate lock commitments to originate residential mortgage loans held for sale (included above in commitments to extend credit) and forward commitments to sell residential mortgage loans held for sale are considered derivative instruments and represented $34.5 million and $11.9 million, respectively, at June 30, 2018. The fair value of these interest rate lock commitments and forward commitments was not significant at June 30, 2018.

Liquidity Management

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

Funds are available from a number of basic banking activity sources, including but not limited to, the core deposit base; repayment and maturity of loans; investment securities calls, maturities, and sales; and procurement of brokered deposits. All securities AFS and equity securities (included in other investments) are reported at fair value on the consolidated balance sheet. At June 30, 2018, approximately 31% of the $402 million securities AFS portfolio was pledged to secure public deposits and short-term borrowings, as applicable, and for other purposes as required by law. Additional funding sources at June 30, 2018, consist of a $10 million available and unused line of credit at the holding company, $158 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $177 million, and borrowing capacity in the brokered deposit market.

Cash and cash equivalents at June 30, 2018 and December 31, 2017 were $104.1 million and $154.9 million, respectively. The decrease in cash and cash equivalents since year-end 2017 was largely attributable to loan growth, net investment purchases, a reduction in deposits, and common stock purchases. Nicolet’s liquidity resources were sufficient as of June 30, 2018 to fund loans, accommodate deposit cycles and trends, and to meet other cash needs as necessary.

Interest Rate Sensitivity Management and Impact of Inflation

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

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

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

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

Table 11: Interest Rate Sensitivity

	June 30, 2018			December 31, 2017
200 bps decrease in interest rates		(1.6	)%		(1.0	)%
100 bps decrease in interest rates		(0.5	)%		(0.2	)%
100 bps increase in interest rates		0.1	%		(0.1	)%
200 bps increase in interest rates		0.4	%		(0.2	)%

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

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

Capital

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

As shown in Table 12, Nicolet’s regulatory capital ratios remain well above minimum regulatory ratios. At June 30, 2018, the Bank’s regulatory capital ratios qualify the Bank as well-capitalized under the prompt-corrective action framework. This strong base of capital has allowed Nicolet to be opportunistic in the current environment and in strategic growth. A summary of Nicolet’s and the Bank’s regulatory capital amounts and ratios as of June 30, 2018 and December 31, 2017 are presented in the following table.

Table 12: Capital

(in millions)	June 30, 2018			December 31, 2017
Company:
Total risk-based capital	$	308.9		$	299.0
Tier 1 risk-based capital		284.1			274.5
Common equity Tier 1 capital		254.7			245.2
Total capital ratio		12.7	%		12.8	%
Tier 1 capital ratio		11.7	%		11.8	%
Common equity tier 1 capital ratio		10.5	%		10.5	%
Tier 1 leverage ratio		9.7	%		10.0	%
Bank:
Total risk-based capital	$	277.7		$	267.2
Tier 1 risk-based capital		264.8			254.5
Common equity Tier 1 capital		264.8			254.5
Total capital ratio		11.5	%		11.5	%
Tier 1 capital ratio		10.9	%		10.9	%
Common equity tier 1 capital ratio		10.9	%		10.9	%
Tier 1 leverage ratio		9.1	%		9.3	%

In managing capital for optimal return, we evaluate capital sources and uses, pricing and availability of our stock in the market, and alternative uses of capital (such as the level of organic growth or acquisition opportunities) in light of strategic plans. During the first half of 2018, $12.5 million was utilized to repurchase and cancel approximately 226,500 shares of common stock pursuant to our 2014 common stock repurchase program, bringing the life-to-date cumulative totals to 933,700 shares repurchased for $36.6 million. On July 17, 2018, Nicolet’s board authorized an increase to the program of $12 million or up to 200,000 shares. As a result, there remains $17.4 million authorized under the repurchase program to be utilized from time-to-time to repurchase shares in the open market, through block transactions or in private transactions.

Critical Accounting Policies

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

Future Accounting Pronouncements

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

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

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Entities should apply the amendment by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company expects to adopt the new accounting standard in 2020, as required, and is currently assessing the impact of the new guidance on its consolidated financial statements. A cross-functional team has been established to assess and implement the new standard.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of the guidance is a lessee should recognize the assets and liabilities that arise from leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new standard will require both types of leases to be recognized on the balance sheet. The updated guidance is effective for annual reporting periods beginning after December 15, 2018. Early application is permitted. The Company will adopt the new accounting standard in 2019, as required, and is currently assessing the impact of the new guidance on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4. CONTROLS AND PROCEDURES

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

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

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

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

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

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

	Total Number of Shares Purchased(a)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(b)
	(#)		($)		(#)		(#)
Period
April 1 – April 30, 2018		70,404	$	55.34		70,281		328,000
May 1 – May 31, 2018		11,648	$	55.98		11,648		316,000
June 1 – June 30, 2018		-	$	-		-		316,000
Total		82,052	$	55.43		81,929		316,000

(a)

During the second quarter of 2018, the Company repurchased 123 shares for minimum tax withholding settlements on restricted stock. These purchases do not count against the maximum number of shares that may yet be purchased under the board of directors’ authorization.

(b)

During the second quarter of 2018, Nicolet utilized $4.5 million to repurchase and cancel approximately 81,900 shares of common stock pursuant to our 2014 common stock repurchase program, bringing the life-to-date cumulative totals to $36.6 million to repurchase and cancel approximately 933,700 shares, or a weighted average price of $39.25 per share excluding commissions. At June 30, 2018, approximately $5.4 million remained available to repurchase up to 316,000 common shares. Subsequent to quarter-end, on July 17, 2018, the stock repurchase program was modified, adding $12 million more to repurchase up to 200,000 shares of outstanding common stock. Including this subsequent modification, there remains $17.4 million authorized under the repurchase program.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The following exhibits are filed herewith:

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

SIGNATURES

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

	NICOLET BANKSHARES, INC.

August 3, 2018	/s/ Robert B. Atwell
	Robert B. Atwell
	Chairman, President and Chief Executive Officer

August 3, 2018	/s/ Ann K. Lawson
	Ann K. Lawson
	Chief Financial Officer