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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of Nicolet. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.

Evaluation of financial performance and certain balance sheet line items was impacted by the timing and size of Nicolet's acquisitions, Choice Bancorp, Inc. (“Choice”) on November 8, 2019, at 12% of Nicolet’s then pre-merger asset size, and Advantage Community Bancshares, Inc. (“Advantage”) on August 21, 2020, at 4% of Nicolet’s then pre-merger asset size. Certain income statement results, average balances and related ratios for 2020 include full contribution from Choice and a partial contribution from Advantage, while 2019 includes partial contribution from Choice and no contribution from Advantage. At consummation, Choice added $457 million in assets, loans of $348 million, deposits of $289 million, core deposit intangible of $1.7 million, goodwill of $45 million, and one net new branch. At consummation, Advantage added $172 million in assets, loans of $88 million, deposits of $141 million, core deposit intangible of $1 million, goodwill of $12 million, and four branches.

The detailed financial discussion that follows focuses on 2020 results compared to 2019. See “2019 Compared to 2018” for the summary comparing 2019 and 2018 results. Some tabular information is shown for trends of three years or for five years as required under SEC regulations.

Overview

Nicolet provides a diversified range of traditional commercial and retail banking services, as well as wealth management services, to individuals, business owners, and businesses in its market area primarily through, as of year-end 2020, the 36 bank branch offices of its banking subsidiary, located in northeast and central Wisconsin and Menominee, Michigan.

The 2020 year was marked by significant events (health pandemic, large sudden rate drop by the Federal Reserve, unprecedented government stimulus, political changes and social issues, and other market and economic disruptions), volatility, and uncertainty, that turned 2020 into a very tactical year for Nicolet management. Management took several actions to respond: added $0.2 billion of liquidity (which later proved to not be necessary, leading to a reduction in non-deposit leverage in the second half of the year), temporarily (and later permanently) closed 8 branches, provided temporary relief to customers through loan payment modifications on nearly 1,000 loans (with only a fraction remaining on modified terms at year end), dramatically elevated the credit loss provision given pervading uncertainty (though slowed the provision in fourth quarter as potential deterioration of loan quality metrics initially anticipated had not materialized), channeled significant resources to originate PPP loans (peaking at 2,725 loans totaling $351 million during 2020) and residential mortgages (over $1 billion originated to consumers under atypical conditions), granted $1.25 million of aid to expedite funds to smaller businesses who would have otherwise waited for small PPP loans, kept people safe (with $0.6 million of expense in second quarter for onsite-bonuses, testing and protective supplies), and prioritized full return to on-site work by June to allow us to move forward on goals and improvements (with offsite workforce peaking at 52%, comprised of 34% remote and 18% paid to stay home and not work due to risk concerns or location closure). During 2020, we still executed on our acquisition strategy, completing the all-cash acquisition of Advantage. While we announced a merger agreement with a $0.7 billion bank in February 2020, we exercised discipline, mutually terminating that deal in May 2020, (given the level of uncertainty and pricing in the significantly depressed market that made the transaction unlikely to close) and incurred a $0.5 million charge. Nicolet has used acquisitions as part of its growth strategy over the past few years and has successfully integrated and realized cost efficiencies related to scale quickly after each acquisition.

In 2020, despite the turbulent year and through the many actions noted above, Nicolet delivered on growth, profitability, capital positioning, and sound asset quality management. At December 31, 2020, Nicolet had total assets of $4.6 billion, loans of $2.8 billion, deposits of $3.9 billion and stockholders’ equity of $539 million, representing increases over December 31, 2019 of 27%, 8%, 32% and 4%, in assets, loans, deposits and total equity, respectively, largely due to the significant increase in liquidity, and only partly due to the Advantage acquisition. At December 31, 2020, cash and cash equivalents grew significantly, up $0.6 billion to $0.8 billion or 18% of assets (compared to $0.2 billion or 5% of assets at year end 2019), while loans increased $0.2 billion and investments grew $0.1 billion, funded by the surge in deposits (up $956 million) over year end 2019. Asset quality remained sound, with nonperforming assets to assets of 0.29% at December 31, 2020 (down from 0.42% at year-end 2019), as the borrowing base has largely remained resilient, profitable and liquid in the uncertain times. The allowance for credit losses-loans grew to $32.2 million (1.15% of loans, or 1.24% of loans excluding PPP loans) compared to $14.0 million or 0.54% of loans at December 31, 2019. The large increase in the allowance resulted from the $10.3 million provision exceeding $1.4 million of net charge-offs (or 0.05% of average loans), and a $9.3 million addition upon adoption of the current expected credit losses (“CECL”) model. Nicolet repurchased approximately 646,700 shares of common stock for $40.5 million in 2020 under its common stock repurchase program, given the opportunity of a depressed market. At December 31, 2020 there remained $20.4 million authorized under the repurchase program, as modified. With total stockholders’ equity to assets of 11.85% at year-end 2020, Nicolet has capacity to act on targets of interest in relevant or growth markets that provide a path to or support our position as the lead-local community bank.

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For 2020, net income was record-breaking at $60.1 million (10% higher than $54.6 million for 2019), and return on average assets was 1.41% (compared to 1.75% for 2019), with 2020 impacted by the sizable increase in average assets (mainly cash). Diluted earnings per common share for 2020 was $5.70 (3% higher than 2019), benefiting from the stronger net income, while covering a 6% increase in average diluted shares, mostly due to the timing of the 1.2 million shares issued in the Choice acquisition net of strong repurchase activity throughout 2020 (totaling 0.6 million shares). Notably, second quarter 2020 net income unfavorably included $4 million of isolated expenses ($3 million after tax) related to the onset of the pandemic, a terminated acquisition and branch closure decisions. During second quarter 2019, net income favorably included $5.4 million (or $0.55 of diluted earnings per share) related to two one-time actions combined, the sale of 80% of Nicolet's equity investment in a data processing entity ($7.4 million after-tax gain) and $2.75 million retirement-related compensation declared to benefit all employees after that sale ($2.0 million after-tax cost).

Net income before taxes for 2020 was $80.9 million ($9.5 million or 13% higher than 2019), predominantly due to increased net interest income (up $13 million or 11% aided mainly on higher volumes, despite an 81bps decline in net interest margin between the years, dominated by the very high proportion of low-earning cash in total interest-earning assets), record net mortgage income (at $30 million versus $12 million in 2019) and strong wealth revenues (up $2 million or 13%), which more than covered a $10 million negative swing in net asset gains or losses (at $2 million net loss for 2020 versus $8 million net gain for 2019), higher credit loss provision (up $9 million) and a $4 million or 4% increase in overall expenses, evidencing diligent expense management and improved efficiencies in a difficult year.

For 2021, Nicolet’s focus will return to its long-term strategies, especially M&A, as we believe such opportunities have grown in light of industry stress, and we have remained well-positioned to capitalize on it through a solid core franchise, strong asset quality, and an experienced team. That said, when evaluating transactions, quantitative and qualitative factors need to make sense in combination with each other, including but not limited to the economics of the transaction, cultural and strategic fit, geographic and business line relevance, and current or potential talent. We will remain committed on driving growth in core earnings through our expanded customer base. Our objective is to achieve solid organic growth in loans, core deposits, wealth management services and other revenue lines within all our markets, in a cost-effective, profitable manner to sustain a healthy return on average assets. We plan to remain active on-site as a differentiator to many of our competitors, remain adaptable for our customers in the continuing uncertainty, and deliver on our long-term leadership succession plans. Additional resources are planned in 2021 for furthering automation and data analysis (to enhance customer experiences and company efficiencies and decision-making), for personnel expenses (in support of deepening talent and leadership in light of growth and succession needs), and for capital management (to balance safety and opportunity for the long-term). While Nicolet believes delivering strong earnings, return on assets, and disciplined capital management aligned with growth will provide upward pressure on our common stock performance throughout the year, ongoing uncertainties remain for 2021 across many environments (health, social, political and economic), which will likely heighten potential challenges for the year.

INCOME STATEMENT ANALYSIS

Net Interest Income

Net interest income is the primary source of Nicolet’s revenue, and is the difference between interest income on earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount, mix and composition of interest-earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies. Tax-equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and is used in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources. Tables 1, 2, and 3 present information to facilitate the review and discussion of selected average balance sheet items, tax-equivalent net interest income, interest rate spread, and net interest margin.

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Table 1: Average Balance Sheet and Net Interest Income Analysis - Tax-Equivalent Basis

Years Ended December 31,

ASSETS

Interest-earning assets

Investment securities:

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities

Selected Additional Information:

Net interest rate spread ex PPP & PPPLF 3.15 % 3.84 % 3.77 %

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

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

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Table 2: Volume/Rate Variance - Tax-Equivalent Basis

Volume Rate Net (1) Volume Rate Net (1)

Interest-earning assets

PPP Loans $ 8,062 $ — $ 8,062 $ — $ — $ —

Investment securities:

Interest-bearing liabilities

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

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

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

Table 3: Interest Rate Spread, Margin and Average Balance Mix - Tax-Equivalent Basis

Years Ended December 31,

Contribution from net free funds 0.23 % 0.35 % 0.27 %

Comparison of 2020 versus 2019

Net interest income was up 11% over 2019, despite an 81 bps decline in net interest margin. Overall asset volumes increased net interest income while the mix of interest-earning assets (particularly the very high cash levels) squeezed the related net interest margin. In general, the lower interest rate environment pressured both net interest income and net interest margin.

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The interest rate environment experienced dramatic change in 2020. Prior to the pandemic, the Federal Reserve steadily raised short-term interest rates during 2017 and 2018 in support of a growing economy (up 175 bps total to 2.50% at December 31, 2018), and then reduced rates by 75 bps in three moves during the second half of 2019 (to 1.75% at December 31, 2019) largely responding to global issues and slowing growth, which contributed to a flattened yield curve with periods of inversion. In response to the pandemic in March 2020, the Federal Reserve dropped short-term rates by 150 bps (to 25 bps at March 31, 2020) in two emergency moves, which brought slope back into the yield curve, though still fairly flat. Comparatively, short-term rates were 150 bps lower at December 31, 2020 than at December 31, 2019. While the following paragraphs will discuss the comparison of 2020 and 2019, we expect that the pandemic impacts will continue to evolve and pressure future quarters even further, including continued margin pressure in the low rate environment and potential unusual loan or deposit volume or pricing impacts.

At the onset of the pandemic, but prior to the announcement of government stimulus, we added liquidity to ensure we could meet customer needs. The action demonstrated our capacity to support our communities, but proved later to not be necessary, leading us to reduce non-deposit leverage in the second half of 2020. Efforts to minimize pressure on net interest income during the changes throughout 2020 included prudent pricing actions on deposits and loans, allowing brokered deposits to mature without renewal, prepayment of selected FHLB advances, and full payback of the PPPLF funding (approximately $335 million used for 5 months at a cost of 35 bps). In addition, we fully redeemed our subordinated notes ($12 million at 5% fixed) in November 2020 and one of our junior subordinated debenture issuances ($6 million at 8% fixed) in December 2020, which combined will reduce annual interest expense by approximately $1.1 million going forward.

Tax-equivalent net interest income was $130.3 million for 2020, up $13.2 million (11%), compared to 2019, comprised of net interest income of $129.3 million ($13.3 million or 11% higher than 2019) and a $1.0 million tax-equivalent adjustment (down nearly $0.1 million between the years). The $13.2 million increase in tax-equivalent net interest income was comprised of $10.6 million higher interest income and $2.6 million lower interest expense. Higher volumes added $26.3 million to net interest income, including a $31.8 million increase to interest income on higher interest-earning assets (mostly from higher loan volumes, due to the inclusion of loans acquired with Choice and Advantage, as well as PPP loans), offset partly by a $5.4 million increase to interest expense on higher interest-bearing liabilities (mostly from higher deposit volumes also related to the inclusion of Choice and Advantage, as well as overall deposit growth from increased liquidity of consumers and businesses). Rate changes reduced net interest income $13.1 million, comprised of $21.2 million lower interest income (with $16.8 million was from lower rates on loans and $3.7 million from the dramatically reduced cash rate earned), but also lower interest expense on funding of $8.1 million (including $7.7 million savings from non-brokered interest-bearing core deposits and $0.9 million savings from wholesale funding, partly offset by $0.6 million more interest expense from term brokered deposits).

The interest rate spread decreased 69 bps between the periods, as the interest-earning asset yield decreased 110 bps to 3.90% and the cost of funds declined favorably 41 bps to 0.75%. The significantly higher mix of cash assets (to 15% of interest-earning assets versus 4% in 2019) combined with their dramatic decline in yield (to 0.46% versus 2.65% in 2019), has pressured the net interest margin most. Loans yielded 4.90% for 2020, down 67 bps from 2019, in part from the inclusion of lower-earning PPP loans (yielding 3.66%) in 2020, while all other loans earned 5.00%, down 57 bps from 2019. Investments yielded 2.26%, 31 bps lower than 2019. The 41 bps favorable decline in the 2020 cost of funds was primarily attributable to prudent pricing actions on core interest-bearing deposits (down 45 bps to 0.57%) and lower wholesale funding rates (down 159 bps to 3.13% for funding costs excluding PPPLF), offset partly by higher-costing brokered deposits (acquired with the Choice acquisition and procured with the March-April 2020 liquidity actions under competitive conditions). The contribution from net free funds decreased 12 bps, due mostly to the reduced value in the lower interest rate environment, though offset partly by the increase in average net free funds (largely from average noninterest-bearing demand deposits and stockholders' equity) between the years. As a result, the net interest margin was 3.38% for 2020, down 81 bps compared to 4.19% for 2019.

Average interest-earning assets were $3.8 billion for 2020, $1.1 billion (38%) higher than 2019, primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020), addition of PPP loans (beginning in second quarter 2020), and significantly higher cash starting in second quarter 2020. Average loans increased $531 million (24%) to $2.8 billion (which includes $348 million of Choice loans at acquisition, $88 million of Advantage loans at acquisition, and $186 million of net PPP loans at December 31, 2020), investments increased $81 million, and other interest-earning assets (which are predominantly cash) increased $444 million. The mix of average interest-earning assets shifted to lower-yielding assets, at 72% loans (comprised of 6% PPP loans and 66% all other loans), 13% investments, and 15% other interest-earning assets (mostly cash) for 2020, compared to 81%, 15%, and 4%, respectively, for 2019.

Tax-equivalent interest income was $150.2 million, up $10.5 million (8%) over 2019, while the related interest-earning asset yield decreased 110 bps to 3.90%. Interest income on loans increased $10.8 million (9%) over 2019, aided by strong volumes, including the Choice and Advantage acquisitions, as well as PPP loans. The 2020 loan yield was 4.90%, down 67 bps from 2019, largely from the significantly lower interest rate environment impacting yields on new, renewed, and variable rate loans, as well as from inclusion of PPP loans at a 3.66% yield. Between the years, interest income on non-loan earning assets combined decreased $0.2

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million to $13.7 million, impacted by a 130 bps decline in the yield (to 1.29%) in the lower rate environment, partially offset by higher average volumes (up 98%) from the significantly higher cash.

Average interest-bearing liabilities were $2.7 billion for 2020, an increase of $721 million (37%) from 2019, primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020), as well as the significant increase in deposits from government stimulus activities and deposited PPP loan proceeds. Average core interest-bearing deposits increased $335 million, brokered deposits grew $214 million, and funding increased $171 million (mostly PPPLF funding). The mix of average interest-bearing liabilities was 80% core deposits, 11% brokered deposits, and 9% other funding for 2020, compared to 92% core deposits, 4% brokered deposits, and 4% other funding in 2019, with the mix changes (especially increased money markets and brokered deposits) influenced by the composition of the $289 million of Choice deposits acquired, and the procurement of brokered deposits in March-April 2020 as part of previously discussed liquidity actions.

Interest expense was $20 million for 2020, down $3 million (12%) from 2019, on larger average interest-bearing liabilities volumes (up 37% to $2.7 billion) but at a lower overall cost (down 41 bps to 0.75%). Interest expense on deposits decreased $2.3 million from 2019 given 29% higher average interest-bearing deposit balances, but at a lower cost (down 33 bps to 0.69%). The 2020 cost of savings, interest-bearing demand, money market accounts, and core time deposits decreased from 2019 by 31 bps, 30 bps, 43 bps, and 48 bps, respectively, as product rate changes were made in the lower interest rate environment, and brokered deposits cost 52 bps more than 2019 largely from higher-costing term brokered funds acquired with the Choice acquisition in November 2019 and procured during March-April 2020 under competitive conditions as part of previously discussed liquidity actions. Interest expense on other interest-bearing liabilities decreased $0.3 million (9%), as additional interest expense on higher average balances (up $171 million) was substantially offset by lower rates (down 341 bps to 1.31%), mostly impacted by the inclusion of the low-costing PPPLF (average balance of $162 million for 2020 at a 0.35% rate), and variable rate debt repricing and maturing advances replaced in the lower rate environment.

Provision for Credit Losses

The provision for credit losses in 2020 was $10.3 million, exceeding $1.4 million of net charge-offs. Comparatively, 2019 provision for credit losses and net charge-offs were $1.2 million and $0.4 million, respectively. The increase in the provision for credit losses between the years was largely due to the unprecedented economic disruptions and uncertainty surrounding the COVID pandemic, and to a lesser extent, to the acquisition of Advantage.

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

Noninterest Income

Table 4: Noninterest Income

(in thousands) Years Ended December 31, Change From Prior Year

N/M means not meaningful.

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Comparison of 2020 versus 2019

Noninterest income was $62.6 million for 2020, an increase of $9.3 million (17%) over 2019, which included a $7.4 million gain on the equity investment sale previously noted in the “Overview” section. Noninterest income excluding net asset gains increased $19.0 million (42%) between 2020 and 2019. Notable contributions to the change in noninterest income were:

•Trust services fee income and brokerage fee income combined were $16.2 million for 2020, up $1.9 million (13%) from 2019, consistent with the growth in assets under management.

•Mortgage income represents net gains received from the sale of residential real estate loans into the secondary market, capitalized mortgage servicing rights (“MSRs”), servicing fees net of MSR amortization, fair value marks on the mortgage interest rate lock commitments and forward commitments (“mortgage derivatives”), and MSR valuation changes, if any. Net mortgage income was $29.8 million for 2020, up $17.9 million (151%) over 2019, predominantly from higher sale gains and capitalized gains combined (up $18.9 million or 168%, commensurate with the increase in volumes sold into the secondary market, aided by the current refinance boom and better pricing between the years), partially offset by a $1.0 million MSR asset valuation allowance given faster paydown activity. See also “Off-Balance Sheet Arrangements, Lending-Related Commitments and Contractual Obligations” and Note 6, “Goodwill and Other Intangibles and Mortgage Servicing Rights” in the Notes to Consolidated Financial Statements, under Part II, Item 8

•Service charges on deposit accounts were down $0.6 million (13%) to $4.2 million for 2020, mainly as we waived certain fees during second quarter 2020 to provide economic relief to our customers.

•Card interchange income grew $0.5 million (8%) to $7.0 million in 2020 due to higher volume and activity.

•BOLI income increased $0.3 million (14%) to $2.7 million for 2020, attributable to the difference in BOLI death benefits received in each year (up $0.2 million) and income on higher average balances from $5 million new BOLI purchased in mid-2019, $6 million BOLI acquired with Choice, and $3 million BOLI acquired with Advantage.

•Other income of $4.5 million was down $1.1 million (19%) from 2019, largely due to $0.5 million lower income from the smaller equity interest in a data processing entity after the partial sale in 2019 and $0.3 million attributable to the fee earned on a customer loan interest rate swap in 2019.

•The $1.8 million net asset losses in 2020 were comprised primarily of $1.0 million market losses on equity securities held in the lower, more volatile market and $0.9 million of net losses on branch other real estate owned write-downs. Net asset gains in 2019 of $7.9 million were comprised primarily of the $7.4 million gain on the equity investment sale in second quarter 2019 and $1.1 million of favorable fair value marks on equity securities, partially offset by losses of $0.6 million on the disposal and write-down of fixed assets, OREO, and an other investment. Additional information on the net gains is also included in Note 15, “Asset Gains (Losses), Net,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

Noninterest Expense

Table 5: Noninterest Expense

($ in thousands) Years Ended December 31, Change From Prior Year

Average full-time equivalent employees 553 560 553 (7) (1) % 7 1 %

Comparison of 2020 versus 2019

Noninterest expense was $100.7 million, an increase of $3.9 million (4%) over 2019, with second quarter 2020 including $4 million of isolated expenses related to the onset of the pandemic, a terminated acquisition, and branch closure decisions. Personnel costs increased $2.7 million, and non-personnel expenses combined increased $1.2 million over 2019. Notable contributions to the change in noninterest expense were:

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•Personnel expense (including salaries, overtime, cash and equity incentives, and employee benefit and payroll-related expenses) was $57.1 million for 2020, an increase of $2.7 million (5%) over 2019. Salaries increased $2.3 million (7%) over 2019, of which $0.6 million was attributable to branch closure severances and on-site bonus pay in second quarter 2020, and $1.7 million (representing a 5% increase over 2019) was due to merit increases and hires between the years. Cash and equity award incentives increased $1.5 million, while retirement-based compensation (401k, profit sharing and nonqualified deferred compensation) declined $1.0 million between the years, rewarding strong performance of both years and matching the mix of incentive compensation to be meaningful to recipients. Overtime pay doubled to $0.6 million (up $0.3 million over 2019), largely to cover the effort of processing PPP originations and significant mortgage volume. All other fringe benefits combined declined $0.4 million from 2019, mainly on lower health costs between the years.

•Occupancy, equipment and office expense was $16.7 million for 2020, up $1.9 million (13%) from 2019, with 2020 including $0.5 million of accelerated depreciation and write-offs related to the branch closures, higher expense for software and technology to drive operational efficiencies and enhance products or services, and for additional licenses and equipment to expand remote workers in response to the pandemic. 2019 also included $0.4 million of accelerated depreciation for branch facility upgrades.

•Business development and marketing expense was $5.4 million for 2020, down $0.3 million (5%), largely due to lower business development costs from less travel and entertainment during the pandemic, partly offset by $1.25 million for the micro-grant program.

•Data processing expense was $10.7 million for 2020, up $0.7 million (7%) over 2019, mostly due to volume-based increases in core processing charges.

•Intangible amortization decreased $0.3 million mainly from declining amortization on the aging intangibles of previous acquisitions, partly offset by amortization from the new intangibles of the August 2020 Advantage and November 2019 Choice acquisitions.

•Other expense was $7.2 million for 2020, down $0.8 million (10%) from 2019. Other expense for 2020 included $1.0 million of lease termination charges related to the branch closures and $0.5 million to terminate the Commerce merger agreement. Other expense for 2019 included a $0.7 million lease termination charge for the closure of Nicolet's Oshkosh branch in conjunction with the Choice acquisition, an $0.8 million full write-off of non-bank goodwill, and $0.7 million related to a fraud loss contingency.

Income Taxes

Income tax expense was $20.5 million, up 4.0 million (24%) over 2019, partly due to 13% higher pre-tax earnings. The 2020 effective tax rate was 25.3%, higher than 23.0% for 2019. The increase in effective tax rate was due to the favorable tax treatment of the partial equity investment sale of a data processing company in 2019, as well as the change in tax benefit on stock-based compensation (see Note 10, “Stock-Based Compensation” for additional information on the tax benefit on stock-based compensation), and nondeductible compensation from compensation limits between the years.

The accounting for income taxes requires deferred income taxes to be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. This analysis involves the use of estimates, assumptions, interpretation, and judgment concerning accounting pronouncements and federal and state tax codes; therefore, income taxes are considered a critical accounting policy. At December 31, 2020 and 2019, no valuation allowance was determined to be necessary. Additional information on the subjectivity of income taxes is discussed further under “Critical Accounting Policies-Income Taxes.” The Company’s accounting policy for income taxes are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures relative to income taxes are included in Note 12, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

BALANCE SHEET ANALYSIS

Loans

Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. The Company concentrates on originating loans in its local markets and assisting current loan customers. Nicolet actively utilizes government loan programs such as those provided by the U.S. Small Business Administration (“SBA”), including the Paycheck Protection Program, to help customers with current economic conditions and positioning their businesses for the future. In addition to the discussion that follows, accounting policies for loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

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Table 6: Period End Loan Composition

PPP loans 186,016 7 % — — % — — % — — % — — %

Total loans were $2.8 billion at December 31, 2020, an increase of $215 million (8%), compared to total loans of $2.6 billion at December 31, 2019. During 2020, we acquired Advantage, which added total loans of $88 million at acquisition. In addition, we originated 2,725 PPP loans totaling $351 million, bearing a 1% contractual rate, and earned a $12.3 million fee, of which $5.7 million was accreted into interest income during 2020. At December 31, 2020, the net carrying value of PPP loans was $186 million, or 7% of loans, with the decline in balance coming almost exclusively from SBA loan forgiveness, boosting overall borrower equity in their businesses. Given strong participation in the PPP and caution around debt levels, utilization of conventional lines of credit fell. For the first time in recent history, commercial lines of credit declined between year-end periods to $221 million (down $104 million or 32% from December 31, 2019). Excluding PPP loans and commercial lines of credit, all other loans combined increased $133 million (6%) over December 31, 2019 (or up 2%, further excluding loans acquired from Advantage).

As noted in Table 6 above, year-end 2020 loans were broadly 78% commercial-based and 22% retail-based compared to 75% commercial-based and 25% retail-based at year-end 2019. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.

Commercial and industrial loans consist primarily of commercial loans to small businesses, PPP loans, and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans, including the PPP loans, continue to be the largest segment of Nicolet’s portfolio, representing 34% of the portfolio at year-end 2020.

Owner-occupied CRE loans represented 19% of loans at year-end 2020, unchanged from year-end 2019. This category primarily consists of loans within a diverse range of industries secured by business real estate that is occupied by borrowers who operate their businesses out of the underlying collateral and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.

Agricultural loans consist of loans secured by farmland and the related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. These loans represented 4% of loans at year-end 2020, unchanged from a year ago.

The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. These loans represented 16% of loans at December 31, 2020, compared to 17% of loans at year-end 2019.

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Loans in the construction and land development portfolio represented 5% of total loans at year-end 2020. Construction and land development loans provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis.

On a combined basis, Nicolet’s residential real estate loans represented 21% of total loans at year-end 2020 compared to 24% of total loans at year-end 2019. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage loans consist of home equity lines and term loans secured by junior mortgage liens. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential first mortgage loans are sold in the secondary market with the servicing rights retained. Nicolet’s mortgage loans are typically of high quality and have historically had low net charge-off rates.

Loans in the retail and other classification represented approximately 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions.

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

The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2020, 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.

Table 7: Loan Maturity Distribution

The following table presents the maturity distribution of the loan portfolio at December 31, 2020.

(in thousands) Loan Maturity

One Yearor Less Over One Yearto Five Years OverFive Years Total

Percent by maturity distribution 23 % 54 % 23 % 100 %

Floating rate percent 47 % 5 % 46 % 24 %

* The residential construction loans with a loan maturity over five years represent a construction to permanent loan product.

Allowance for Credit Losses - Loans

In addition to the discussion that follows, accounting policies for the allowance for credit losses - loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional ACL-Loans disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

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Credit risks within the loan portfolio are inherently different for each loan type as described under “BALANCE SHEET ANALYSIS – Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and ongoing review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, interest, and related expenses. For additional information regarding nonperforming assets see “BALANCE SHEET ANALYSIS – Nonperforming Assets.”

The ACL-Loans represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date. To assess the overall appropriateness of the ACL-Loans, management applies an allocation methodology which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management's ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonaccrual loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect expected credit losses. Assessing these factors involves significant judgment; therefore, management considers the ACL-Loans a critical accounting policy, as further discussed under “Critical Accounting Policies – Allowance for Credit Losses - Loans.”

Management allocates the ACL-Loans by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve is established for individually evaluated and other credit-deteriorated loans, which management defines as nonaccrual credit relationships over $250,000, collateral dependent loans, and other loans with evidence of credit deterioration. The specific reserve in the ACL-Loans for these credit deteriorated loans is equal to the aggregate collateral or discounted cash flow shortfall. Management allocates the ACL-Loans with historical loss rates by loan segment. The loss factors are measured on a quarterly basis and applied to each loan segment based on current loan balances and projected for their expected remaining life. Next, management allocates the ACL-Loans using the qualitative and environmental factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses at the evaluation date to differ from the historical loss experience of each loan segment. Lastly, management considers reasonable and supportable forecasts to assess the collectability of future cash flows.

Management performs ongoing intensive analysis of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ACL-Loans. In addition, various regulatory agencies periodically review the ACL-Loans. These agencies may require the Company to make additions to the ACL-Loans or may require that certain loan balances be charged off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments of collectability from information available to them at the time of their examination.

At December 31, 2020, the ACL-Loans was $32.2 million (representing 1.15% of period end loans and 1.24% of period end loans excluding PPP loans) compared to $14.0 million at December 31, 2019. The increase in the ACL-Loans was largely due to the $9.3 million impact from the adoption of CECL (comprised of $8.5 million for the CECL impact on the loan portfolio and $0.8 million for the PCD gross-up) and a much higher provision for credit losses in 2020 given the unprecedented economic disruption and uncertainty surrounding the COVID pandemic. The components of the ACL-Loans are detailed further in Tables 8 and 9 below.

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Table 8: Allowance for Credit Losses - Loans

(in thousands) Years Ended December 31,

Allowance for credit losses - loans:

Adoption of CECL 8,488 — — — —

Initial PCD ACL 797 — — — —

Total impact for adoption of CECL 9,285 — — — —

Loans charged off:

Agricultural — — — — —

CRE investment (190) — (37) — —

Construction & land development — — — (13) —

Residential construction — (226) — — —

Residential first mortgage (2) (22) (85) (8) (80)

Residential junior mortgage — (80) — (72) (57)

Recoveries of loans previously charged off:

Agricultural — — — — —

CRE investment — — — 1 221

Construction & land development — — — — —

Residential construction — — — — —

Ratios:

The allocation of the ACL-Loans by loan category for each of the past five years is shown in Table 9. The largest portions of the ACL-Loans were allocated to commercial & industrial loans and owner-occupied CRE loans combined, representing 54% and 61% of the ACL-Loans at December 31, 2020 and 2019, respectively. The change in allocated ACL-Loans from December 31, 2019 to December 31, 2020 was consistent with changes related to the adoption of CECL, as well as changes in outstanding loan balances between the years and risk trends within loan categories.

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Table 9: Allocation of the Allowance for Credit Losses - Loans

* See Table 6 for the ratio of loans by category to total loans.

Nonperforming Assets

As part of its overall credit risk management process, management is committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized. Management is actively working with customers and monitoring credit risk from the unprecedented economic disruptions surrounding the COVID pandemic (as also discussed in the Overview section). Since the pandemic started, nearly 1,000 loans with a current balance of $456 million were provided temporary payment modifications. Initial metrics reflected the loan modifications as 88% commercial and 12% retail, with 67% on interest only payments and 33% on full payment deferrals. As of December 31, 2020, $408 million (90%) had returned to normal payment structures, $29 million (6%) were paid off, $15 million (3%) remain under temporary modification structure, and only $4 million (1%) became troubled debt restructurings (included in Table 10 below). The combined $19 million under modification or restructure represented less than 1% of total loans at December 31, 2020. In addition to the discussion that follows, accounting policies for loans and the ACL-Loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional credit quality disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans were $9 million at December 31, 2020, compared to $14 million at December 31, 2019. Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $13 million at December 31, 2020, compared to $15 million at December 31, 2019. OREO was $4 million at December 31, 2020, up from $1 million at year-end 2019, with the increase primarily due to the addition of closed bank branch properties. Nonperforming assets as a percent of total assets was 0.29% at December 31, 2020, compared to 0.42% at December 31, 2019.

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 ACL-Loans. 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 $21 million (0.7% of total loans) and $23 million (0.9% of total loans) at December 31, 2020 and 2019, 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.

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Table 10: Nonperforming Assets

Nonaccrual assets:

PPP loans — — — — —

Residential construction — — 1 80 260

Retail & other 88 1 — 4 —

Accruing loans past due 90 days or more — — — — —

OREO:

Residential real estate owned — — — 70 29

Performing troubled debt restructurings $ 2,120 $ — $ — $ — $ —

Ratios:

Table 11 shows the approximate gross interest that would have been recorded if the loans accounted for on a nonaccrual basis at the end of each year shown had performed in accordance with their original terms, in contrast to the amount of interest income that was included in interest income on such loans for the period. The interest income recognized generally includes cash interest received and potentially includes prior nonaccrual interest on acquired loans which existed at acquisition and was subsequently collected.

Table 11: Foregone Loan Interest

(in thousands) Years Ended December 31,

Interest income in accordance with original terms $ 651 $ 1,178 $ 1,046

Reduction in interest income $ 71 $ 243 $ 98

Investment Securities Portfolio

The investment securities portfolio is intended to provide Nicolet with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is structured with minimal credit exposure to Nicolet. All securities are classified as available for sale (“AFS”) and are carried at fair value. In addition to the discussion that follows, the investment securities portfolio accounting policies are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 3, “Securities Available for Sale,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

Table 12: Investment Securities Portfolio

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At December 31, 2020, the total fair value of investment securities was $539 million (representing 12% of total assets), compared to $449 million (representing 13% of total assets) at December 31, 2019. The increase in securities AFS from year-end 2019 was primarily due to the purchase of approximately $50 million U.S. Treasury securities in early 2020, $24 million of investments Advantage added at acquisition and an $11 million change in the unrealized gain position (from an unrealized gain of $6 million at December 31, 2019 to an unrealized gain of $17 million at December 31, 2020). At December 31, 2020, the securities AFS portfolio did not contain securities of any single issuer, including any securities issued by a state or political subdivision that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.

In addition to securities AFS, Nicolet had other investments of $28 million and $24 million at December 31, 2020 and 2019, respectively, consisting of capital stock in the Federal Reserve and the Federal Home Loan Bank (“FHLB”) (required as members of the Federal Reserve Bank System and the FHLB System), equity securities with readily determinable fair values, and to a lesser degree equity investments in other private companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus not liquid, have no ready market or quoted market value, and are carried at cost. The private company equity investments have no quoted market prices, and are carried at cost less impairment charges, if any. The other investments are evaluated periodically for impairment, considering financial condition and other available relevant information. A $0.1 million write-off was recorded on the surrender of our Commerce common stock in connection with the terms of the mutual termination of the Commerce merger agreement during 2020, and a $0.1 million impairment charge was recorded on a private company equity investment during 2019.

Table 13: Investment Securities Portfolio Maturity Distribution (1)

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

Deposits

Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Deposit challenges include competitive deposit product features, price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Additional disclosures on deposits are included in Note 7, “Deposits,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

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Table 14: Period End Deposit Composition

Amount % ofTotal Amount % ofTotal Amount % ofTotal

Total deposits were $3.9 billion at December 31, 2020, an increase of $956 million (32%) over year-end 2019. Since December 31, 2019, customer transaction accounts increased $884 million (38%), including $490 million in interest-bearing transaction accounts and $394 million in noninterest-bearing transaction accounts, influenced by the very uncertain times, government stimulus payments and pandemic stay-at-home orders, which reduced spending and increased liquidity of many consumers and businesses, and by PPP loan proceeds retained on deposit by commercial borrowers. In addition, during 2020, we acquired Advantage, which added customer deposits of $141 million at acquisition. Total brokered deposits increased $165 million over year-end 2019, largely due to our liquidity build executed at the onset of the pandemic. In the second half of 2020, given continued growth in core deposit funding, brokered deposits were allowed to mature without renewal and nearly half of the brokered time deposits outstanding at year-end 2020 are expected to mature in 2021.

On average, deposits grew $841 million (32%) between 2020 and 2019 (as detailed in Table 1), primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020) and the signficant increase in deposits from government stimulus activities and deposited PPP loan proceeds. Noninterest-bearing demand deposits increased $292 million (40%) and core interest-bearing deposits (savings, interest-bearing demand, money market) increased $347 million (25%), while core time deposits decreased $12 million (3%). Average brokered deposits grew $214 million, attributable to the mix of deposits acquired with Choice and the procurement of brokered deposits at the onset of the pandemic as part of liquidity actions.

Table 15: Maturity Distribution of Certificates of Deposit of $100,000 or More

Other Funding Sources

Other funding sources include short-term borrowings (zero at both December 31, 2020 and 2019) and long-term borrowings (totaling $54 million and $68 million at December 31, 2020 and 2019, respectively). Short-term borrowings consist mainly of short-term FHLB advances, customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include FHLB advances, PPP Liquidity Facility (“PPPLF”) funding (credit provided by the Federal Reserve to financial institutions participating in the PPP loan program), junior subordinated debentures (largely qualifying as Tier 1 capital for regulatory purposes given their long maturity dates, even though they are redeemable in whole or in part at par), and subordinated notes (issued in 2015 with 10-year maturities, callable on or after the fifth anniversary date of their respective issuance dates, and qualifying as Tier 2 capital for regulatory purposes). The interest on all long-term borrowings is current.

During 2020, the Company added $24 million in long-term FHLB advances to support liquidity actions initiated at the onset of the pandemic (prior to the announcement of government stimulus) and $344 million of PPPLF funding to support the PPP loans. Based on growth in core deposits during the year, select long-term FHLB advances and the full PPPLF funding was repaid in the second half of 2020. In addition, the subordinated notes ($12 million at 5% fixed) were fully redeemed on November 16, 2020, and one issuance of junior subordinated debentures ($6 million at 8% fixed) was redeemed in full on December 31, 2020. See Note 8, “Short

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and Long-Term Borrowings,” of the Notes to Consolidated Financial Statements under Part II, Item 8 for additional details. See section “Liquidity Management,” for information on available other funding sources at December 31, 2020.

RISK MANAGEMENT AND CAPITAL

Liquidity Management

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

Given the stable core customer deposit base, fairly consistent patterns of activity in the core deposit base (including extra growth in core deposits during the pandemic as previously discussed), and the minimal use of capacity available in numerous non-core funding sources, Nicolet's liquidity levels and resources have been sufficient to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary. At the onset of the pandemic, but prior to the announcement of government stimulus, management initiated preparatory actions to increase on-balance sheet liquidity to ensure we could meet customer needs, and brokered deposits of approximately $200 million were procured, increasing liquid cash. These actions proved later to not be necessary, leading us to reduce non-deposit leverage in the second half of 2020. In addition to the on-balance sheet liquidity build, remaining liquidity facilities continue to provide capacity and flexibility in an uncertain time.

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 additional brokered deposits or other wholesale funding. All securities AFS and equity securities (included in other investments) are reported at fair value on the consolidated balance sheet. At December 31, 2020, approximately 27% of the $539 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 December 31, 2020, consist of a $10 million available and unused line of credit at the holding company, $175 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $163 million, and borrowing capacity in the brokered deposit market.

In consideration of the funds availability for the Bank and the current high levels of cash in a very low interest rate environment, management has taken prudent pricing actions on deposits and loans, as well as actions to reduce non-deposit funding. Brokered deposits have matured without renewal, selected FHLB advances were repaid early, and the PPPLF funding was fully paid back (approximately $335 million used for 5 months at a cost of 35 bps). In addition, we fully redeemed our subordinated notes ($12 million at 5% fixed) in November and one of our junior subordinated debenture issuances ($6 million at 8% fixed) in December.

Management is committed to the Parent Company being a source of strength to the Bank and its other subsidiaries, and therefore, regularly evaluates capital and liquidity positions of the Parent Company in light of current and projected needs, growth or strategies. The Parent Company uses cash for normal expenses, debt service requirements and, when opportune, for common stock repurchases or investment in other strategic actions such as mergers or acquisitions. At December 31, 2020, the Parent Company had $50 million in cash. Additional cash sources, among others, available to the Parent Company include its $10 million available and unused line of credit, and access to the public or private markets to issue new equity, subordinated notes or other debt. Dividends from the Bank and, to a lesser extent, stock option exercises, represent significant sources of cash flows for the Parent Company. The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed certain thresholds, as more fully described in “Business—Regulation of the Bank – Payment of Dividends” and in Note 16, “Regulatory Capital Requirements,” in the Notes to the Consolidated Financial Statements under Part II, Item 8. Management does not believe that regulatory restrictions on dividends from the Bank will adversely affect its ability to meet its cash obligations.

Cash and cash equivalents at December 31, 2020 and 2019 were approximately $803 million and $182 million, respectively. The $621 million increase in cash and cash equivalents since year-end 2019 included $79 million net cash provided by operating activities (mostly earnings), more than offset by $209 million net cash used in investing activities (primarily to fund loan growth, mostly PPP loans) and $751 million net cash provided by financing activities (with funds from increased deposits partly offset by the early redemption of selected debt and common stock repurchases). Nicolet’s liquidity resources were sufficient as of December 31, 2020 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.

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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.

Among other scenarios, 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 results provided include the liquidity measures mentioned above and reflect the changed interest rate environment in response to the current crisis. 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 December 31, 2020 and 2019, the projected changes in net interest income over a one-year time horizon, versus the baseline, are presented in Table 16 below. The results were within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% for +/- 200 bps, and given the relatively short nature of the Company’s balance sheet, reflect a largely unchanged risk position as expected.

Table 16: Interest Rate Sensitivity

200 bps decrease in interest rates (0.8) % (1.8) %

100 bps decrease in interest rates (0.8) % (1.0) %

100 bps increase in interest rates 4.0 % 0.8 %

200 bps increase in interest rates 8.1 % 1.7 %

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. Inflation may also have impacts on the Bank’s customers, on businesses and consumers and their ability or willingness to invest, save or spend, and perhaps on their ability to repay loans. As such, there would likely be impacts on the general appetite of banking products and the credit health of the Bank’s customer base.

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.

Capital balances and changes in capital are presented in the Consolidated Statements of Changes in Stockholders’ Equity in Part II, Item 8. Further discussion of capital components is included in Note 11, “Stockholders' Equity,” and a summary of dividend

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restrictions, as well as regulatory capital amounts and ratios for Nicolet and the Bank is presented in Note 16, “Regulatory Capital Requirements,” of the Notes to Consolidated Financial Statements under Part II, Item 8.

The Company’s regulatory capital ratios remain well above minimum regulatory ratios, including the capital conservation buffer. At December 31, 2020, 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. For a discussion of the regulatory restrictions applicable to the Company and the Bank, see section “Business-Regulation of Nicolet” and “Business-Regulation of the Bank,” included within Part I, Item 1. A summary of Nicolet’s and the Bank’s regulatory capital amounts and ratios, as well as selected capital metrics are presented in Table 17.

Table 17: Capital

Company Stock Repurchases: *

Common stock repurchased during the year (dollars) $ 40,544 $ 18,701

Common stock repurchased during the year (shares) 646,748 310,781

Company Risk-Based Capital:

Total capital ratio 12.9 % 13.4 %

Common equity tier 1 capital ratio 11.4 % 11.6 %

Tier 1 leverage ratio 9.0 % 11.9 %

Bank Risk-Based Capital:

Total capital ratio 11.2 % 10.8 %

Common equity tier 1 capital ratio 10.5 % 10.3 %

Tier 1 leverage ratio 7.8 % 9.8 %

At December 31, 2020, Nicolet’s total capital was $539 million, compared to $516 million at December 31, 2019 (mostly due to solid earnings and favorable changes in the fair value AFS securities, partly offset by common stock repurchase activity and the $6 million net impact of adopting CECL). Book value per common share increased to $53.86 at year-end 2020, up 10% over $48.76 at year-end 2019.

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. Based on this evaluation, the Company early redeemed certain capital-equivalent debt during fourth quarter 2020, including its higher-costing subordinated Notes ($12 million at 5% fixed) and one issuance of junior subordinated debentures ($6 million at 8% fixed). These redemptions reduced the Company’s Tier 1 risk-based capital $6 million and Total risk-based capital $16 million. The redemptions had no impact on the Bank’s risk-based capital.

Through an ongoing repurchase program, the Board has authorized the repurchase of Nicolet’s common stock as an alternative use of capital. During 2020, $40.5 million was used to repurchase and cancel nearly 646,700 shares at a weighted average price per share of $62.69. At December 31, 2020, there remained $20.4 million authorized under this repurchase program, as modified, to be utilized from time to time to repurchase shares in the open market, through block transactions or in private transactions.

Off-Balance Sheet Arrangements, Lending-Related Commitments and Contractual Obligations

Nicolet is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. At December 31, 2020, interest rate lock commitments to originate residential mortgage loans held for sale of $113 million (included in the commitments to extend credit) and forward commitments to sell residential mortgage loans held for sale of $20 million are considered derivative instruments. Further information and discussion of these commitments is included in Note 13, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, under Part II, Item 8.

The table below outlines the principal amounts and timing of Nicolet’s contractual obligations. The amounts presented below exclude amounts due for interest, if applicable, and include any unamortized premiums / discounts or other similar carrying value

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adjustments. Most of these obligations are routinely refinanced into similar replacement obligations. However, renewal of these obligations is dependent on the ability to procure competitive interest rates, liquidity needs, availability of collateral for pledging purposes supporting the long-term advances, or other borrowing alternatives. As of December 31, 2020, Nicolet had the following contractual obligations.

Table 18: Contractual Obligations

(in thousands) Note Maturity by Years

Reference Total 1 or less 1-3 3-5 Over 5

Fourth Quarter 2020 Results

Nicolet recorded net income of $18.0 million for fourth quarter 2020, or $1.74 for diluted earnings per common share, compared to $12.3 million, or $1.18, respectively for fourth quarter 2019. Return on average assets was 1.58% and 1.46% for fourth quarter 2020 and 2019, respectively, even with the elevated cash assets in 2020. See Table 19 for selected quarterly information.

Net interest income increased $3.5 million (12%) between the comparable fourth quarter periods, despite a 77 bps decline in net interest margin, mostly due to the high cash levels and much lower interest rate environment. Interest income increased $1.8 million (including $6.3 million on higher volumes, partly offset by $4.5 million lower rates), while interest expense decreased $1.7 million (with $2.8 million from lower rates more than covering the $1.1 million higher volumes). The net interest margin between the comparable quarters decreased 77 bps to 3.29% in fourth quarter 2020, comprised of 60 bps lower interest rate spread (to 3.10%, as the yield on earning assets decreased 114 bps and the rate on interest-bearing liabilities decreased 54 bps) and a 17 bps lower contribution from net free funds (with the higher balances worth less in the very low interest rate environment).

Average interest-earning assets increased $1.1 billion to $4.1 billion for fourth quarter 2020, largely due to growth in loans (up $430 million) and other interest-earning assets, which is mostly cash (up $591 million). The mix of average earning assets between fourth quarter periods shifted from 82% in average loans, 14% in average investments, and 4% in other interest-earning assets (mostly low-earning cash assets) to 70% in loans, 13% in investments, and 17% in other interest-earning assets for fourth quarter 2020. On the funding side, average interest-bearing deposits were up $651 million and average demand deposits increased $386 million.

Noninterest income for fourth quarter 2020 increased $3.6 million (27%) to $16.9 million versus fourth quarter 2019. Net mortgage income increased $2.9 million (60%), mostly on higher sale gains and capitalized gains combined (up $3.6 million) from strong refinance activity and better pricing between the comparable quarters, partly offset by an unfavorable change in the fair values on the mortgage derivatives and mortgage servicing asset combined (down $0.8 million). Trust services fee income and brokerage fee income combined grew $0.6 million (17%), consistent with growth in accounts and assets under management in a volatile market.

On a comparable quarter basis, noninterest expense was minimally changed (down $0.1 million) to $25.4 million for fourth quarter 2020. Personnel expense of $15.2 million, increased $1.6 million (12%) from fourth quarter 2019, reflecting changes in the timing (with 2019 including a mid-year profit sharing contribution after the partial equity sale of a data processing entity versus a fourth quarter contribution in 2020) and mix of incentive compensation. All nonpersonnel expense categories combined were down $1.7 million (14%), as fourth quarter 2019 included a $0.7 million lease termination charge for the closure of Nicolet's Oshkosh branch in conjunction with the Choice acquisition and a $0.8 million full write-off of non-bank goodwill.

For fourth quarter 2020, Nicolet recognized income tax expense of $6.1 million with an effective tax rate of 25.4%, compared to income tax expense of $5.7 million with an effective tax rate of 31.4% for fourth quarter 2019. The increase in income tax expense was attributable to a 34% increase in pretax income, partly offset by salary deduction limitations that exceeded the tax benefit on stock-based compensation between the comparable fourth quarter periods (tax benefit of $0.1 million and $1.3 million in fourth quarter 2020 and 2019, respectively, mainly due to large stock option exercises in fourth quarter 2019). Additional information on income taxes is also included in “Income Taxes,” and Note 12, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

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Selected Quarterly Financial Data

The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 2020 and 2019.

Table 19: Selected Quarterly Financial Data

(in thousands, except per share data) 2020 Quarter Ended

December 31, September 30, June 30, March 31,

Less: Net income attributable to noncontrolling interest 98 30 101 118

Diluted earnings per common share* $ 1.74 $ 1.72 $ 1.28 $ 0.98

December 31, September 30, June 30, March 31,

Less: Net income attributable to noncontrolling interest 87 82 95 83

Diluted earnings per common share* $ 1.18 $ 1.40 $ 1.91 $ 1.05

*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.

2019 Compared to 2018

Net income attributable to Nicolet was $54.6 million for 2019, or $5.52 per diluted common share. Comparatively, 2018 net income attributable to Nicolet was $41.0 million or $4.12 per diluted common share. Return on average assets was 1.75% and 1.38% for 2019 and 2018, respectively, while return on average common equity was 12.89% for 2019 and 11.04% for 2018. Book value per common share was $48.76 at December 31, 2019, up 20% over $40.72 at December 31, 2018.

Key factors contributing to the 2019 versus 2018 results are discussed below.

•Net income for 2019 benefited from the net of two nonrecurring items in the second quarter, a $7.4 million after-tax gain on the partial sale of our equity interest in a data processing company, and $2.75 million ($2.0 million after-tax) in personnel expense for retirement-related compensation declared to benefit all employees after that sale. Excluding these two nonrecurring items, 2019 net income would be $49.2 million (20% over 2018), return on average assets would be 1.58% and diluted earnings per share would be $4.98 (or 21% over 2018).

•Net interest income was $116.1 million for 2019, an increase of $9.4 million or 9% compared to 2018, as we exercised discipline in the challenging rate environment. Interest income grew $13.1 million (overcoming $0.9 million lower aggregate discount income on purchased loans), aided by a 5% increase in average interest-earning assets and the elevated rate environment particularly on new, renewed and variable rate loans through the first half of 2019, before rates declined

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during the second half. Interest expense increased $3.6 million, primarily due to the initially rising rates on a relatively unchanged funding base. The improvement consisted of $7.1 million from net favorable volume and mix variances, and $2.2 million from favorable rate variances. The interest rate spread increased 7 bps to 3.84% for 2019, due to the increase in the interest-earning asset yield (up 26 bps to 5.00% for 2019), exceeding the rise in the cost of funds (up 19 bps to 1.16% for 2019). The contribution from net free funds increased 8 bps due to stronger net free fund balances (led by a 16% increase in average noninterest-bearing demand deposits) and the higher cost of funds. As a result, the net interest margin increased 15 bps to 4.19% for 2019, compared to 4.04% for 2018. Tables 1, 2, and 3 show additional average balance sheet, net interest income, and net interest margin information.

•Loans were $2.6 billion at December 31, 2019, an increase of $408 million (19%) compared to $2.2 billion at December 31, 2018, largely due to the acquisition of Choice. Excluding the $348 million loans Choice added at acquisition in 2019, loans increased $60 million (3%) over year-end 2018, reflective of the growth in Nicolet's markets. Average loans were $2.3 billion in 2019 yielding 5.57%, compared to $2.1 billion in 2018 yielding 5.37%, a 6% increase in average balances. Table 6 shows additional information on loans.

•Total deposits were $3.0 billion at December 31, 2019, an increase of $340 million (13%) over December 31, 2018, largely due to the acquisition of Choice. Excluding the $289 million deposits Choice added at acquisition in 2019, deposits increased $51 million (2%) over 2018. Between 2019 and 2018, average deposits increased $89 million (4%), with average cored deposits up $106 million from solid growth in noninterest-bearing demand deposits (up $99 million to represent 28% of total deposits for 2019 versus 25% for 2018), partly offset by a reduction in brokered deposits. Tables 14 and 15 show additional information on deposits.

•Asset quality measures remained strong. Nonperforming assets were $15 million, representing 0.42% of total assets at December 31, 2019, compared to $6 million, representing 0.19% of assets at December 31, 2018. For 2019, the provision for credit losses was $1.2 million, exceeding net charge-offs of $0.4 million, versus provision of $1.6 million and net charge-offs of $1.1 million for 2018. The ACL-Loans was $14.0 million at December 31, 2019 (representing 0.54% of loans), compared to $13.2 million (representing 0.61% of loans) at December 31, 2018. Tables 8, 9, 10, and 11 show additional information on asset quality measures.

•Noninterest income was $53.4 million for 2019 (including $7.9 million of net asset gains, largely from the equity interest sale noted above), compared to $39.5 million for 2018 (including $1.2 million of net asset gains). Excluding the net asset gains, noninterest income was up $7.1 million (19%), most notably in net mortgage income (up $5.5 million or 87% on significantly higher volumes), trust and brokerage fees combined (up $0.8 million or 6%), and card interchange income (up $0.8 million or 15%), benefiting from increased business and activity. Table 4 shows additional noninterest income information.

•Noninterest expense was $96.8 million for 2019, an increase of $7.0 million (8%) over 2018 noninterest expense of $89.8 million, mostly due to the continued investment in people and improvements. Personnel expense was $54.4 million for 2019, up $5.0 million (10%) over 2018, including the one-time compensation action noted above, as well as merit increases on a minimally changed workforce (with average full-time equivalent employees up 1% between the years), and higher cash and equity incentives supporting strong performance. Non-personnel expenses also increased on a combined basis (up $2.1 million or 5%), mostly due to volume-based processing costs partially offset by process efficiencies, as well as a $0.7 million lease termination charge on a branch closure related to the Choice acquisition and $0.8 million full write-off of non-bank goodwill for a change in business strategy. Table 5 shows additional noninterest expense information.

Critical Accounting Policies

The consolidated financial statements of Nicolet are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loan acquisition transactions, as well as the determination of the allowance for credit losses and income taxes and, therefore, are critical accounting policies. The critical accounting policies are discussed directly with Nicolet’s Audit Committee. In addition to the discussion that follows, these critical accounting policies are further described in Note 1, “Nature of Business and Significant Accounting Policies,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.

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Business Combinations and Valuation of Loans Acquired in Business Combinations

We account for acquisitions under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at the estimated fair value on their purchase date. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation. Management finalized the fair values of acquired assets and assumed liabilities within this 12-month period and management currently considers such values to be the Day 1 Fair Values for the acquisition transactions.

In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Loans acquired in a business combination transaction are evaluated either individually or in pools of loans with similar characteristics; including consideration of a credit component. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.

Allowance for Credit Losses - Loans

Management’s evaluation process used to determine the appropriateness of the ACL-Loans is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated credit losses and therefore the appropriateness of the ACL-Loans could change significantly. Effective January 1, 2020, the Company changed its methodology for accounting for the allowance for credit losses-loans due to the adoption of a new accounting standard, which requires use of a lifetime expected credit losses model versus the historical incurred credit losses model. See section Recent Accounting Pronouncements Adopted within Note 1, “Nature of Business and Significant Accounting Policies,” in the Notes to Consolidated Financial Statements, under Part II, Item 8 for additional information on this new accounting standard.

The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ACL-Loans and includes allocations for individually evaluated credit-deteriorated loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative and environmental factors. The methodology includes evaluation and consideration of several factors, including but not limited to: management’s ongoing review and grading of the loan portfolio, evaluation of facts and issues related to specific loans, consideration of historical loan loss and delinquency experience on each portfolio segment, trends in past due and nonaccrual loans, the risk characteristics of specific loans or various loan segments, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, the fair value of underlying collateral, existing economic conditions, and other qualitative and quantitative factors which could affect expected credit losses. In addition, with adoption of CECL in 2020, the model also now considers reasonable and supportable forecasts to assess the collectability of future cash flows. While management uses the best information available to make its evaluation, future adjustments to the ACL-Loans may be necessary if there are significant changes in economic conditions (both existing and forecast) or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ACL-Loans is made for analytical purposes and is not necessarily indicative of the trend of future credit losses in any particular loan category. The ACL-Loans is available to absorb losses from any segment of the loan portfolio. Management believes the ACL-Loans is appropriate at December 31, 2020. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements.

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

Income Taxes

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

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

Future Accounting Pronouncements

Recent accounting pronouncements adopted are included in Note 1, “Nature of Business and Significant Accounting Policies” of the Notes to Consolidated Financial Statements under Part II, Item 8.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The updated guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company continues to evaluate the impact of reference rate reform on its consolidated financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For additional disclosure, see section, “Interest Rate Sensitivity Management and Impact of Inflation,” of the Management’s Discussion and Analysis of Financial Condition and Results of Operation under Part II, Item 7.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NICOLET BANKSHARES, INC.Consolidated Balance Sheets

Assets

Federal funds sold — —

Certificates of deposit in other banks 29,521 19,305

Securities available for sale (“AFS”), at fair value 539,337 449,302

Allowance for credit losses - loans (“ACL-Loans”) (32,173) (13,972)

Accrued interest receivable and other assets 55,516 39,461

Liabilities and Stockholders’ Equity

Liabilities:

Short-term borrowings — —

Accrued interest payable and other liabilities 48,332 38,188

Stockholders’ Equity:

Accumulated other comprehensive income (loss) 12,747 4,418

Total Nicolet Bankshares, Inc. stockholders’ equity 539,189 516,262

Noncontrolling interest — 728

Total stockholders’ equity and noncontrolling interest 539,189 516,990

Preferred shares issued and outstanding — —

See accompanying Notes to Consolidated Financial Statements.

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Interest income:

Investment securities:

Interest expense:

Short-term borrowings 66 5 9

Noninterest income:

Noninterest expense:

Less: Net income attributable to noncontrolling interest 347 347 317

Net income attributable to Nicolet Bankshares, Inc. $ 60,122 $ 54,641 $ 41,036

Earnings per common share:

Weighted average common shares outstanding:

See accompanying Notes to Consolidated Financial Statements.

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Other comprehensive income (loss), net of tax:

Unrealized gains (losses) on securities AFS:

Net (gains) losses included in income (395) 22 212

Total other comprehensive income (loss), net of tax 8,329 10,058 (2,557)

See accompanying Notes to Consolidated Financial Statements.

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Nicolet Bankshares, Inc. Stockholders’ Equity

Comprehensive income:

Other comprehensive income (loss) — — — (2,557) — (2,557)

Stock-based compensation expense — 4,901 — — — 4,901

Exercise of stock options, net 1 1,517 — — — 1,518

Issuance of common stock — 282 — — — 282

Purchase and retirement of common stock (4) (22,745) — — — (22,749)

Distribution to noncontrolling interest — — — — (275) (275)

Adoption of new accounting pronouncement — — 937 (937) — —

Comprehensive income:

Other comprehensive income (loss) — — — 10,058 — 10,058

Stock-based compensation expense — 5,038 — — — 5,038

Exercise of stock options, net 3 8,147 — — — 8,150

Issuance of common stock — 592 — — — 592

Purchase and retirement of common stock (4) (28,456) — — — (28,460)

Distribution to noncontrolling interest — — — — (362) (362)

Comprehensive income:

Other comprehensive income (loss) — — — 8,329 — 8,329

Stock-based compensation expense — 5,700 — — — 5,700

Exercise of stock options, net — 1,474 — — — 1,474

Issuance of common stock — 581 — — — 581

Purchase and retirement of common stock (6) (42,082) — — — (42,088)

Purchase of noncontrolling interest — (5,016) — — (860) (5,876)

Distribution to noncontrolling interest — — — — (215) (215)

Adoption of new accounting pronouncement (See Note 1) — — (6,175) — — (6,175)

See accompanying Notes to Consolidated Financial Statements.

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Cash Flows From Operating Activities:

Increase in cash surrender value of life insurance (2,199) (1,967) (1,857)

Net change in accrued interest receivable and other assets 6,991 (2,951) (666)

Net change in accrued interest payable and other liabilities 5,716 9,010 242

Cash Flows From Investing Activities:

Proceeds from sales of other investments — 17,144 807

Proceeds from sales of other real estate and other assets 343 457 2,824

Purchase of BOLI — (5,000) —

Net cash (paid) received in business combination (21,820) 7,331 —

Cash Flows From Financing Activities:

Net increase (decrease) in short-term borrowings — (4,233) —

Proceeds from long-term borrowings 367,842 — —

Distribution to noncontrolling interest (215) (362) (275)

Purchase of noncontrolling interest (8,000) — —

Capitalized issuance costs, net — (163) —

Proceeds from issuance of common stock, net 2,055 8,742 1,800

Supplemental Disclosures of Cash Flow Information:

Transfer of loans and bank premises to other real estate owned 2,608 1,025 607

Acquisitions:

Common stock issued in acquisitions — 79,797 —

* Cash and cash equivalents at December 31, 2020 include restricted cash of $1.9 million pledged as collateral on interest rate swaps and no reserve balance was required with the Federal Reserve. At December 31, 2019 cash and cash equivalents included restricted cash of $1.3 million pledged as collateral on interest rate swaps and $6.0 million for the reserve balance required with the Federal Reserve, while at December 31, 2018, cash and cash equivalents included $6.3 million for the reserve balance required with the Federal Reserve and no cash was pledged as collateral on interest rate swaps.

See accompanying Notes to Consolidated Financial Statements.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Banking Activities and Subsidiaries: Nicolet Bankshares, Inc. (the “Company” or “Nicolet”) was incorporated on April 5, 2000, to serve as the holding company and sole shareholder of Nicolet National Bank (the “Bank”). The Bank opened for business on November 1, 2000. Since its opening in late 2000, Nicolet has supplemented its organic growth with branch purchase and acquisition transactions. See Note 2 for additional information on the Company’s recent acquisitions.

At December 31, 2020, the Company had two wholly owned subsidiaries, the Bank and Nicolet Advisory Services, LLC (“Nicolet Advisory”). At December 31, 2020, the Bank wholly owns an investment subsidiary based in Nevada, a subsidiary in Green Bay that provides a web-based investment management platform for financial advisor trades and related activity, and an entity that owns the building in which Nicolet is headquartered, Nicolet Joint Ventures, LLC (the “JV”). The JV was owned 50% by a real estate development and investment firm (the “Firm”) through the JV until late 2020 when the Bank became the 100% owner and sole managing member of the JV. The Firm is considered a related party, as one of its principals is a Board member and shareholder of the Company. See Note 14 for additional related party disclosures, including details of the 50% interest purchased from the Firm.

Nicolet Advisory is a registered investment advisor subsidiary that provides brokerage and investment advisory services to customers. In late 2020, to improve process efficiencies and organizational structure, the Company dissolved its wholly owned subsidiary, Brookfield Investment Partners, LLC, which provided limited investment services (transactional and strategy) to a few smaller banks, and Nicolet Advisory assumed those additional investment services contracts.

Principles of Consolidation: The consolidated financial statements of the Company include the accounts of its subsidiaries. The JV underlies the noncontrolling interest reflected in the consolidated financial statements until late 2020 when the Bank purchased the remaining interest as discussed in Note 1 above under Nature of Banking Activities and Subsidiaries. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Results of operations of companies purchased, if any, are included from the date of acquisition.

Operating Segment: The consolidated income of the Company is derived principally from the Bank, which conducts lending (primarily commercial-based loans, as well as residential and consumer loans) and deposit gathering (including other banking- and deposit-related products and services, such as ATMs, safe deposit boxes, check cashing, wires, and debit cards) to businesses, consumers and governmental units principally in its trade area of northeastern and central Wisconsin, and Menominee, Michigan, trust services, brokerage services (delivered through the Bank and Nicolet Advisory), and the support to deliver, fund and manage all such banking and wealth management services to its customer base. The individual contribution from wealth management was not significant to the consolidated balance sheet or net income for 2020, 2019, or 2018. 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.

Use of 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 credit losses, valuation of loans in acquisition transactions, useful lives for depreciation and amortization, fair value of financial instruments, 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 credit losses-loans, 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.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

Business Combinations: The Company accounts for business combinations under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”). The Company recognizes the full fair value of the assets acquired and liabilities assumed and immediately expenses transaction costs. If the amount of consideration exceeds the fair value of assets purchased less the fair value of liabilities assumed, goodwill is recorded. Alternatively, if the amount by which the fair value of assets purchased exceeds the fair value of liabilities assumed and consideration paid, a gain (“bargain purchase gain”) is recorded. Fair values are subject to refinement for up to one year after the closing date of an acquisition as information relative to closing date fair values becomes available. Results of operations of the acquired business are included in the statements of income from the effective date of the acquisition. Additional information regarding recent acquisitions is provided in Note 2.

Cash and Cash Equivalents: For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits in other banks with original maturities of less than 90 days, if any, and federal funds sold. The Bank maintains amounts in due from banks which, at times, may exceed federally insured limits. Management monitors these correspondent relationships. The Bank has not experienced any losses in such accounts. The Bank may have restrictions on cash and due from banks as it is required to maintain certain vault cash and reserve balances with the Federal Reserve Bank to meet specific reserve requirements. At December 31, 2020, no reserve balance was required with the Federal Reserve Bank (as the Federal Reserve’s board authorized a reduction to the reserve requirement ratios to 0% effective March 26, 2020 to provide monetary stimulus in response to the economic disruptions resulting from the pandemic), while at December 31, 2019, the required reserve balance was approximately $6.0 million, of which there was sufficient cash to cover the reserve requirement. In addition, cash and cash equivalents includes restricted cash of $1.9 million and $1.3 million pledged as collateral on an interest rate swap at December 31, 2020 and 2019, respectively.

Securities Available for Sale: Securities classified as AFS are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities classified as AFS are carried at fair value, with unrealized gains or losses, net of related deferred income taxes, reported as increases or decreases in accumulated other comprehensive income. Realized gains or losses on sales of securities AFS (using the specific identification method) are included in the consolidated statements of income under asset gains (losses), net. Premiums and discounts are amortized or accreted into interest income over the estimated life of the related securities using the effective interest method.

Management evaluates securities AFS in unrealized loss positions on a quarterly basis to determine whether the decline in fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. In making this evaluation, management considers the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Any impairment that is not credit-related is recognized in other comprehensive income, net of related deferred income taxes. Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the balance sheet based on the amount by which the amortized cost basis exceeds the fair value, with a corresponding charge to net income. Both the ACL and charge to net income may be reversed if conditions change. However, if the Company intends to sell an impaired AFS security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment must be recognized in net income with a corresponding adjustment to the security’s amortized cost basis rather than through the establishment on an ACL. See Note 3 for additional disclosures on AFS securities.

Other Investments: Other investments include equity securities with readily determinable fair values, “restricted” equity securities, and private company securities. At December 31, 2020, other investments included $3.6 million of equity securities with readily determinable fair values, $20.2 million of “restricted“ equity securities, and $3.9 million of private company securities. As a member of the Federal Reserve Bank System and the Federal Home Loan Bank (“FHLB”) System, the Bank is required to maintain an investment in the capital stock of these entities. These equity securities are “restricted” in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other exchange traded equity securities. As no ready market exists for these stocks, and they have no quoted market value, these investments are carried at cost. Also included are investments in other private companies that do not have quoted market prices, which are carried at cost less impairment charges, if any. Management’s evaluation of these other investments for impairment includes consideration of the financial condition and other available relevant information of the issuer.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value as determined on an aggregate basis and generally consist of current production of certain fixed-rate residential first mortgages. The amount by which cost exceeds fair value is recorded as a valuation allowance and charged to earnings. Changes, if any, in the valuation allowance are included in earnings in the period in which the change occurs. As of December 31, 2020 and 2019, no valuation allowance was necessary. Loans held for sale may be sold servicing retained or servicing released, and are generally sold without recourse. The carrying value of mortgage loans sold with servicing retained is reduced by the amount allocated to the servicing right at the time of sale. Gains and losses on sales of mortgage loans held for sale are included in earnings in mortgage income, net.

Loans – Originated: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are carried at their amortized cost basis, which is the unpaid principal amount outstanding, net of deferred loan fees and costs, and any direct principal charge-off. The Company made an accounting policy election to exclude accrued interest from the amortized cost basis of loans and report such accrued interest as part of accrued interest receivable and other assets on the consolidated balance sheets.

Interest income is accrued on the unpaid principal balance using the simple interest method. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower’s ability to meet payment of interest or principal when due. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal, though may be placed in such status earlier based on the circumstances. Loans past due 90 days or more may continue on accrual only when they are well secured and/or in process of collection or renewal. When interest accrual is discontinued, all previously accrued but uncollected interest is reversed against current period interest income. Except in very limited circumstances, cash collections on nonaccrual loans are credited to the loan receivable balance and no interest income is recognized on those loans until the principal balance is paid in full. Accrual of interest may be resumed when the customer is current on all principal and interest payments and has been paying on a timely basis for a sustained period of time. See Note 4 for additional information and disclosures on loans.

Loans – Acquired: Loans purchased in acquisition transactions are acquired loans, and are recorded at their estimated fair value on the acquisition date.

Subsequent to January 1, 2020, acquired loans that have evidence of more-than-insignificant deterioration in credit quality since origination are considered purchased credit deteriorated (“PCD”) loans. At acquisition, an estimate of expected credit losses is made for PCD loans. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair value to establish the initial amortized cost basis of the PCD loans. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors, resulting in a discount or premium that is amortized to interest income. For acquired loans not deemed PCD loans at acquisition, the difference between the initial fair value mark and the unpaid principal balance are recognized in interest income over the estimated life of the loans. In addition, an initial allowance for expected credit losses is estimated and recorded as provision expense at the acquisition date. The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans. See Note 4 for additional information and disclosures on loans.

Prior to January 1, 2020, the Company initially classified acquired loans as either purchased credit impaired (“PCI”) loans (i.e., loans that reflect credit deterioration since origination and for which it was probable at acquisition that the Company would be unable to collect all contractually required payments) or purchased non-impaired loans (i.e., “performing acquired loans”). The Company estimated the fair value of PCI loans based on the amount and timing of expected principal, interest and other cash flows for each loan. The excess of the loan’s contractual principal and interest payments over all cash flows expected to be collected at acquisition was considered an amount that should not be accreted. These credit discounts (“nonaccretable marks”) were included in the determination of the initial fair value for acquired loans; therefore, no allowance for credit losses was recorded at the acquisition date. Differences between the estimated fair values and expected cash flows of acquired loans at the acquisition date that were not credit-based (“accretable marks”) were subsequently accreted to interest income over the estimated life of the loans. Subsequent to the acquisition date for PCI loans, increases in cash flows over those expected at the acquisition date resulted in a move of the discount from nonaccretable to accretable, while decreases in expected cash flows after the acquisition date were recognized through the provision for credit losses.

Allowance for Credit Losses - Loans: The ACL-Loans represents management’s estimate of expected credit losses over the lifetime of the loan based on loans in the Company’s loan portfolio at the balance sheet date. The Company estimates the ACL-Loans based

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

on the amortized cost basis of the underlying loan and has made an accounting policy election to exclude accrued interest from the loan’s amortized cost basis and the related measurement of the ACL-Loans. Estimating the amount of the ACL-Loans is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and nonaccrual loans, and the level of potential problem loans, all of which may be susceptible to significant change. Actual credit losses, net of recoveries, are deducted from the ACL-Loans. Loans are charged-off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ACL-Loans. A provision for credit losses, which is a charge against income, is recorded to bring the ACL-Loans to a level that, in management’s judgment, is appropriate to absorb expected credit losses in the loan portfolio.

Prior to January 1, 2020, the Company used an incurred loss impairment model to estimate the ACL-Loans. This methodology assessed the overall appropriateness of the allowance for credit losses and included allocations for specifically identified impaired loans and loss factors for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans were individually assessed and measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan was collateral dependent. Loans that were determined not to be impaired were collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments were also provided for certain environmental and other qualitative factors.

Effective January 1, 2020, the Company uses a current expected credit loss model (“CECL”) to estimate the ACL-Loans. This methodology also considers historical loss rates and other qualitative adjustments, as well as a new forward-looking component that considers reasonable and supportable forecasts over the expected life of each loan. To develop the ACL-Loans estimate under the CECL model, the Company segments the loan portfolio into loan pools based on loan type and similar credit risk elements; performs an individual evaluation of PCD and other credit-deteriorated loans; calculates the historical loss rates for the segmented loan pools; applies the loss rates over the calculated life of the pooled loans; adjusts for forecasted macro-level economic conditions; and determines qualitative adjustments based on factors and conditions unique to Nicolet's portfolio.

To assess the overall appropriateness of the ACL-Loans, management applies an allocation methodology which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management's ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonaccrual loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect expected credit losses. Assessing these numerous factors involves significant judgment.

Management allocates the ACL-Loans by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve is established for individually evaluated PCD and other credit-deteriorated loans, which management defines as nonaccrual credit relationships over $250,000, collateral dependent loans, and other loans with evidence of credit deterioration. The specific reserve in the ACL-Loans for these credit deteriorated loans is equal to the aggregate collateral or discounted cash flow shortfall. Management allocates the ACL-Loans with historical loss rates by loan segment. The loss factors are measured on a quarterly basis and applied to each loan segment based on current loan balances and projected for their expected remaining life. Next, management allocates the ACL-Loans using the qualitative and environmental factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses at the evaluation date to differ from the historical loss experience of each loan segment. Lastly, management considers reasonable and supportable forecasts to assess the collectability of future cash flows. See Note 4 for additional information and disclosures on the ACL-Loans.

Allocations to the ACL-Loans may be made for specific loans but the entire ACL-Loans is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized. The allowance analysis is reviewed by the Board on a quarterly basis in compliance with internal and regulatory requirements.

Credit-Related Financial Instruments: In the ordinary course of business the Company has entered into financial instruments consisting of commitments to extend credit, financial standby letters of credit, and performance standby letters of credit. Financial standby letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party, while performance standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

party. Such financial instruments are recorded in the consolidated financial statements when they are funded. See Note 13 for additional information and disclosures on credit-related financial instruments.

Transfers of Financial Assets: Transfers of financial assets, primarily in loan participation activities, are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return assets.

Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment from acquisitions were recorded at estimated fair value on the respective dates of acquisition. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Maintenance and repairs are expensed as incurred. See Note 5 for additional information on premises and equipment.

Estimated useful lives of new premises and equipment generally range as follows:

Building and improvements 25 – 40 years

Leasehold improvements 5 – 15 years

Furniture and equipment 3 – 10 years

Operating Leases: The Company accounts for its operating leases in accordance with ASC 842, Leases (“ASC 842”), which requires lessees to record almost all leases on the balance sheet as a right-of-use (“ROU”) asset and lease liability. The operating lease ROU asset represents the right to use an underlying asset during the lease term (included in accrued interest receivable and other assets on the consolidated balance sheets), while the operating lease liability represents the obligation to make lease payments arising from the lease (included in accrued interest payable and other liabilities on the consolidated balance sheets). The ROU asset and lease liability are recognized at lease commencement based on the present value of the remaining lease payments, considering a discount rate that represents Nicolet's incremental borrowing rate. Operating lease expense is recognized on a straight-line basis over the lease term and is recognized in occupancy, equipment, and office on the consolidated statements of income.

Other Real Estate Owned (“OREO”): OREO acquired through partial or total satisfaction of loans or bank facilities no longer in use are carried at fair value less estimated costs to sell. Any write-down in the carrying value of loans or vacated bank premises at the time of transfer to OREO is charged to the ACL-Loans or to write-down of assets, respectively. OREO properties acquired in conjunction with acquisition transactions were recorded at fair value on the date of acquisition. Any subsequent write-downs to reflect current fair value, as well as gains or losses on disposition and revenues and expenses incurred to hold and maintain such properties, are treated as period costs. At December 31, 2020 and 2019, OREO was $3.6 million and $1.0 million, respectively.

Goodwill and Other Intangibles: Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis or more frequently if certain events or circumstances occur. Other intangibles include core deposit intangibles (which represent the value of acquired customer core deposit bases) and customer list intangibles. The core deposit intangibles have an estimated finite life, are amortized on an accelerated basis over a 10-year period, and are subject to periodic impairment evaluation. The customer list intangibles have finite lives, are amortized on a straight-line basis to expense over their initial weighted average life of approximately 12 years as of acquisition, and are subject to periodic impairment evaluation. See Note 6 for additional information on goodwill and other intangibles.

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 annual assessments resulted in a $0.8 million impairment charge on goodwill in late 2019 for a change in business strategy, while no other impairment was indicated on the remaining goodwill and other intangibles for 2020 or 2019.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

Mortgage Servicing Rights (“MSRs”): The Company sells originated residential mortgages into the secondary market and retains the right to service the loans sold. A mortgage servicing right asset (liability) is capitalized upon sale of such loans with the offsetting effect recorded as a gain (loss) on sale of loan in earnings (included in mortgage income, net), representing the then-current estimated fair value of future net cash flows expected to be realized for performing the servicing activities. MSRs when purchased (including MSRs purchased in acquisitions) are initially recorded at their then-estimated fair value. As the Company has not elected to measure any class of servicing assets under the fair value method, the Company utilizes the amortization method. MSRs are amortized in proportion to and over the period of estimated net servicing income, with the amortization charged to earnings (included in mortgage income, net). MSRs are carried at the lower of initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets. Loan servicing fee income for servicing loans is typically based on a contractual percentage of the outstanding principal and is recorded as income when earned (included in mortgage income, net with less material late fees and ancillary fees related to loan servicing).

The Company periodically evaluates its MSRs for impairment. At each reporting date impairment is assessed based on estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans (predominantly loan type and note interest rate). The value of MSRs is adversely affected when mortgage interest rates decline and mortgage loan prepayments increase. A valuation allowance is established through a charge to earnings (included in mortgage income, net) to the extent the amortized cost of the MSRs exceeds the estimated fair value by stratification. If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings, though not beyond the net amortized cost carried. An other-than-temporary impairment (i.e., recoverability is considered remote when considering interest rates and loan payoff activity) is recognized as a write-down of the MSRs and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings. A direct write-down permanently reduces the carrying value of the MSRs and valuation allowance, precluding subsequent recoveries. A valuation allowance of $1 million was recorded for 2020, while no valuation allowance or impairment charge was recorded for 2019. See Note 6 for additional information on MSRs.

Bank-owned Life Insurance (“BOLI”): The Company owns BOLI on certain executives and employees. BOLI balances are recorded at their cash surrender values. Changes in the cash surrender values and death proceeds exceeding carrying values are included in BOLI income.

Short-term Borrowings: Short-term borrowings consist primarily of overnight Federal funds purchased and securities sold under agreements to repurchase (“repos”), or other short-term borrowing arrangements with an original maturity of one year or less. Repos are with commercial deposit customers, and are treated as financing activities carried at the amounts that will be subsequently repurchased as specified in the respective agreements. Repos generally mature within one to four days from the transaction date. The Company may be required to provide additional collateral based on the fair value of the underlying securities. There were no outstanding agreements at December 31, 2020 or 2019.

Stock-based Compensation: Stock-based payments to employees, including grants of restricted stock or stock options, are valued at fair value of the award on the date of grant and expensed on a straight-line basis as compensation expense over the applicable vesting period. A Black-Scholes model is utilized to estimate the fair value of stock options and the quoted market price of the Company’s stock at the date of grant is used to estimate the fair value of restricted stock awards. See Note 10 for additional information on stock-based compensation.

Income Taxes: The Company files a consolidated federal income tax return and a combined state income tax return (both of which include the Company and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities.

Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

At acquisition, deferred taxes were evaluated in respect to the acquired assets and assumed liabilities (including the acquired net operating losses), and a net deferred tax asset was recorded. Certain limitations within the provisions of the tax code are placed on the amount of net operating losses which can be utilized as part of acquisition accounting rules and were incorporated into the calculation of the deferred tax asset. In addition, a portion of the fair value discounts on PCI loans which resolved in the first twelve months after the acquisition were disallowed under provisions of the tax code.

The Company may also recognize a liability for unrecognized tax benefits from uncertainty in income tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the consolidated financial statements. At December 31, 2020, the Company determined it had no significant uncertainty in income tax positions. Interest and penalties related to unrecognized tax benefits are classified as income tax expense. See Note 12 for additional information on income taxes.

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 common shares adjusted for the dilutive effect of outstanding common stock awards, if any. See Note 19 for additional information on earnings per common share.

Treasury Stock: Treasury stock is accounted for at cost on a first-in-first-out basis. It is the Company’s general practice to cancel treasury stock shares in the same quarter as purchased, and thus, not carry a treasury stock balance.

Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on securities AFS, are reported in accumulated other comprehensive income, as a separate component of the equity section of the balance sheet. Realized gains or losses are reclassified to current period income. Changes in these items, along with net income, are components of comprehensive income. The Company presents comprehensive income in a separate consolidated statement of comprehensive income.

Revenue Recognition: Accounting principles (Revenue from Contracts with Customers, Topic 606) require that an entity 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. The guidance includes 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. See Note 20 for additional information on revenue recognition.

Reclassifications: Certain amounts in the 2019 and 2018 consolidated financial statements have been reclassified to conform to the 2020 presentation.

New Accounting Pronouncements Adopted: In August 2018, the FASB issued Accounting Standards Update (“ASU”) 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements by removing, modifying or adding certain disclosures. The updated guidance was effective for annual reporting periods, including interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted the updated guidance effective January 1, 2020, with no material impact on its consolidated financial statements as the new ASU only revises disclosure requirements. See Note 17 for fair value disclosures.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring earlier recognition of credit losses on loans and certain other financial assets. Topic 326 replaced the incurred loss impairment model (which recognized losses when a probable threshold was met) with a requirement to recognize lifetime expected credit losses immediately when a financial asset is originated or purchased. The measurement of lifetime expected credit losses is based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU was effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted the new accounting standard on January 1, 2020, as required, and recorded a cumulative-effect adjustment of $6 million to retained earnings. See Securities Available for Sale, Loans, and Allowance for Credit Losses above for changes to accounting policies and see Notes 3 and 4 for additional disclosures related to this new accounting pronouncement.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

NOTE 2. ACQUISITIONS

Completed Acquisitions:

Advantage Community Bancshares, Inc. (“Advantage”): On August 21, 2020, Nicolet completed its merger with Advantage, pursuant to the terms of the definitive merger agreement dated March 2, 2020, whereby Advantage merged with and into Nicolet, and Advantage Community Bank, the wholly owned bank subsidiary of Advantage, was merged with and into the Company's banking subsidiary, Nicolet National Bank. Advantage’s four branches in Dorchester, Edgar, Mosinee, and Wausau opened as Nicolet National Bank branches on August 24, 2020, expanding our presence in Central Wisconsin and the Wausau area. Due to the small size of the transaction, terms of the all-cash deal were not disclosed.

Upon consummation, Advantage added total assets of approximately $172 million (representing 4% of Nicolet’s then pre-merger asset size), loans of $88 million, deposits of $141 million, core deposit intangible of $1 million, and goodwill of $12 million.

Choice Bancorp, Inc. (“Choice”): On November 8, 2019, the Company consummated its merger with Choice, pursuant to the terms of the Agreement and Plan of Merger dated June 26, 2019, (the “Choice Merger Agreement”), whereby Choice (at 12% of Nicolet’s then pre-merger asset size) was merged with and into Nicolet, and Choice Bank, the wholly owned bank subsidiary of Choice, was merged with and into the Bank. The system integration was completed, and the two branches of Choice opened on November 12, 2019, as Nicolet National Bank branches, expanding its presence in the Oshkosh marketplace. The Company closed its legacy Oshkosh location concurrently with the consummation of the Choice 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 Oshkosh marketplace.

Pursuant to the Choice Merger Agreement, the final purchase price consisted of issuing 1,184,102 shares of the Company’s common stock (given the final stock-for-stock exchange ratio of 0.497, and not exchanging the Choice shares owned by the Company immediately prior to the time of the merger), for common stock consideration of $79.8 million (based on $67.39 per share, the volume weighted average closing price of the Company’s common stock over the preceding 30 trading day period) plus cash consideration of $1.7 million. Approximately $0.2 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital.

Upon consummation, Choice added $457 million in assets, including $348 million in loans, $289 million in deposits, $1.7 million in core deposit intangible, and $45 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 Choice 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.

Terminated Acquisition:

Commerce Financial Holdings, Inc. (“Commerce”): On February 17, 2020, Nicolet entered into a definitive merger agreement (“Merger Agreement”) with Commerce pursuant to which Nicolet would acquire Commerce and its wholly owned bank subsidiary, Commerce State Bank. On May 18, 2020, Nicolet and Commerce announced a mutual agreement to terminate their Merger Agreement. Nicolet paid Commerce $0.5 million and surrendered its $0.1 million of Commerce common stock.

NOTE 3. SECURITIES AVAILABLE FOR SALE

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

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

All mortgage-backed securities included in the tables above were issued by U.S. government agencies and corporations. Securities AFS with a fair value of $146 million and $166 million as of December 31, 2020 and 2019, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. Accrued interest on securities AFS totaled $2.3 million and $2.2 million at December 31, 2020 and 2019, respectively, and is included in accrued interest receivable and other assets on the consolidated balance sheets.

The following tables present gross unrealized losses and the related estimated fair value of investment securities AFS for which an allowance for credit losses has not been recorded, aggregated by investment category and the length of time the individual securities have been in a continuous unrealized loss position.

Less than 12 months 12 months or more Total

Less than 12 months 12 months or more Total

The Company evaluates securities AFS in unrealized loss positions to determine whether the impairment is due to credit-related factors or noncredit-related factors. In making this evaluation, management considers the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

As of December 31, 2020, no allowance for credit losses on securities AFS was recognized. The Company does not consider its securities AFS with unrealized losses to be attributable to credit-related factors as the unrealized losses in each category have occurred as a result of changes in noncredit-related factors such as changes in interest rates, market spreads, and market conditions subsequent to purchase, not credit deterioration. Furthermore, the Company does not have the intent to sell any of these securities AFS and believes that it is more likely than not that we will not have to sell any such securities before a recovery of cost. There were no other-than-temporary impairment charges recognized in earnings on securities AFS during 2019 or 2018.

The amortized cost and fair value of securities AFS by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties; as this is particularly inherent in mortgage-backed securities, these securities are not included in the maturity categories below. See Note 17 for additional information on the Company’s fair value measurements.

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

(in thousands) Amortized Cost Fair Value

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

Years Ended December 31,

Gains (losses) on sales of securities AFS, net $ 395 $ (22) $ (212)

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NICOLET BANKSHARES, INC.

Notes to Consolidated Financial Statements

NOTE 4. LOANS, ALLOWANCE FOR CREDIT LOSSES - LOANS, AND CREDIT QUALITY

Loans:

The loan composition was as follows.

(in thousands) Amount % of Total Amount % of Total

Paycheck Protection Program (“PPP”) loans 186,016 7 — —

ACL-Loans to loans 1.15 % 0.54 %

Accrued interest on loans totaled $7 million at both December 31, 2020 and December 31, 2019, and is included in accrued interest receivable and other assets on the consolidated balance sheets. See Note 1 for the Company’s accounting policy on loans and the allowance for credit losses.

Allowance for Credit Losses-Loans:

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

A roll forward of the allowance for credit losses - loans was as follows.

Years Ended December 31,

Adoption of CECL 8,488 — —

Initial PCD ACL 797 — —