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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________
 
Commission file number: 0-12247
SOUTHSIDE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

TEXAS
 
75-1848732
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
1201 S. Beckham Avenue, Tyler, Texas
 
75701
(Address of principal executive offices)
 
(Zip Code)
903-531-7111
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x
The number of shares of the issuer’s common stock, par value $1.25, outstanding as of April 27, 2018 was 35,052,547 shares.
 



TABLE OF CONTENTS
 
PART I.  FINANCIAL INFORMATION
 
PART II.  OTHER INFORMATION
 


Table of Contents


PART I.   FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
 
 
March 31, 2018
 
December 31, 2017
 
 
ASSETS
 
 
 
 
Cash and due from banks
 
$
65,480

 
$
79,171

Interest earning deposits
 
183,241

 
111,541

Federal funds sold
 
14,090

 
7,980

Total cash and cash equivalents
 
262,811

 
198,692

Securities available for sale, at estimated fair value
 
2,062,539

 
1,538,755

Securities held to maturity, at carrying value (estimated fair value of $161,305 and $921,800, respectively)
 
164,847

 
909,506

FHLB stock, at cost
 
42,676

 
55,729

Equity investments
 
12,067

 
5,821

Loans held for sale
 
2,003

 
2,001

Loans:
 
 

 
 

Loans
 
3,309,627

 
3,294,356

Less:  Allowance for loan losses
 
(24,220
)
 
(20,781
)
Net loans
 
3,285,407

 
3,273,575

Premises and equipment, net
 
131,625

 
133,640

Goodwill
 
201,246

 
201,246

Other intangible assets, net
 
21,615

 
22,993

Interest receivable
 
20,664

 
28,491

Deferred tax asset, net
 
16,648

 
12,204

Unsettled trades to sell securities
 
35,307

 

Bank owned life insurance
 
100,963

 
100,368

Other assets
 
12,779

 
15,076

Total assets
 
$
6,373,197

 
$
6,498,097

 
 
 

 
 

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

Deposits:
 
 

 
 

Noninterest bearing
 
$
1,055,423

 
$
1,037,401

Interest bearing
 
3,586,474

 
3,478,046

Total deposits
 
4,641,897

 
4,515,447

Federal funds purchased and repurchase agreements
 
7,825

 
9,498

FHLB borrowings
 
772,165

 
1,017,361

Subordinated notes, net of unamortized debt issuance costs
 
98,286

 
98,248

Trust preferred subordinated debentures, net of unamortized debt issuance costs
 
60,242

 
60,241

Unsettled trades to purchase securities
 
3,646

 

Other liabilities
 
42,740

 
43,162

Total liabilities
 
5,626,801

 
5,743,957

 
 
 

 
 

Off-balance-sheet arrangements, commitments and contingencies (Note 13)
 


 


 
 
 

 
 
Shareholders’ equity:
 
 

 
 

Common stock:  ($1.25 par value, 40,000,000 shares authorized, 37,812,387 shares issued at March 31, 2018 and 37,802,352 shares issued at December 31, 2017)
 
47,265

 
47,253

Paid-in capital
 
758,653

 
757,439

Retained earnings
 
39,184

 
32,851

Treasury stock, at cost (2,759,840 at March 31, 2018 and 2,802,019 at December 31, 2017)
 
(46,736
)
 
(47,105
)
Accumulated other comprehensive loss
 
(51,970
)
 
(36,298
)
Total shareholders’ equity
 
746,396

 
754,140

Total liabilities and shareholders’ equity
 
$
6,373,197

 
$
6,498,097

The accompanying notes are an integral part of these consolidated financial statements.


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Table of Contents


SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
 
Three Months Ended
 
March 31,
 
2018
 
2017
Interest income
 
 
 
Loans
$
38,830

 
$
27,254

Investment securities – taxable
227

 
377

Investment securities – tax-exempt
6,381

 
6,554

Mortgage-backed securities
10,894

 
10,045

FHLB stock and equity investments
414

 
298

Other interest earning assets
448

 
360

Total interest income
57,194

 
44,888

Interest expense
 

 
 

Deposits
7,451

 
4,281

FHLB borrowings
3,632

 
3,464

Subordinated notes
1,398

 
1,393

Trust preferred subordinated debentures
569

 
467

Other borrowings
11

 
3

Total interest expense
13,061

 
9,608

Net interest income
44,133

 
35,280

Provision for loan losses
3,735

 
1,098

Net interest income after provision for loan losses
40,398

 
34,182

Noninterest income
 

 
 

Deposit services
6,179

 
5,114

Net (loss) gain on sale of securities available for sale
(827
)
 
322

Gain on sale of loans
115

 
701

Trust income
1,760

 
890

Bank owned life insurance income
632

 
634

Brokerage services
450

 
547

Other
1,301

 
1,465

Total noninterest income
9,610

 
9,673

Noninterest expense
 

 
 

Salaries and employee benefits
18,559

 
16,007

Occupancy expense
3,583

 
2,863

Acquisition expense
832

 

Advertising, travel & entertainment
685

 
583

ATM and debit card expense
346

 
927

Professional fees
1,070

 
939

Software and data processing expense
1,023

 
725

Telephone and communications
538

 
526

FDIC insurance
497

 
441

Amortization expense on intangibles
1,378

 
431

Other
3,156

 
2,416

Total noninterest expense
31,667

 
25,858

Income before income tax expense
18,341

 
17,997

Income tax expense
2,090

 
3,008

Net income
$
16,251

 
$
14,989

 
 
 
 
Earnings per common share – basic
$
0.46

 
$
0.51

Earnings per common share – diluted
$
0.46

 
$
0.51

Dividends paid per common share
$
0.28

 
$
0.25

The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)
 
Three Months Ended

March 31,
 
2018
 
2017
Net income
$
16,251

 
$
14,989

Other comprehensive (loss) income:
 

 
 

Securities available for sale and transferred securities:
 
 
 
Change in net unrealized holding (losses) gains on available for sale securities during the period
(37,783
)
 
4,885

Unrealized net gain on securities transferred from held to maturity to available for sale under the transition guidance enumerated in ASU 2017-12
11,881

 

Change in net unrealized losses on securities transferred from held to maturity to available for sale
401

 

Reclassification adjustment for net loss on equity investments, reclassed to retained earnings with adoption of ASU 2016-01
107

 

Reclassification adjustment for amortization related to available for sale and held to maturity debt securities
138

 
488

Reclassification adjustment for net loss (gain) on sale of available for sale securities, included in net income
827

 
(322
)
Derivatives:
 
 
 
Change in net unrealized gain (loss) on effective cash flow hedge interest rate swap derivatives
4,245

 
(80
)
Change in net unrealized gains on interest rate swap derivatives terminated during the period

 
273

Reclassification adjustment from other comprehensive income related to derivatives designated as cash flow hedge
(127
)
 
370

Pension plans:
 
 
 
Amortization of net actuarial loss and prior service credit, included in net periodic benefit cost
473

 
389

Other comprehensive (loss) income, before tax
(19,838
)
 
6,003

Income tax benefit (expense) related to items of other comprehensive income (loss)
4,166

 
(2,101
)
Other comprehensive (loss) income, net of tax
(15,672
)
 
3,902

Comprehensive income
$
579

 
$
18,891


The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
(in thousands, except share and per share data)
 
Common
Stock
 
Paid In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders’
Equity
Balance at December 31, 2016
$
39,320

 
$
535,240

 
$
30,098

 
$
(47,891
)
 
$
(38,493
)
 
$
518,274

Net income

 

 
14,989

 

 

 
14,989

Other comprehensive income

 

 

 

 
3,902

 
3,902

Issuance of common stock for dividend reinvestment plan (10,433 shares)
13

 
340

 

 

 

 
353

Stock compensation expense

 
494

 

 

 

 
494

Net issuance of common stock under employee stock plans (33,596 shares)
42

 
579

 
(24
)
 

 

 
597

Cash dividends paid on common stock ($0.25 per share)

 

 
(7,143
)
 

 

 
(7,143
)
Balance at March 31, 2017
$
39,375

 
$
536,653

 
$
37,920

 
$
(47,891
)
 
$
(34,591
)
 
$
531,466

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
$
47,253

 
$
757,439

 
$
32,851

 
$
(47,105
)
 
$
(36,298
)
 
$
754,140

Net income

 

 
16,251

 

 

 
16,251

Other comprehensive loss

 

 

 

 
(15,672
)
 
(15,672
)
Issuance of common stock for dividend reinvestment plan (10,035 shares)
12

 
341

 

 

 

 
353

Stock compensation expense

 
456

 

 

 

 
456

Net issuance of common stock under employee stock plans (42,179 shares)

 
417

 
(25
)
 
369

 

 
761

Cash dividends paid on common stock ($0.28 per share)

 

 
(9,808
)
 

 

 
(9,808
)
Cumulative effect of ASU 2016-01

 

 
(85
)
 

 

 
(85
)
Balance at March 31, 2018
$
47,265

 
$
758,653

 
$
39,184

 
$
(46,736
)
 
$
(51,970
)
 
$
746,396


The accompanying notes are an integral part of these consolidated financial statements.

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
 
Three Months Ended
 
March 31,
 
2018
 
2017
OPERATING ACTIVITIES:
 
 
 
Net income
$
16,251

 
$
14,989

Adjustments to reconcile net income to net cash provided by operations:
 

 
 

Depreciation and net amortization
3,566

 
2,417

Securities premium amortization (discount accretion), net
4,058

 
4,567

Loan (discount accretion) premium amortization, net
(1,057
)
 
(290
)
Provision for loan losses
3,735

 
1,098

Stock compensation expense
456

 
494

Deferred tax benefit
(255
)
 
(19
)
Net loss (gain) on sale of securities available for sale
827

 
(322
)
Net loss on premises and equipment
35

 

Gross proceeds from sales of loans held for sale
5,600

 
22,521

Gross originations of loans held for sale
(5,602
)
 
(20,183
)
Net loss on other real estate owned
67

 

Net change in:
 

 
 

Interest receivable
7,827

 
6,910

Other assets
1,875

 
7,419

Interest payable
(1,219
)
 
(1,523
)
Other liabilities
5,501

 
(5,377
)
Net cash provided by operating activities
41,665

 
32,701

 
 
 
 
INVESTING ACTIVITIES:
 

 
 

Securities available for sale:
 
 
 
Purchases
(138,581
)
 
(139,246
)
Sales
237,526

 
99,653

Maturities, calls and principal repayments
53,717

 
29,770

Securities held to maturity:
 

 
 

Purchases

 
(1,521
)
Maturities, calls and principal repayments
1,222

 
8,305

Proceeds from redemption of FHLB stock and other investments
13,377

 
81

Purchases of FHLB stock and other investments
(638
)
 
(221
)
Net loan originations
(15,154
)
 
17,201

Purchases of premises and equipment
(2,018
)
 
(1,287
)
Proceeds from sales of premises and equipment
1,903

 
3

Proceeds from sales of other real estate owned
91

 

Proceeds from sales of repossessed assets
198

 
179

Net cash provided by investing activities
151,643

 
12,917

 
 
 
 
(continued)
 
 
 

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED) (continued)
(in thousands)
 
Three Months Ended
 
March 31,
 
2018
 
2017
FINANCING ACTIVITIES:
 
 
 
Net change in deposits
$
126,372

 
$
140,978

Net (decrease) increase in federal funds purchased and repurchase agreements
(1,673
)
 
717

Proceeds from FHLB borrowings
1,110,000

 
725,000

Repayment of FHLB borrowings
(1,355,194
)
 
(828,780
)
Proceeds from stock option exercises
801

 
639

Cash paid to tax authority from stock option exercises
(40
)
 
(42
)
Proceeds from the issuance of common stock for dividend reinvestment plan
353

 
353

Cash dividends paid
(9,808
)
 
(7,143
)
Net cash (used in) provided by financing activities
(129,189
)
 
31,722

 
 
 
 
Net increase in cash and cash equivalents
64,119

 
77,340

Cash and cash equivalents at beginning of period
198,692

 
169,654

Cash and cash equivalents at end of period
$
262,811

 
$
246,994

 
 
 
 
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
 

 
 


 
 
 
Interest paid
$
14,280

 
$
11,131

Income taxes paid
$

 
$

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 

 
 


 
 
 
Loans transferred to other repossessed assets and real estate through foreclosure
$
649

 
$
184

Transfer of held to maturity securities to available for sale securities
$
743,421

 
$

Adjustment to pension liability
$
(473
)
 
$
(389
)
Unsettled trades to purchase securities
$
(3,646
)
 
$
(10,465
)
Unsettled trades to sell securities
$
35,307

 
$
57,385

Unsettled issuances of brokered CDs
$

 
$
31,232


The accompanying notes are an integral part of these consolidated financial statements.


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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.    Summary of Significant Accounting and Reporting Policies
Basis of Presentation
In this report, the words “the Company,” “we,” “us,” and “our” refer to the combined entities of Southside Bancshares, Inc. and its subsidiaries.  The words “Southside” and “Southside Bancshares” refer to Southside Bancshares, Inc.  The words “Southside Bank” and “the Bank” refer to Southside Bank. “Omni” refers to OmniAmerican Bancorp, Inc., a bank holding company acquired by Southside on December 17, 2014. “Diboll” refers to Diboll State Bancshares, Inc., a bank holding company and its wholly-owned subsidiary, First Bank & Trust East Texas, acquired by Southside on November 30, 2017.
The accompanying unaudited consolidated financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, not all information required by GAAP for complete financial statements is included in these interim statements. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included.  Such adjustments consisted only of normal recurring items.  The preparation of these consolidated financial statements in accordance with GAAP requires the use of management’s estimates.  These estimates are subjective in nature and involve matters of judgment.  Actual amounts could differ from these estimates.
Interim results are not necessarily indicative of results for a full year.  These financial statements should be read in conjunction with the financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2017.  
Accounting Changes and Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation.
We adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” as modified by subsequently issued ASUs 2015-14, 2016-08, 2016-10, 2016-12 and 2016-20, on January 1, 2018, the effective date of the guidance, using the modified retrospective approach. As the majority of the Company’s revenues are not subject to the new guidance, the adoption of ASU 2014-09 did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows. We did adjust the presentation of revenue received from our brokerage services, merchant services, as well as our interchange income associated with debit cards services which were all deemed to be services offered in an agent capacity. These lines of revenue will now be presented on a net basis with the fee income disclosed net of the related costs in the noninterest income section of the consolidated statements of income. In connection with the adoption, for the three months ended March 31, 2018, we netted $796,000 of debit card expense against deposit services income and $151,000 of brokerage expense against brokerage income. Due to the implementation of the guidance under the modified retrospective method, prior-periods have not been adjusted and are not comparative. Refer to our revenue recognition discussion below and “Note 1 - Summary of Significant Accounting and Reporting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2017 for more information related to our revenue recognition policies.
We adopted ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities,” on January 1, 2018, the effective date of the guidance.  ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale (“AFS”) securities in combination with the entity’s other deferred tax assets. The guidance requires companies to apply the requirements in the year of adoption, through cumulative adjustment, while the guidance related to equity securities without readily determinable fair values should be applied prospectively. Adoption of this guidance resulted in a cumulative adjustment to retained earnings of $85,000 on January 1, 2018 and an equity security with a carrying value of $5.9 million that was previously recognized in securities available for sale, at estimated fair value on our consolidated balance sheet to being recognized in equity investments, with subsequent changes in fair value being recognized in income.  Also in conjunction with the adoption, our fair value measurement of financial instruments will be based upon an exit

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price notion as required in ASC 820.  The guidance was applied on a prospective approach resulting in prior-periods no longer being comparable.
We adopted ASU 2017-07, “Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” on January 1, 2018. ASU 2017-07 requires employers to present the service cost component of net periodic postretirement benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. Employers are required to present the other components of the net periodic benefit cost separately from the line item that includes the service cost and outside of any subtotal of operating income, if one is presented. The guidance requires companies to apply the requirements retrospectively to all prior periods presented. We elected to use the practical expedient that permits us to use the amounts in our pension plan disclosures in our employee benefit footnotes for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements, which resulted in an increase of $88,000 in salaries and employee benefits expense and a decrease of $88,000 in other noninterest expense for the three months ended March 31, 2017.
We early adopted ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” on January 1, 2018. ASU 2017-12 (i) expands hedge accounting for nonfinancial and financial risk components and amends measurement methodologies to more closely align hedge accounting with a company’s risk management activities, (ii) decreases the complexity of preparing and understanding hedge results by eliminating the separate measurement and reporting of hedge ineffectiveness, (iii) enhances transparency, comparability, and understanding of hedge results through enhanced disclosures and changing the presentation of hedge results to align the effects of the hedging instrument and the hedged item, and (iv) reduces the cost and complexity of applying hedge accounting by simplifying the manner in which assessments of hedge effectiveness may be performed. The guidance also permits a transition election to reclassify held to maturity (“HTM”) securities to AFS securities if a portion of those securities would qualify to be hedged under the new “last-of-layer” approach. The guidance requires companies to apply the requirements to existing hedging relationships on the date of adoption, and the effect of the adoption should be reflected as of the beginning of the fiscal year of adoption. The guidance did not have an impact on our derivatives that qualified as hedges on the date of adoption and thus no adjustment was made to beginning retained earnings. In conjunction with the adoption of ASU 2017-12, we made the transition election to reclassify approximately $743.4 million in book value of securities from HTM to AFS that qualified for the last-of-layer method described in ASU 2017-12.
Revenue Recognition
Our revenue consists of net interest income on financial assets and financial liabilities and noninterest income.  The classifications of our revenue are presented in the consolidated statements of income. On January 1, 2018, we adopted ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the modified retrospective method. The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
ASU 2014-09 permits an entity to recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset would have been one year or less. We generally expense sales commissions when incurred because the amortization period is within one year or less. These costs are recorded within salaries and employee benefits on the consolidated statements of income.
Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; generally this occurs with the transfer of control of goods or services. Under ASC 2014-09’s practical expedient to recognize revenue equal to the amounts for which we have a right to invoice, revenue is measured as the amount of consideration we expect to receive in exchange for the transfer of those goods or services.
The following summarizes our revenue recognition policies as they relate to revenue from contracts with customers under ASU 2014-09:
Deposit services. Service charges on deposit accounts include fees for banking services provided, overdrafts and non-sufficient funds. Revenue is generally recognized in accordance with published deposit account agreements for retail accounts or contractual agreements for commercial accounts. Our deposit services also include our ATM and debit card interchange revenue that is presented net of the associated costs. Interchange revenue is generated by our deposit customers’ usage and volume of activity. Interchange rates are not controlled by the Company, which effectively acts as processor that collects and remits payments associated with customer debit card transactions.
Trust income. Trust income includes fees and commissions from investment management, administrative and advisory services primarily for individuals, and to a lesser extent, partnerships and corporations. Revenue is recognized on an accrual basis at the time the services are performed and when we have a right to invoice and are based on either the market value of the assets managed or the services provided.

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Brokerage services. Brokerage services income includes fees and commissions charged when we arrange for another party to transfer brokerage services to a customer. The fees and commissions under this agent relationship are based upon stated fee schedules based upon the type of transaction, volume, and value of the services provided.
Other noninterest income. Other noninterest income includes among other things, merchant services income. Merchant services revenue is derived from third party vendors that process credit card transactions on behalf of our merchant customers. Merchant services revenue is primarily comprised of residual fee income based on the referred merchant’s processing volumes and/or margin.
Securities
Available for Sale (“AFS”).  Debt securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield on alternative investments are classified as AFS.  These assets are carried at fair value with changes recorded in other comprehensive income.  Fair value is determined using quoted market prices as of the close of business on the balance sheet date.  If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services.
Held to Maturity (“HTM”). Debt securities that management has the positive intent and ability to hold until maturity are classified as HTM and are carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts.
Equity Investments. Beginning January 1, 2018, upon adoption of ASU 2016-01, equity investments with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. For periods prior to January 1, 2018, equity investments were classified as available-for-sale and stated at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (“AOCI”), net of tax. Equity investments without readily determinable fair values are recorded at cost less impairment, if any.
Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires a lessee to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new ASU 2016-02 will require both finance (formerly known as “capital”) and operating leases to be recognized on the balance sheet. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The guidance requires companies to apply the requirements in the year of adoption using a modified retrospective approach. We are currently evaluating the impact this guidance will have on our consolidated financial statements, and we anticipate our assessment to be completed during the fiscal year 2018. 
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. ASU 2016-13 also modifies the impairment model for available for sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The guidance requires companies to apply the requirements in the year of adoption through cumulative adjustment with some aspects of the update requiring a prospective transition approach. We are currently evaluating the potential impact of the pending adoption of ASU 2016-13 on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 is intended to simplify goodwill impairment testing by eliminating the second step of the analysis which requires the calculation of the implied fair value of goodwill to measure a goodwill impairment charge. The update requires entities to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for any amount by which the carrying amount exceeds the reporting unit’s fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual and interim goodwill impairment tests performed in periods beginning after December 15, 2019. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The guidance requires companies to apply the requirements prospectively in the year of adoption. ASU 2017-04 is not expected to have a significant impact on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” Under current GAAP, premiums on callable debt securities are generally amortized over the contractual life of the security. ASU 2017-08 requires the premium on callable debt securities to be amortized to the earliest call date. If the debt security is not called at the earliest call date, the holder of the debt security would be required to reset the effective yield on the debt security based on the payment terms required by the debt security. ASU 2017-08 is effective

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for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We have elected to adopt on January 1, 2019. The guidance requires companies to apply the requirements on a modified retrospective basis through a cumulative adjustment directly to retained earnings as of the beginning of the period of adoption. We have evaluated an estimate of the potential impact of the pending adoption of ASU 2017-08 on our consolidated financial statements. Based on our existing municipal securities portfolio, we believe the change to amortizing premiums to the earliest call date will increase amortization expense recorded through interest income for the year ended December 31, 2019 by approximately $3.4 million, net of tax.

2.    Acquisition
On November 30, 2017, we acquired 100% of the outstanding stock of Diboll State Bancshares, Inc. and its wholly-owned subsidiary First Bank & Trust East Texas (collectively, “Diboll”) headquartered in Diboll, Texas. Diboll operated 17 banking offices in Diboll and surrounding areas. We acquired Diboll to further expand our presence in the East Texas market. The operations of Diboll were merged into the Company as of the date of the acquisition.
The Diboll acquisition was accounted for using the acquisition method of accounting and accordingly, purchased assets, including identifiable intangible assets and assumed liabilities were recorded at their respective acquisition date fair values.  The purchase price allocation is preliminary and is subject to final determination and valuation of the fair value of assets acquired and liabilities assumed. As of December 31, 2017, the Company recognized $109.7 million in initial goodwill associated with the Diboll acquisition. Our consolidated goodwill totaled $201.2 million as of March 31, 2018 and December 31, 2017. For more information concerning the fair value of the assets acquired and liabilities assumed in relation to the acquisition of Diboll, see "Note 2 - Acquisition" in our Annual Report on Form 10-K for the year ended December 31, 2017.

3.     Earnings Per Share
Earnings per share on a basic and diluted basis has been adjusted to give retroactive recognition to stock dividends and is calculated as follows (in thousands, except per share amounts):
 
Three Months Ended
March 31,
 
2018
 
2017
Basic and Diluted Earnings:
 
 
 
Net income
$
16,251

 
$
14,989

Basic weighted-average shares outstanding
35,022

 
29,288

Add:   Stock awards
178

 
216

Diluted weighted-average shares outstanding
35,200

 
29,504

Basic Earnings Per Share:
 
 
 
Net Income
$
0.46

 
$
0.51

Diluted Earnings Per Share:
 
 
 
Net Income
$
0.46

 
$
0.51

For the three-month periods ended March 31, 2018 and 2017, there were approximately 41,000 and 50,000 anti-dilutive shares, respectively.

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4.     Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) by component are as follows (in thousands):

 
Three Months Ended March 31, 2018
 

 
 
Pension Plans
 
 
 
Unrealized Gains (Losses) on Securities
 
Unrealized Gains (Losses) on Derivatives
 
Net Prior
Service
(Cost)
Credit
 
Net Gain (Loss)
 
Total
Beginning balance, net of tax
$
(16,295
)
 
$
6,399

 
$
(133
)
 
$
(26,269
)
 
$
(36,298
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income before reclassifications
(25,501
)
 
4,245

 

 

 
(21,256
)
Reclassified from accumulated other comprehensive income (1)
1,072

 
(127
)
 
(2
)
 
475

 
1,418

Income tax benefit (expense)
5,130

 
(865
)
 
1

 
(100
)
 
4,166

Net current-period other comprehensive (loss) income, net of tax
(19,299
)
 
3,253

 
(1
)
 
375

 
(15,672
)
Ending balance, net of tax
$
(35,594
)
 
$
9,652

 
$
(134
)
 
$
(25,894
)
 
$
(51,970
)

(1)
As discussed in “Note 1 – Summary of Significant Accounting and Reporting Policies,” the Company adopted ASU 2016-01 on January 1, 2018. This amount includes a reclassification for the cumulative adjustment to retained earnings of $107,000 ($85,000, net of tax).

 
Three Months Ended March 31, 2017
 

 
 
Pension Plans
 
 
 
Unrealized Gains (Losses) on Securities
 
Unrealized Gains (Losses) on Derivatives
 
Net Prior
 Service
 (Cost)
 Credit
 
Net Gain (Loss)
 
Total
Beginning balance, net of tax
$
(23,708
)
 
$
4,595

 
$
(133
)
 
$
(19,247
)
 
$
(38,493
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive income before reclassifications
4,885

 
193

 

 

 
5,078

Reclassified from accumulated other comprehensive income
166

 
370

 
(2
)
 
391

 
925

Income tax (expense) benefit
(1,768
)
 
(197
)
 
1

 
(137
)
 
(2,101
)
Net current-period other comprehensive income (loss), net of tax
3,283

 
366

 
(1
)
 
254

 
3,902

Ending balance, net of tax
$
(20,425
)
 
$
4,961

 
$
(134
)
 
$
(18,993
)
 
$
(34,591
)

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The reclassifications out of accumulated other comprehensive income (loss) into net income are presented below (in thousands):
 
Three Months Ended
March 31,
 
2018
 
2017
 
 
 
 
Unrealized losses on securities transferred:
 
 
 
Amortization of unrealized losses (1)
$
(138
)
 
$
(488
)
Tax benefit
29

 
171

Net of tax
$
(109
)
 
$
(317
)
 
 
 
 
Unrealized gains and losses on available for sale securities:
 
 
 
Realized net (loss) gain on sale of securities (2)
$
(827
)
 
$
322

Tax benefit (expense)
174

 
(113
)
Net of tax
$
(653
)
 
$
209

 
 
 
 
Derivatives:
 
 
 
Realized net gain (loss) on interest rate swap derivatives (3)
$
106

 
$
(379
)
Tax (expense) benefit
(22
)
 
133

Net of tax
$
84

 
$
(246
)
 
 
 
 
Amortization of unrealized gains on terminated interest rate swap derivatives (3)
$
21

 
$
9

Tax expense
(4
)
 
(3
)
Net of tax
$
17

 
$
6

 
 
 
 
Amortization of pension plan:
 
 
 
Net actuarial loss (4)
$
(475
)
 
$
(391
)
Prior service credit (4)
2

 
2

Total before tax
(473
)
 
(389
)
Tax benefit
99

 
136

Net of tax
(374
)
 
(253
)
Total reclassifications for the period, net of tax
$
(1,035
)
 
$
(601
)
(1)    Included in interest income on the consolidated statements of income.
(2)    Listed as net (loss) gain on sale of securities available for sale on the consolidated statements of income.
(3)    Included in interest expense for FHLB borrowings on the consolidated statements of income.
(4)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (income) presented in “Note 8 - Employee Benefit Plans.”

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5.     Securities

Debt securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of investment and mortgage-backed securities available for sale and held to maturity as of March 31, 2018 and December 31, 2017 are reflected in the tables below (in thousands):
 
 
March 31, 2018

 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Fair Value
Investment Securities:
 
 
 
 
 
 
 
 
State and Political Subdivisions
 
$
789,752

 
$
8,000

 
$
16,394

 
$
781,358

Other Stocks and Bonds
 
5,006

 

 
8

 
4,998

Mortgage-backed Securities: (1)
 
 

 
 

 
 

 
 
Residential
 
743,381

 
3,501

 
15,092

 
731,790

Commercial

552,568

 
1,027

 
9,202

 
544,393

Total
 
$
2,090,707

 
$
12,528

 
$
40,696

 
$
2,062,539

 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
State and Political Subdivisions
 
$
3,207

 
$

 
$
36

 
$
3,171

Mortgage-backed Securities: (1)
 
 
 
 
 
 
 
 
Residential
 
60,256

 
231

 
1,641

 
58,846

Commercial
 
101,384

 
189

 
2,285

 
99,288

Total
 
$
164,847

 
$
420

 
$
3,962

 
$
161,305




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December 31, 2017
 
 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Fair Value
Investment Securities:
 
 
 
 
 
 
 
 
U.S. Government Agency Debentures
 
$
108,869

 
$

 
$

 
$
108,869

State and Political Subdivisions
 
392,760

 
3,895

 
3,991

 
392,664

Other Stocks and Bonds
 
5,024

 
31

 


5,055

Other Equity Securities (2)
 
6,027

 

 
107

 
5,920

Mortgage-backed Securities: (1)
 
 
 
 
 
 

 
 
Residential
 
720,930

 
4,476

 
7,377


718,029

Commercial

308,357


761


900


308,218

Total
 
$
1,541,967

 
$
9,163

 
$
12,375

 
$
1,538,755

 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
State and Political Subdivisions
 
$
413,632

 
$
10,879

 
$
2,583

 
$
421,928

Mortgage-backed Securities: (1)
 
 
 
 
 
 
 
 

Residential
 
129,044

 
1,631

 
239

 
130,436

Commercial
 
366,830

 
3,812

 
1,206

 
369,436

Total
 
$
909,506

 
$
16,322

 
$
4,028

 
$
921,800


(1)
All mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
(2)
See “Note 1 – Summary of Significant Accounting and Reporting Policies” for further information.

From time to time, we have transferred securities from available for sale (“AFS”) to held to maturity (“HTM”) due to overall balance sheet strategies. The net unamortized, unrealized loss on the remaining transferred securities included in AOCI in the accompanying balance sheets totaled $16.9 million ($13.3 million, net of tax) at March 31, 2018 and $17.4 million ($13.8 million, net of tax) at December 31, 2017. We transferred these securities due to overall balance sheet strategies. Any net unrealized gain or loss on the transferred securities included in AOCI at the time of transfer will be amortized over the remaining life of the underlying security as an adjustment to the yield on those securities. Securities transferred with losses included in AOCI continue to be included in management’s assessment for other-than-temporary impairment for each individual security. There were no securities transferred from AFS to HTM during the three months ended March 31, 2018 or the year ended December 31, 2017.

On January 1, 2018, we early-adopted ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” and in conjunction with the adoption took the one-time transition election to reclassify approximately $743.4 million book value of securities from HTM to AFS that qualified for hedging under the last-of-layer approach.. The unrealized gain of $11.9 million ($9.4 million, net of tax) on the transferred securities was recognized in other comprehensive income on the date of transfer.

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The following tables represent the estimated fair value and unrealized loss on investment and mortgage-backed securities AFS and HTM as of March 31, 2018 and December 31, 2017 (in thousands):
 
As of March 31, 2018
 
Less Than 12 Months
 
More Than 12 Months
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
AVAILABLE FOR SALE
 
 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
299,263

 
$
5,177

 
$
210,827

 
$
11,217

 
$
510,090

 
$
16,394

Other Stocks and Bonds
4,998

 
8

 

 

 
4,998

 
8

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
515,266

 
8,898

 
100,400

 
6,194

 
615,666

 
15,092

Commercial
464,092

 
8,389

 
12,799

 
813

 
476,891

 
9,202

Total
$
1,283,619

 
$
22,472

 
$
324,026

 
$
18,224

 
$
1,607,645

 
$
40,696

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
3,033

 
$
36

 
$

 
$

 
$
3,033

 
$
36

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
50,381

 
1,491

 
2,269

 
150

 
52,650

 
1,641

Commercial
77,938

 
1,500

 
12,337

 
785

 
90,275

 
2,285

Total
$
131,352

 
$
3,027

 
$
14,606

 
$
935

 
$
145,958

 
$
3,962

 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2017
 
Less Than 12 Months
 
More Than 12 Months
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
AVAILABLE FOR SALE
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
32,341

 
$
121

 
$
172,006

 
$
3,870

 
$
204,347

 
$
3,991

  Other Equity Securities (1)
5,920

 
107

 

 

 
5,920

 
107

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
429,742

 
3,232

 
102,973

 
4,145

 
532,715

 
7,377

Commercial
146,796

 
419

 
13,134

 
481

 
159,930

 
900

Total
$
614,799

 
$
3,879

 
$
288,113

 
$
8,496

 
$
902,912

 
$
12,375

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Investment Securities:
 
 
 
 
 
 
 
 
 
 
 
State and Political Subdivisions
$
85,608

 
$
807

 
$
56,736

 
$
1,776

 
$
142,344

 
$
2,583

Mortgage-backed Securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
24,707

 
157

 
2,736

 
82

 
27,443

 
239

Commercial
136,491

 
782

 
13,552

 
424

 
150,043

 
1,206

Total
$
246,806

 
$
1,746

 
$
73,024

 
$
2,282

 
$
319,830

 
$
4,028


(1)
See “Note 1 – Summary of Significant Accounting and Reporting Policies” for further information.


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We review those securities in an unrealized loss position for significant differences between fair value and the cost basis to evaluate if a classification of other-than-temporary impairment is warranted. In estimating other-than-temporary impairment losses, management considers, among other things, the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. We consider an other-than-temporary impairment to have occurred when there is an adverse change in expected cash flows. When it is determined that a decline in fair value of AFS and HTM securities is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and a charge to other comprehensive income for the noncredit portion. Based upon the length of time and the extent to which fair value is less than cost, we believe that none of the securities with an unrealized loss have other-than-temporary impairment at March 31, 2018.
The majority of the securities in an unrealized loss position are highly rated Texas municipal securities and U.S. Agency mortgage-backed securities (“MBS”) where the unrealized loss is a direct result of the change in interest rates and spreads. For those securities in an unrealized loss position, we do not currently intend to sell the securities and it is not more likely than not that we will be required to sell the securities before the anticipated recovery of their amortized cost basis. To the best of management’s knowledge and based on our consideration of the qualitative factors associated with each security, there were no securities in our investment and MBS portfolio with an other-than-temporary impairment at March 31, 2018.
Interest income recognized on securities for the periods presented (in thousands):
 
 
 
 
 
Three Months Ended
March 31,
 
2018
 
2017
U.S. Treasury
$
108

 
$
315

U.S. Government Agency Debentures
89

 

State and Political Subdivisions
6,381

 
6,554

Other Stocks and Bonds
30

 
34

Other Equity Securities (1)

 
28

Mortgage-backed Securities
10,894

 
10,045

Total interest income on securities
$
17,502

 
$
16,976


(1)
See “Note 1 – Summary of Significant Accounting and Reporting Policies” for further information.

Of the $827,000 in net securities loss from the AFS portfolio for the three months ended March 31, 2018, there were $941,000 in realized gains and $1.8 million in realized losses.  Of the $322,000 in net securities gains from the AFS portfolio for the three months ended March 31, 2017, there were $1.7 million in realized gains and $1.4 million in realized losses. There were no sales from the HTM portfolio during the three months ended March 31, 2018 or 2017. We calculate realized gains and losses on sales of securities under the specific identification method.  




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The amortized cost and estimated fair value of AFS and HTM securities at March 31, 2018, are presented below by contractual maturity (in thousands).  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.  MBS are presented in total by category due to the fact that MBS typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with varying maturities.  The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the security holder.  The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.
 
March 31, 2018
 
Amortized Cost
 
Fair Value
AVAILABLE FOR SALE
 
Investment Securities:
 
 
 
Due in one year or less
$
35,143

 
$
34,893

Due after one year through five years
81,926

 
82,446

Due after five years through ten years
179,060

 
179,134

Due after ten years
498,629

 
489,883

 
794,758

 
786,356

Mortgage-backed Securities
1,295,949

 
1,276,183

Total
$
2,090,707

 
$
2,062,539


 
March 31, 2018
 
Amortized Cost
 
Fair Value
HELD TO MATURITY
 
Investment Securities:
 
 
 
Due in one year or less
$
110

 
$
110

Due after one year through five years
1,124

 
1,115

Due after five years through ten years
1,973

 
1,946

Due after ten years

 

 
3,207

 
3,171

Mortgage-backed Securities:
161,640

 
158,134

Total
$
164,847

 
$
161,305


Investment securities and MBS with carrying values of $1.34 billion and $1.24 billion were pledged as of March 31, 2018 and December 31, 2017, respectively. Pledged securities may be used to collateralize one or more of the following: Federal Home Loan Bank of Dallas (“FHLB”) borrowings, repurchase agreements, and public funds or for other purposes as required by law.

Equity Investments

Equity investments on our consolidated balance sheet include Community Reinvestment Act funds with a readily determinable fair value as well as equity investments without readily determinable fair values. At March 31, 2018, we had equity investments recorded in our consolidated balance sheet of $12.1 million. At December 31, 2017, we had $5.8 million in equity investments without readily determinable fair values recorded at cost, which approximated their fair value.

Beginning January 1, 2018, upon adoption of ASU 2016-01, equity investments with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. For periods prior to January 1, 2018, these equity investments were classified as AFS and stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. Equity investments without readily determinable fair values are recorded at cost less any impairment, if any.

17

Table of Contents



At December 31, 2017, we had $5.9 million in equity investments included in AFS securities and recorded at fair value, with net unrealized losses of $85,000 recognized in AOCI. On January 1, 2018, these unrealized losses were reclassified out of AOCI and into retained earnings with subsequent changes in fair value being recognized in net income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity investments during the three months ended March 31, 2018 (in thousands):

 
Three months ended
 
March 31, 2018
Net (losses) recognized during the period on equity investments
$
(92
)
 
Less: Net gains and (losses) recognized during the period on equity investments sold during the period
 
 
Unrealized (losses) recognized during the reporting period on equity investments still held at the reporting date
$
(92
)
 

Equity investments are assessed quarterly for other-than-temporary impairment. Based upon that evaluation, management does not consider any of our equity investments to be other-than-temporarily impaired at March 31, 2018.

Federal Home Loan Bank Stock

Our FHLB stock, which has limited marketability, is carried at cost.



18

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6.     Loans and Allowance for Probable Loan Losses

Loans in the accompanying consolidated balance sheets are classified as follows (in thousands):
    
 
March 31, 2018
 
December 31, 2017
Real Estate Loans:
 
 
 
Construction
$
474,791

 
$
475,867

1-4 Family Residential
797,088

 
805,341

Commercial
1,285,591

 
1,265,159

Commercial Loans
281,901

 
266,422

Municipal Loans
342,404

 
345,798

Loans to Individuals
127,852

 
135,769

Total Loans (1)
3,309,627

 
3,294,356

Less: Allowance for Loan Losses (2)
24,220

 
20,781

Net Loans
$
3,285,407

 
$
3,273,575


(1)
Includes approximately $803.2 million and $861.8 million of acquired loans as of March 31, 2018 and December 31, 2017, respectively.
(2)
Loans acquired with the Diboll acquisition were measured at fair value on November 30, 2017 with no carryover of allowance for loan loss. There was no allowance for loan loss recorded on purchase credit impaired (“PCI”) loans as of March 31, 2018 and December 31, 2017.
Real Estate Construction Loans
Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral. Our construction loans have both adjustable and fixed interest rates during the construction period. Construction loans to individuals are typically priced and made with the intention of granting the permanent loan on the property. Speculative and commercial construction loans are subject to underwriting standards similar to that of the commercial portfolio.  Owner occupied 1-4 family residential construction loans are subject to the underwriting standards of the permanent loan.
Real Estate 1-4 Family Residential Loans
Residential loan originations are generated by our loan officers, in-house origination staff, marketing efforts, present customers, walk-in customers and referrals from real estate agents and builders.  We focus our lending efforts primarily on the origination of loans secured by first mortgages on owner occupied 1-4 family residences.  Substantially all of our 1-4 family residential originations are secured by properties located in or near our market areas.  
Our 1-4 family residential loans generally have maturities ranging from five to 30 years.  These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan.  Our 1-4 family residential loans are made at both fixed and adjustable interest rates.
Underwriting for 1-4 family residential loans includes debt-to-income analysis, credit history analysis, appraised value and down payment considerations. Changes in the market value of real estate can affect the potential losses in the portfolio.
Commercial Real Estate Loans
Commercial real estate loans as of March 31, 2018 consisted of $1.17 billion of owner and non-owner occupied real estate, $99.0 million of loans secured by multi-family properties and $17.5 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. Management does not consider there to be a risk in any one industry type. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years.

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Commercial Loans
Our commercial loans are diversified loan types including short-term working capital loans for inventory and accounts receivable and short- and medium-term loans for equipment or other business capital expansion.  Management does not consider there to be a concentration of risk in any one industry type. In our commercial loan underwriting, we assess the creditworthiness, ability to repay, and the value and liquidity of the collateral being offered.  Terms of commercial loans are generally commensurate with the useful life of the collateral offered.
Municipal Loans
We have a specific lending department that makes loans to municipalities and school districts primarily throughout the state of Texas.  Municipal loans outside the state of Texas have been limited to adjoining states. The majority of the loans to municipalities and school districts have tax or revenue pledges and in some cases are additionally supported by collateral.  Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. 
Loans to Individuals
Substantially all originations of our loans to individuals are made to consumers in our market areas.  The majority of loans to individuals are collateralized by titled equipment, which are primarily automobiles. Loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower.  The underwriting standards we employ for consumer loans include an application, a determination of the applicant’s payment history on other debts, with the greatest weight being given to payment history with us, and an assessment of the borrower’s ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. Most of our loans to individuals are collateralized, which management believes assists in limiting our exposure.
Allowance for Loan Losses
The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes.  First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in the historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral.  These recommendations are reviewed by senior loan administration, the special assets department, and the loan review department on a monthly basis.  Third, the loan review department independently reviews the portfolio on an annual basis.  The loan review department follows a board-approved annual loan review scope.  The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan.  The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater.  The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list (“Watch List”) of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated quarterly based on actual charge-off experience and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans.
Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of our loans will require partial or full charge-off.  Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the

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loan.  Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, and geographic and industry loan concentration.
Credit Quality Indicators
We categorize loans into risk categories on an ongoing basis based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  We use the following definitions for risk ratings:
Pass (Rating 1 – 4) – This rating is assigned to all satisfactory loans.  This category, by definition, consists of acceptable credit.  Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Pass, if deficiencies are in the process of correction.  These loans are not included in the Watch List.
Pass Watch (Rating 5) – These loans require some degree of special treatment, but not due to credit quality.  This category does not include loans specially mentioned or adversely classified; however, particular attention is warranted to characteristics such as:
A lack of, or abnormally extended payment program;
A heavy degree of concentration of collateral without sufficient margin;
A vulnerability to competition through lesser or extensive financial leverage; and
A dependence on a single or few customers or sources of supply and materials without suitable substitutes or alternatives.
Special Mention (Rating 6) – A Special Mention loan has potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in our credit position at some future date.  Special Mention loans are not adversely classified and do not expose us to sufficient risk to warrant adverse classification.
Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful (Rating 8) – Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
All accruing loans are reserved for as a group of similar type credits and included in the general portion of the allowance for loan losses. Loans to individuals and 1-4 family residential loans, including loans not accruing, are collectively evaluated and included in the general portion of the allowance for loan losses. All loans considered troubled debt restructurings (“TDR”) are evaluated individually for impairment.
The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors.  These factors are likely to cause estimated losses to differ from historical loss experience and include:
Changes in lending policies or procedures, including underwriting, collection, charge-off, and recovery procedures;
Changes in local, regional and national economic and business conditions, including entry into new markets;
Changes in the volume or type of credit extended;
Changes in the experience, ability, and depth of lending management;
Changes in the volume and severity of past due, nonaccrual, restructured, or classified loans;
Changes in charge-off trends;
Changes in loan review or Board oversight;
Changes in the level of concentrations of credit; and
Changes in external factors, such as competition and legal and regulatory requirements.

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These factors are also considered for the non-PCI loan portfolio specifically in regards to changes in credit quality, past due, nonaccrual and charge-off trends.
The following tables detail activity in the allowance for loan losses by portfolio segment for the periods presented (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2018
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Balance at beginning of period (1)
$
3,676

 
$
2,445

 
$
10,821

 
$
2,094

 
$
860

 
$
885

 
$
20,781

Provision (reversal) for loan losses (2)
(65
)
 
(82
)
 
3,266

 
333

 
(9
)
 
292

 
3,735

Loans charged off
(14
)
 

 

 
(85
)
 

 
(668
)
 
(767
)
Recoveries of loans charged off

 
14

 
2

 
43

 

 
412

 
471

Balance at end of period
$
3,597

 
$
2,377

 
$
14,089

 
$
2,385

 
$
851

 
$
921

 
$
24,220

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2017
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Balance at beginning of period
$
4,147

 
$
2,665

 
$
7,204

 
$
2,263

 
$
750

 
$
882

 
$
17,911

Provision (reversal) for loan losses (2)
(722
)
 
(62
)
 
1,577

 
(112
)
 
(4
)
 
421

 
1,098

Loans charged off
(18
)
 
(287
)
 

 
(3
)
 

 
(746
)
 
(1,054
)
Recoveries of loans charged off

 
1

 
6

 
111

 

 
412

 
530

Balance at end of period
$
3,407

 
$
2,317

 
$
8,787

 
$
2,259

 
$
746

 
$
969

 
$
18,485

(1) Loans acquired with the Diboll acquisition were measured at fair value on November 30, 2017 with no carryover of allowance for loan loss.
(2)
Of the $3.7 million and $1.1 million recorded in provision for loan losses for the three months ended March 31, 2018 and March 31, 2017, none related to provision expense on PCI loans.

The following tables present the balance in the allowance for loan losses by portfolio segment based on impairment method (in thousands):
 
As of March 31, 2018
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Ending balance – individually evaluated for impairment (1)
$
1

 
$
14

 
$
3,892

 
$
305

 
$
10

 
$
91

 
$
4,313

Ending balance – collectively evaluated for impairment
3,596

 
2,363

 
10,197

 
2,080

 
841

 
830

 
19,907

Balance at end of period
$
3,597

 
$
2,377

 
$
14,089

 
$
2,385

 
$
851

 
$
921

 
$
24,220


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As of December 31, 2017
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Ending balance – individually evaluated for impairment (1)
$
12

 
$
14

 
$
14

 
$
252

 
$
10

 
$
51

 
$
353

Ending balance – collectively evaluated for impairment
3,664

 
2,431

 
10,807

 
1,842

 
850

 
834

 
20,428

Balance at end of period
$
3,676

 
$
2,445

 
$
10,821