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Section 1: 10-Q (10-Q)

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Table of Contents


 
 
 
 
 
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, 2019
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  x    No  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
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 24, 2019 was 33,718,079 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,
2019
 
December 31,
2018
 
 
ASSETS
 
 
 
 
Cash and due from banks
 
$
81,981

 
$
87,375

Interest earning deposits
 
184,612

 
23,884

Federal funds sold
 
3,350

 
9,460

Total cash and cash equivalents
 
269,943

 
120,719

Securities:
 
 
 
 
Securities available for sale, at estimated fair value
 
1,876,255

 
1,989,436

Securities held to maturity, at carrying value (estimated fair value of $147,666 and $159,781, respectively)
 
147,431

 
162,931

FHLB stock, at cost
 
35,269

 
32,583

Equity investments
 
12,182

 
12,093

Loans held for sale
 
384

 
601

Loans:
 
 

 
 

Loans
 
3,305,110

 
3,312,799

Less:  Allowance for loan losses
 
(24,155
)
 
(27,019
)
Net loans
 
3,280,955

 
3,285,780

Premises and equipment, net
 
138,290

 
135,972

Operating lease right-of-use assets
 
9,455

 

Goodwill
 
201,116

 
201,116

Other intangible assets, net
 
16,600

 
17,779

Interest receivable
 
20,017

 
27,287

Deferred tax asset, net
 
491

 
9,776

Unsettled trades to sell securities
 
95,482

 

Unsettled issuances of brokered certificates of deposit
 

 
15,236

Bank owned life insurance
 
98,704

 
98,160

Other assets
 
14,622

 
14,025

Total assets
 
$
6,217,196

 
$
6,123,494

 
 
 

 
 

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 

 
 

Deposits:
 
 

 
 

Noninterest bearing
 
$
1,038,116

 
$
994,680

Interest bearing
 
3,529,777

 
3,430,350

Total deposits
 
4,567,893

 
4,425,030

Federal funds purchased and repurchase agreements
 
8,637

 
36,810

FHLB borrowings
 
619,861

 
719,065

Subordinated notes, net of unamortized debt issuance costs
 
98,448

 
98,407

Trust preferred subordinated debentures, net of unamortized debt issuance costs
 
60,247

 
60,246

Unsettled trades to purchase securities
 
55,826

 
6,378

Operating lease liabilities
 
9,811

 

Other liabilities
 
38,440

 
46,267

Total liabilities
 
5,459,163

 
5,392,203

 
 
 

 
 

Off-balance-sheet arrangements, commitments and contingencies (Note 14)
 


 


 
 
 

 
 
Shareholders’ equity:
 
 

 
 

Common stock:  ($1.25 par value, 80,000,000 shares authorized, 37,855,789 shares issued at March 31, 2019 and 37,845,224 shares issued at December 31, 2018)
 
47,320

 
47,307

Paid-in capital
 
763,582

 
762,470

Retained earnings
 
57,023

 
64,797

Treasury stock: (shares at cost, 4,137,710 at March 31, 2019 and 4,120,475 at December 31, 2018)
 
(94,119
)
 
(93,055
)
Accumulated other comprehensive loss
 
(15,773
)
 
(50,228
)
Total shareholders’ equity
 
758,033

 
731,291

Total liabilities and shareholders’ equity
 
$
6,217,196

 
$
6,123,494

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,
 
2019
 
2018
Interest income:
 
 
 
Loans
$
41,619

 
$
38,830

Investment securities – taxable
28

 
227

Investment securities – tax-exempt
4,118

 
6,381

Mortgage-backed securities
12,474

 
10,894

FHLB stock and equity investments
355

 
414

Other interest earning assets
433

 
448

Total interest income
59,027

 
57,194

Interest expense:
 

 
 

Deposits
11,241

 
7,451

FHLB borrowings
4,457

 
3,632

Subordinated notes
1,400

 
1,398

Trust preferred subordinated debentures
729

 
569

Other borrowings
75

 
11

Total interest expense
17,902

 
13,061

Net interest income
41,125

 
44,133

Provision for loan losses
(918
)
 
3,735

Net interest income after provision for loan losses
42,043

 
40,398

Noninterest income:
 

 
 

Deposit services
5,986

 
6,179

Net gain (loss) on sale of securities available for sale
256

 
(827
)
Gain on sale of loans
93

 
115

Trust income
1,541

 
1,760

Bank owned life insurance income
544

 
632

Brokerage services
517

 
450

Other
601

 
1,301

Total noninterest income
9,538

 
9,610

Noninterest expense:
 

 
 

Salaries and employee benefits
18,046

 
18,559

Net occupancy expense
3,175

 
3,583

Acquisition expense

 
832

Advertising, travel & entertainment
847

 
685

ATM expense
180

 
346

Professional fees
1,314

 
1,070

Software and data processing expense
1,076

 
1,023

Telephone and communications
487

 
538

FDIC insurance
422

 
497

Amortization expense on intangibles
1,179

 
1,378

Other
2,901

 
3,156

Total noninterest expense
29,627

 
31,667

Income before income tax expense
21,954

 
18,341

Income tax expense
3,137

 
2,090

Net income
$
18,817

 
$
16,251

 
 
 
 
Earnings per common share – basic
$
0.56

 
$
0.46

Earnings per common share – diluted
$
0.56

 
$
0.46

Cash dividends paid per common share
$
0.30

 
$
0.28

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,
 
2019
 
2018
Net income
$
18,817

 
$
16,251

Other comprehensive income (loss):
 

 
 

Securities available for sale and transferred securities:
 
 
 
Change in unrealized holding gain (loss) on available for sale securities during the period
46,626

 
(37,783
)
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 loss on securities transferred from held to maturity to available for sale

 
401

Reclassification adjustment for amortization related to available for sale and held to maturity debt securities
491

 
138

Reclassification adjustment for net (gain) loss on sale of available for sale securities, included in net income
(256
)
 
827

Derivatives:
 
 
 
Change in net unrealized (loss) gain on effective cash flow hedge interest rate swap derivatives
(3,120
)
 
4,245

Reclassification adjustment of net gain related to derivatives designated as cash flow hedge
(668
)
 
(127
)
Pension plans:
 
 
 
Amortization of net actuarial loss and prior service credit, included in net periodic benefit cost
541

 
473

Other comprehensive income (loss), before tax
43,614

 
(19,945
)
Income tax (expense) benefit related to items of other comprehensive income (loss)
(9,159
)
 
4,188

Other comprehensive income (loss), net of tax
34,455

 
(15,757
)
Comprehensive income
$
53,272

 
$
494


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, 2017
$
47,253

 
$
757,439

 
$
32,851

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

Cumulative effect of accounting change

 

 
(85
)
 

 
85

 

Adjusted beginning balance
47,253

 
757,439

 
32,766

 
(47,105
)
 
(36,213
)
 
754,140

Net income

 

 
16,251

 

 

 
16,251

Other comprehensive loss

 

 

 

 
(15,757
)
 
(15,757
)
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
)
Balance at March 31, 2018
$
47,265

 
$
758,653

 
$
39,184

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

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
$
47,307

 
$
762,470

 
$
64,797

 
$
(93,055
)
 
$
(50,228
)
 
$
731,291

Cumulative effect of accounting change

 

 
(16,452
)
 

 

 
(16,452
)
Adjusted beginning balance
47,307

 
762,470

 
48,345

 
(93,055
)
 
(50,228
)
 
714,839

Net income

 

 
18,817

 

 

 
18,817

Other comprehensive income

 

 

 

 
34,455

 
34,455

Issuance of common stock for dividend reinvestment plan (10,565 shares)
13

 
342

 

 

 

 
355

Purchase of common stock (40,852 shares)

 

 

 
(1,325
)
 

 
(1,325
)
Stock compensation expense

 
661

 

 

 

 
661

Net issuance of common stock under employee stock plans (23,617 shares)

 
109

 
(32
)
 
261

 

 
338

Cash dividends paid on common stock ($0.30 per share)

 

 
(10,107
)
 

 

 
(10,107
)
Balance at March 31, 2019
$
47,320

 
$
763,582

 
$
57,023

 
$
(94,119
)
 
$
(15,773
)
 
$
758,033


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 FLOWS
(UNAUDITED)
(in thousands)
 
Three Months Ended
 
March 31,
 
2019
 
2018
OPERATING ACTIVITIES:
 
 
 
Net income
$
18,817

 
$
16,251

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

 
 

Depreciation and net amortization
3,023

 
3,566

Securities premium amortization (discount accretion), net
3,448

 
4,058

Loan (discount accretion) premium amortization, net
(438
)
 
(1,057
)
Provision for loan losses
(918
)
 
3,735

Stock compensation expense
661

 
456

Deferred tax expense (benefit)
126

 
(255
)
Net (gain) loss on sale of securities available for sale
(256
)
 
827

Net loss on premises and equipment
5

 
35

Gross proceeds from sales of loans held for sale
4,244

 
5,600

Gross originations of loans held for sale
(4,027
)
 
(5,602
)
Net (gain) loss on other real estate owned
(92
)
 
67

Net change in:
 

 
 

Interest receivable
7,270

 
7,827

Other assets
3,305

 
1,875

Interest payable
(321
)
 
(1,219
)
Other liabilities
(14,373
)
 
5,501

Net cash provided by operating activities
20,474

 
41,665

 
 
 
 
INVESTING ACTIVITIES:
 

 
 

Securities available for sale:
 
 
 
Purchases
(372,465
)
 
(138,581
)
Sales
436,182

 
237,526

Maturities, calls and principal repayments
30,077

 
53,717

Securities held to maturity:
 

 
 

Maturities, calls and principal repayments
15,405

 
1,222

Proceeds from redemption of FHLB stock and other investments
8,788

 
13,377

Purchases of FHLB stock and other investments
(11,551
)
 
(638
)
Net loan paydowns (originations)
5,868

 
(15,154
)
Purchases of premises and equipment
(4,040
)
 
(2,018
)
Proceeds from sales of premises and equipment
2

 
1,903

Proceeds from sales of other real estate owned
470

 
91

Proceeds from sales of repossessed assets
137

 
198

Net cash provided by investing activities
108,873

 
151,643

 
 
 
 
(continued)
 
 
 

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (continued)
(in thousands)
 
Three Months Ended
 
March 31,
 
2019
 
2018
FINANCING ACTIVITIES:
 
 
 
Net change in deposits
$
157,991

 
$
126,372

Net decrease in federal funds purchased and repurchase agreements
(28,173
)
 
(1,673
)
Proceeds from FHLB borrowings
1,556,293

 
1,110,000

Repayment of FHLB borrowings
(1,655,495
)
 
(1,355,194
)
Proceeds from stock option exercises
412

 
801

Cash paid to tax authority related to tax withholding on share-based awards
(74
)
 
(40
)
Purchase of common stock
(1,325
)
 

Proceeds from the issuance of common stock for dividend reinvestment plan
355

 
353

Cash dividends paid
(10,107
)
 
(9,808
)
Net cash provided by (used in) financing activities
19,877

 
(129,189
)
 
 
 
 
Net increase in cash and cash equivalents
149,224

 
64,119

Cash and cash equivalents at beginning of period
120,719

 
198,692

Cash and cash equivalents at end of period
$
269,943

 
$
262,811

 
 
 
 
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
 

 
 


 
 
 
Interest paid
$
18,224

 
$
14,280

Income taxes paid
$

 
$

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 

 
 


 
 
 
Loans transferred to other repossessed assets and real estate through foreclosure
$
336

 
$
649

Transfer of held to maturity securities to available for sale securities
$

 
$
743,421

Adjustment to pension liability
$
(541
)
 
$
(473
)
Unsettled trades to purchase securities
$
(55,826
)
 
$
(3,646
)
Unsettled trades to sell securities
$
95,482

 
$
35,307


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, including Southside Bank.  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, and its wholly-owned subsidiary, OmniAmerican Bank, 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, 2018.  
Accounting Changes and Reclassifications
Certain prior period amounts may be reclassified to conform to current year presentation.
Debt Securities
We adopted Accounting Standards Update (“ASU”) 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities,” on January 1, 2019, the effective date of the guidance. Under previous GAAP, premiums on callable debt securities were 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. The guidance requires companies to apply the requirements on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Adoption of this guidance on January 1, 2019, resulted in a cumulative-effect adjustment to reduce retained earnings by $16.5 million, before tax. Subsequent to January 1, 2019, we sold the majority of the securities impacted by ASU 2017-08, and thus, the standard did not materially impact our consolidated net income.
Leases
We evaluate our contracts at inception to determine if an arrangement is or contains a lease. Operating leases are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in our consolidated balance sheets. The Company has no finance leases.
ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Our leases do not provide an implicit rate, so we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The incremental borrowing rate is reevaluated upon lease modification. The operating lease ROU asset also includes any initial direct costs and prepaid lease payments made less any lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.
We adopted ASU 2016-02, “Leases (Topic 842),” on January 1, 2019, the effective date of the guidance, using the practical expedient transition method whereby we did not revise comparative period information or disclosure. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. We elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. We also elected certain optional practical expedients including the hindsight practical expedient under which we considered the actual outcomes of lease renewals and terminations when measuring the lease term at adoption, and we made an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. We recognize these lease payments in the consolidated statements of income on a straight-line basis over the lease

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term. We have lease agreements with lease and non-lease components, and we have elected the practical expedient to account for these as a single lease component.
Our operating leases relate primarily to bank branches and office space. In conjunction with the adoption on January 1, 2019, we recognized operating lease liabilities of $10.1 million and related lease assets of $9.8 million on our balance sheet. The difference between the lease assets and lease liabilities primarily consists of deferred rent liabilities reclassified upon adoption to reduce the measurement of the lease assets. The standard did not materially impact our consolidated net income and had no impact on cash flows.
Accounting Pronouncements
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 AFS 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 a cumulative-effect 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. We plan to adopt on January 1, 2020, the effective date. We have developed a project plan and have assigned a project team to complete the analysis needed to implement the guidance. We are also currently working with a third party vendor solution to assist with the application of ASU 2016-13. The team is currently completing the data collection and anticipates running parallel models during 2019.
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 material impact on our consolidated financial statements.

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 total merger consideration for the Diboll merger was $224.3 million. The operations of Diboll were merged into the Company as of the date of the acquisition.
The fair value of assets acquired, adjusted for subsequent measurement period adjustments, excluding goodwill, totaled $1.03 billion, including total loans of $621.3 million and total investment securities of $234.4 million.  Total fair value of the liabilities assumed totaled $910.7 million, including deposits of $899.3 million.  We recognized goodwill of $109.6 million associated with Diboll acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of our markets into the Southeast Texas region and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service.  Goodwill was $201.1 million as of March 31, 2019 and December 31, 2018 and is not expected to be deductible for tax purposes.
We recognized a core deposit intangible of $14.7 million and a trust relationship intangible of $5.4 million which we are amortizing using an accelerated method over a 9- and 13-year weighted average amortization period, respectively, consistent with expected future cash flows.
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.  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, 2018.

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3.     Earnings Per Share
Earnings per share on a basic and diluted basis are calculated as follows (in thousands, except per share amounts):
 
Three Months Ended
March 31,
 
2019
 
2018
Basic and Diluted Earnings:
 
 
 
Net income
$
18,817

 
$
16,251

Basic weighted-average shares outstanding
33,697

 
35,022

Add:   Stock awards
149

 
178

Diluted weighted-average shares outstanding
33,846

 
35,200

Basic earnings per share:
 
 
 
Net Income
$
0.56

 
$
0.46

Diluted earnings per share:
 
 
 
Net Income
$
0.56

 
$
0.46

For the three months ended March 31, 2019 and 2018, there were approximately 490,000 and 186,000 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, 2019
 

 
 
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
$
(31,120
)
 
$
7,146

 
$
(139
)
 
$
(26,115
)
 
$
(50,228
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
46,626

 
(3,120
)
 

 

 
43,506

Reclassified from accumulated other comprehensive income (loss)
235

 
(668
)
 
(1
)
 
542

 
108

Income tax (expense) benefit
(9,840
)
 
795

 

 
(114
)
 
(9,159
)
Net current-period other comprehensive income (loss), net of tax
37,021

 
(2,993
)
 
(1
)
 
428

 
34,455

Ending balance, net of tax
$
5,901

 
$
4,153

 
$
(140
)
 
$
(25,687
)
 
$
(15,773
)

 
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
)
Cumulative effect of ASU 2016-01 (1)
85

 

 

 

 
85

Adjusted beginning balance, net of tax
(16,210
)
 
6,399

 
(133
)
 
(26,269
)
 
(36,213
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
(25,501
)
 
4,245

 

 

 
(21,256
)
Reclassified from accumulated other comprehensive income (loss)
965

 
(127
)
 
(2
)
 
475

 
1,311

Income tax benefit (expense)
5,152

 
(865
)
 
1

 
(100
)
 
4,188

Net current-period other comprehensive (loss) income, net of tax
(19,384
)
 
3,253

 
(1
)
 
375

 
(15,757
)
Ending balance, net of tax
$
(35,594
)
 
$
9,652

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

(1)
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).


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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,
 
2019
 
2018
 
 
 
 
Unrealized losses on securities transferred:
 
 
 
Amortization of unrealized losses (1)
$
(491
)
 
$
(138
)
Tax benefit
103

 
29

Net of tax
$
(388
)
 
$
(109
)
 
 
 
 
Unrealized gains and losses on available for sale securities:
 
 
 
Realized net gain (loss) on sale of securities (2)
$
256

 
$
(827
)
Tax (expense) benefit
(54
)
 
174

Net of tax
$
202

 
$
(653
)
 
 
 
 
Derivatives:
 
 
 
Realized net gain on interest rate swap derivatives (3)
$
646

 
$
106

Tax expense
(136
)
 
(22
)
Net of tax
$
510

 
$
84

 
 
 
 
Amortization of unrealized gains on terminated interest rate swap derivatives (3)
$
22

 
$
21

Tax expense
(5
)
 
(4
)
Net of tax
$
17

 
$
17

 
 
 
 
Amortization of pension plan:
 
 
 
Net actuarial loss (4)
$
(542
)
 
$
(475
)
Prior service credit (4)
1

 
2

Total before tax
(541
)
 
(473
)
Tax benefit
114

 
99

Net of tax
(427
)
 
(374
)
Total reclassifications for the period, net of tax
$
(86
)
 
$
(1,035
)
(1)    Included in interest income on the consolidated statements of income.
(2)    Listed as net gain (loss) 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 9 - 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, 2019 and December 31, 2018 are reflected in the tables below (in thousands):
 
 
March 31, 2019

 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Fair Value
Investment securities:
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
446,006

 
$
9,130

 
$
1,865

 
$
453,271

Other stocks and bonds
 
3,000

 

 
79

 
2,921

Mortgage-backed securities: (1)
 
 

 
 

 
 

 
 
Residential
 
999,201

 
8,669

 
4,168

 
1,003,702

Commercial

416,618

 
910

 
1,167

 
416,361

Total
 
$
1,864,825

 
$
18,709

 
$
7,279

 
$
1,876,255

 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
3,025

 
$
29

 
$

 
$
3,054

Mortgage-backed securities: (1)
 
 
 
 
 
 
 
 
Residential
 
59,720

 
962

 
413

 
60,269

Commercial
 
84,686

 
514

 
857

 
84,343

Total
 
$
147,431

 
$
1,505

 
$
1,270

 
$
147,666




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December 31, 2018
 
 
Amortized
 
Gross
Unrealized
 
Gross Unrealized
 
Estimated
AVAILABLE FOR SALE
 
Cost
 
Gains
 
Losses
 
Fair Value
Investment securities:
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
728,142

 
$
6,115

 
$
17,656

 
$
716,601

Other stocks and bonds
 
3,000

 

 
291

 
2,709

Mortgage-backed securities: (1)
 
 
 
 
 
 

 
 
Residential
 
738,585

 
3,498

 
9,111

 
732,972

Commercial
 
543,758

 
941

 
7,545

 
537,154

Total
 
$
2,013,485

 
$
10,554

 
$
34,603

 
$
1,989,436

 
 
 
 
 
 
 
 
 
HELD TO MATURITY
 
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
 
State and political subdivisions
 
$
3,083

 
$
5

 
$
42

 
$
3,046

Mortgage-backed securities: (1)
 
 
 
 
 
 
 
 

Residential
 
59,655

 
154

 
1,140

 
58,669

Commercial
 
100,193

 
201

 
2,328

 
98,066

Total
 
$
162,931

 
$
360

 
$
3,510

 
$
159,781


(1)
All mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.

From time to time, we have transferred securities from AFS to HTM due to overall balance sheet strategies. The remaining net unamortized, unrealized loss on the transferred securities included in AOCI in the accompanying balance sheets totaled $4.0 million ($3.1 million, net of tax) at March 31, 2019 and $15.3 million ($12.1 million, net of tax) at December 31, 2018. 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, 2019 or the year ended December 31, 2018.
On January 1, 2019, we adopted ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities,” and in conjunction with the adoption recognized a cumulative effect adjustment to reduce retained earnings by $16.5 million, before tax, related to premiums on callable debt securities. Prior to January 1, 2019, premiums were amortized over the contractual life of the security. With the adoption of ASU 2017-08, premiums on debt securities will be amortized to the earliest call date.

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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, 2019 and December 31, 2018 (in thousands):
 
March 31, 2019
 
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
$
241

 
$

 
$
91,310

 
$
1,865

 
$
91,551

 
$
1,865

Other stocks and bonds
2,921

 
79

 

 

 
2,921

 
79

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
14,666

 
83

 
314,543

 
4,085

 
329,209

 
4,168

Commercial

 

 
186,267

 
1,167

 
186,267

 
1,167

Total
$
17,828

 
$
162

 
$
592,120

 
$
7,117

 
$
609,948

 
$
7,279

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
$
1,213

 
$
18

 
$
4,759

 
$
395

 
$
5,972

 
$
413

Commercial

 

 
44,916

 
857

 
44,916

 
857

Total
$
1,213

 
$
18

 
$
49,675

 
$
1,252

 
$
50,888

 
$
1,270

 
 
 
 
 
 
 
 
 
 
 
 
 
December 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
$
98,112

 
$
899

 
$
399,205

 
$
16,757

 
$
497,317

 
$
17,656

Other stocks and bonds
2,709

 
291

 

 

 
2,709

 
291

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
5,552

 
27

 
488,334

 
9,084

 
493,886

 
9,111

Commercial
9,529

 
30

 
457,704

 
7,515

 
467,233

 
7,545

Total
$
115,902

 
$
1,247

 
$
1,345,243

 
$
33,356

 
$
1,461,145

 
$
34,603

HELD TO MATURITY
 

 
 

 
 

 
 

 
 

 
 

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
$
235

 
$
1

 
$
2,022

 
$
41

 
$
2,257

 
$
42

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
4,826

 
60

 
51,046

 
1,080

 
55,872

 
1,140

Commercial
399

 
2

 
89,168

 
2,326

 
89,567

 
2,328

Total
$
5,460

 
$
63

 
$
142,236

 
$
3,447

 
$
147,696

 
$
3,510





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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, 2019.
The majority of the securities in an unrealized loss position are highly rated Texas municipal securities and U.S. Agency 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, 2019.
The following table reflects interest income recognized on securities for the periods presented (in thousands):
 
 
 
 
 
Three Months Ended
March 31,
 
2019
 
2018
U.S. Treasury
$

 
$
108

U.S. government agency debentures

 
89

State and political subdivisions
4,118

 
6,381

Other stocks and bonds
28

 
30

Mortgage-backed securities
12,474

 
10,894

Total interest income on securities
$
16,620

 
$
17,502



There was a $256,000 net realized gain from the AFS securities portfolio for the three months ended March 31, 2019, which consisted of $5.0 million in realized gains and $4.8 million in realized losses.  There was an $827,000 net realized loss from the AFS securities portfolio for the three months ended March 31, 2018, which consisted of $1.8 million in realized losses and $941,000 in realized gains. There were no sales from the HTM portfolio during the three months ended March 31, 2019 or 2018.  We calculate realized gains and losses on sales of securities under the specific identification method.





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Table of Contents


The amortized cost and estimated fair value of AFS and HTM securities at March 31, 2019, 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, 2019
 
Amortized Cost
 
Fair Value
AVAILABLE FOR SALE
 
Investment securities:
 
 
 
Due in one year or less
$
3,827

 
$
3,866

Due after one year through five years
7,743

 
7,741

Due after five years through ten years
29,416

 
30,332

Due after ten years
408,020

 
414,253

 
449,006

 
456,192

Mortgage-backed securities
1,415,819

 
1,420,063

Total
$
1,864,825

 
$
1,876,255


 
March 31, 2019
 
Amortized Cost
 
Fair Value
HELD TO MATURITY
 
Investment securities:
 
 
 
Due in one year or less
$
115

 
$
115

Due after one year through five years
1,663

 
1,676

Due after five years through ten years
1,247

 
1,263

Due after ten years

 

 
3,025

 
3,054

Mortgage-backed securities:
144,406

 
144,612

Total
$
147,431

 
$
147,666


Investment securities and MBS with carrying values of $1.03 billion and $1.08 billion were pledged as of March 31, 2019 and December 31, 2018, respectively, to collateralize 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 sheets include Community Reinvestment Act funds with a readily determinable fair value as well as equity investments without readily determinable fair values. At March 31, 2019 and December 31, 2018, we had equity investments recorded in our consolidated balance sheets of $12.2 million and $12.1 million, respectively.

Any realized and unrealized gains and losses on equity investments are reported in income. Equity investments without readily determinable fair values are recorded at cost less any impairment, if any.

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The following is a summary of unrealized and realized gains and losses on equity investments recognized in other noninterest income in the consolidated statements of income during the three months ended March 31, 2019 (in thousands):

 
Three Months Ended
March 31,
 
2019
 
2018
Net gains (losses) recognized during the period on equity investments
$
76

 
$
(92
)
Less: Net gains (losses) recognized during the period on equity investments sold during the period

 

Unrealized gains (losses) recognized during the reporting period on equity investments still held at the reporting date
$
76

 
$
(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, 2019.

Federal Home Loan Bank Stock

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



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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, 2019
 
December 31, 2018
Real estate loans:
 
 
 
Construction
$
603,411

 
$
507,732

1-4 family residential
786,198

 
794,499

Commercial
1,104,378

 
1,194,118

Commercial loans
367,995

 
356,649

Municipal loans
343,026

 
353,370

Loans to individuals
100,102

 
106,431

Total loans
3,305,110

 
3,312,799

Less: Allowance for loan losses (1)
24,155

 
27,019

Net loans
$
3,280,955

 
$
3,285,780


(1)
The allowance for loan loss recorded on purchased credit impaired (“PCI”) loans totaled $250,000 and $302,000 as of March 31, 2019 and December 31, 2018, respectively.
Construction Real Estate 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.
1-4 Family Residential Real Estate 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, 2019 consisted of $1.05 billion of owner and non-owner occupied real estate, $34.9 million of loans secured by multi-family properties and $17.3 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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Table of Contents


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, with a small percentage originating outside of the state.  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. Lending money directly to these municipalities allows us to earn a higher yield than we could if we purchased municipal securities for similar durations.
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 the review we determine it is probable 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 allowance.  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 loans.
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

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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 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 purchased 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, 2019
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Balance at beginning of period
$
3,597

 
$
3,844

 
$
13,968

 
$
3,974

 
$
525

 
$
1,111

 
$
27,019

Provision (reversal) for loan losses (2)
662

 
(447
)
 
(2,112
)
 
734

 
(17
)
 
262

 
(918
)
Loans charged off

 
(18
)
 
(1,215
)
 
(451
)
 

 
(601
)
 
(2,285
)
Recoveries of loans charged off

 
3

 
19

 
30

 

 
287

 
339

Balance at end of period
$
4,259

 
$
3,382

 
$
10,660

 
$
4,287

 
$
508

 
$
1,059

 
$
24,155

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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

(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 $918,000 reversal of provision for loan losses for the three months ended March 31, 2019, $52,000 related to provision expense reversed on PCI loans. Of the $3.7 million recorded in provision for loan losses for the three months ended March 31, 2018, 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):
 
March 31, 2019
 
Real Estate
 
 
 
 
 
 
 
 
 
Construction
 
1-4 Family
Residential
 
Commercial
 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 
Total
Ending balance – individually evaluated for impairment (1)
$
13

 
$
83

 
$
3,100

 
$
403

 
$
1

 
$
150

 
$
3,750

Ending balance – collectively evaluated for impairment
4,246

 
3,299

 
7,560

 
3,884

 
507

 
909

 
20,405

Balance at end of period
$
4,259

 
$
3,382

 
$
10,660

 
$
4,287

 
$
508

 
$
1,059

 
$
24,155


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December 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)
$
13

 
$
40

 
$
5,337

 
$
368

 
$
1

 
$
149

 
$
5,908

Ending balance – collectively evaluated for impairment
3,584

 
3,804

 
8,631

 
3,606

 
524

 
962

 
21,111

Balance at end of period
$
3,597

 
$
3,844

 
$
13,968

 
$
3,974

 
$
525

 
$
1,111

 
$
27,019