Edgar Filing: SOUTHSIDE BANCSHARES INC

10-Q

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, 2016



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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



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

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 25, 2016 was 24,969,676 shares.

TABLE OF CONTENTS



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS	1
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	37
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	55
ITEM 4. CONTROLS AND PROCEDURES	55
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	57
ITEM 1A. RISK FACTORS	57
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	57
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	57
ITEM 4. MINE SAFETY DISCLOSURES	57
ITEM 5. OTHER INFORMATION	57
ITEM 6. EXHIBITS	57
SIGNATURES	58
EXHIBIT INDEX	59
EXHIBIT 31.1 – CERTIFICATION PURSUANT TO SECTION 302
EXHIBIT 31.2 – CERTIFICATION PURSUANT TO SECTION 302
EXHIBIT 32 – CERTIFICATION PURSUANT TO SECTION 906

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (in thousands, except share amounts)

	March 31, 2016			December 31, 2015
ASSETS
Cash and due from banks	$	52,324		$	54,288
Interest earning deposits	16,130			26,687
Total cash and cash equivalents	68,454			80,975
Securities available for sale, at estimated fair value	1,332,381			1,460,492
Securities held to maturity, at carrying value (estimated fair value of $818,108 and $799,763, respectively)	784,579			784,296
FHLB stock, at cost	47,550			51,047
Other investments	5,501			5,462
Loans held for sale	4,971			3,811
Loans:
Loans	2,443,231			2,431,753
Less: Allowance for loan losses	(21,799		)	(19,736		)
Net Loans	2,421,432			2,412,017
Premises and equipment, net	107,556			107,929
Goodwill	91,520			91,520
Other intangible assets, net	6,029			6,548
Interest receivable	16,548			22,700
Deferred tax asset	12,512			19,903
Unsettled trades to sell securities	15,039			9,343
Bank owned life insurance	95,718			95,080
Other assets	9,222			10,953
TOTAL ASSETS	$	5,019,012		$	5,162,076
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest bearing	$	698,695		$	672,470
Interest bearing	2,920,673			2,782,937
Total deposits	3,619,368			3,455,407
Short-term obligations:
Federal funds purchased and repurchase agreements	2,501			2,429
FHLB advances	257,145			645,407
Total short-term obligations	259,646			647,836
Long-term obligations:
FHLB advances	561,990			502,281
Long-term debt	60,311			60,311
Total long-term obligations	622,301			562,592
Unsettled trades to purchase securities	23,920			19,350
Other liabilities	36,201			32,829
TOTAL LIABILITIES	4,561,436			4,718,014

Off-Balance-Sheet Arrangements, Commitments and Contingencies (Note 12)

Shareholders’ equity:
Common stock ($1.25 par value, 40,000,000 shares authorized, 27,882,740 shares issued at March 31, 2016 and 27,865,798 shares issued at December 31, 2015)	34,853			34,832
Paid-in capital	424,753			424,078
Retained earnings	49,254			41,527
Treasury stock, at cost (2,913,064 at March 31, 2016 and 2,469,638 at December 31, 2015)	(47,891		)	(37,692		)
Accumulated other comprehensive loss	(3,393		)	(18,683		)
TOTAL SHAREHOLDERS’ EQUITY	457,576			444,062
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	5,019,012		$	5,162,076

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

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (in thousands, except per share data)

	Three Months Ended
	March 31,
	2016		2015
Interest income
Loans	$	27,765	$	23,916
Investment securities – taxable	214		237
Investment securities – tax-exempt	5,355		5,865
Mortgage-backed securities	9,391		8,462
FHLB stock and other investments	217		93
Other interest earning assets	70		34
Total interest income	43,012		38,607
Interest expense
Deposits	3,256		2,529
Short-term obligations	696		142
Long-term obligations	2,443		2,145
Total interest expense	6,395		4,816
Net interest income	36,617		33,791
Provision for loan losses	2,316		3,848
Net interest income after provision for loan losses	34,301		29,943
Noninterest income
Deposit services	5,085		4,989
Net gain on sale of securities available for sale	2,441		2,476
Gain on sale of loans	643		377
Trust income	855		893
Bank owned life insurance income	674		669
Brokerage services	575		639
Other	1,323		745
Total noninterest income	11,596		10,788
Noninterest expense
Salaries and employee benefits	17,732		18,199
Occupancy expense	3,335		3,199
Advertising, travel & entertainment	685		657
ATM and debit card expense	712		679
Professional fees	1,338		742
Software and data processing expense	749		1,031
Telephone and communications	484		469
FDIC insurance	638		638
Other	3,735		3,835
Total noninterest expense	29,408		29,449

Income before income tax expense	16,489		11,282
Income tax expense	2,973		1,903
Net income	$	13,516	$	9,379
Earnings per common share – basic	$	0.54	$	0.37
Earnings per common share – diluted	$	0.54	$	0.37
Dividends paid per common share	$	0.23	$	0.23

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,
	2016			2015
Net income	$	13,516		$	9,379
Other comprehensive income:
Securities available for sale and transferred securities:
Net unrealized holding gains on available for sale securities during the period	27,744			9,520
Change in net unrealized loss on securities transferred to held to maturity	—			—
Reclassification adjustment for amortization of unrealized losses on securities transferred to held to maturity	57			282
Reclassification adjustment for net gain on sale of available for sale securities, included in net income	(2,441		)	(2,476		)
Derivatives:
Change in net unrealized loss on effective cash flow hedge interest rate swap derivatives	(2,244		)	—
Pension plans:
Amortization of net actuarial loss, included in net periodic benefit cost	411			531
Amortization of prior service credit, included in net periodic benefit cost	(4		)	(4		)
Other comprehensive income, before tax	23,523			7,853
Income tax expense related to other items of comprehensive income	(8,233		)	(2,749		)
Other comprehensive income, net of tax	15,290			5,104
Comprehensive income	$	28,806		$	14,483

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, 2014	$	33,223	$	389,886		$	55,396		$	(37,692	)	$	(15,570	)	$	425,243
Net income	—		—			9,379			—			—			9,379
Other comprehensive income	—		—			—			—			5,104			5,104
Issuance of common stock (9,983 shares)	12		292			—			—			—			304
Stock compensation expense	—		273			—			—			—			273
Tax benefits related to stock awards	—		4			—			—			—			4
Net issuance of common stock under employee stock plans	4		60			(11		)	—			—			53
Cash dividends paid on common stock ($0.23 per share)	—		—			(5,546		)	—			—			(5,546		)
Balance at March 31, 2015	$	33,239	$	390,515		$	59,218		$	(37,692	)	$	(10,466	)	$	434,814

Balance at December 31, 2015	$	34,832	$	424,078		$	41,527		$	(37,692	)	$	(18,683	)	$	444,062
Net income	—		—			13,516			—			—			13,516
Other comprehensive income	—		—			—			—			15,290			15,290
Issuance of common stock (12,030 shares)	15		299			—			—			—			314
Purchase of common stock (443,426 shares)	—		—			—			(10,199		)	—			(10,199		)
Stock compensation expense	—		355			—			—			—			355
Tax expense related to stock awards	—		(12		)	—			—			—			(12		)
Net issuance of common stock under employee stock plans	6		33			(15		)	—			—			24
Cash dividends paid on common stock ($0.23 per share)	—		—			(5,774		)	—			—			(5,774		)
Balance at March 31, 2016	$	34,853	$	424,753		$	49,254		$	(47,891	)	$	(3,393	)	$	457,576

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,
	2016			2015
OPERATING ACTIVITIES:
Net income	$	13,516		$	9,379
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and net amortization	2,169			2,123
Securities premium amortization (discount accretion), net	4,510			5,264
Loan (discount accretion) premium amortization, net	(799		)	(565		)
Provision for loan losses	2,316			3,848
Stock compensation expense	355			273
Deferred tax benefit	(812		)	(1,535		)
Tax expense (benefit) related to stock awards	12			(4		)
Net gain on sale of securities available for sale	(2,441		)	(2,476		)
Net (gain) loss on premises and equipment	(19		)	138
Gross proceeds from sales of loans held for sale	17,944			15,176
Gross originations of loans held for sale	(19,104		)	(16,373		)
Net loss on other real estate owned	152			272
Net change in:
Interest receivable	6,152			5,792
Other assets	590			3,564
Interest payable	291			(66		)
Other liabilities	1,243			(3,142		)
Net cash provided by operating activities	26,075			21,668

INVESTING ACTIVITIES:
Securities available for sale:
Purchases	(135,648		)	(279,911		)
Sales	251,976			285,326
Maturities, calls and principal repayments	47,407			77,202
Securities held to maturity:
Purchases	(18,922		)	—
Maturities, calls and principal repayments	5,168			4,061
Proceeds from redemption of FHLB stock	3,644			—
Purchases of FHLB stock and other investments	(171		)	(20		)
Net loans originated	(11,420		)	6,266
Purchases of premises and equipment	(1,648		)	(1,223		)
Proceeds from sales of premises and equipment	50			3
Proceeds from sales of other real estate owned	483			548
Proceeds from sales of repossessed assets	311			1,088
Net cash provided by investing activities	141,230			93,340

(continued)

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) (continued) (in thousands)

	Three Months Ended
	March 31,
	2016			2015
FINANCING ACTIVITIES:
Net change in deposits	$	164,249		$	121,246
Net increase (decrease) in federal funds purchased and repurchase agreements	72			(2,110		)
Proceeds from FHLB advances	2,916,882			5,227,768
Repayment of FHLB advances	(3,245,382		)	(5,434,204		)
Tax (expense) benefit related to stock awards	(12		)	4
Net issuance of common stock under employee stock plan	24			53
Purchase of common stock	(10,199		)	—
Proceeds from the issuance of common stock	314			304
Cash dividends paid	(5,774		)	(5,546		)
Net cash used in financing activities	(179,826		)	(92,485		)

Net (decrease) increase in cash and cash equivalents	(12,521		)	22,523
Cash and cash equivalents at beginning of period	80,975			84,655
Cash and cash equivalents at end of period	$	68,454		$	107,178

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:

Interest paid	$	6,104		$	4,881
Income taxes paid	$	—		$	—

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Loans transferred to other repossessed assets and real estate through foreclosure	$	465		$	674
Adjustment to pension liability	$	(407	)	$	(527	)
Unsettled trades to purchase securities	$	(23,920	)	$	(13,096	)
Unsettled trades to sell securities	$	15,039		$	1,792

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. “SFG” refers to SFG Finance, LLC (formerly Southside Financial Group, LLC), which was a wholly-owned subsidiary of the Bank that was dissolved in April 2015.

The consolidated balance sheet as of March 31, 2016, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, cash flows and notes to the financial statements for the three-month periods ended March 31, 2016 and 2015 are unaudited; in the opinion of management, all adjustments necessary for a fair statement of such financial statements have been included. Such adjustments consisted only of normal recurring items. All significant intercompany accounts and transactions are eliminated in consolidation. The preparation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles (“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.

Certain prior period amounts have been reclassified to conform to current year presentation and had no impact on net income, equity or cash flows.

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, 2015.

For a description of our significant accounting and reporting policies, refer to “Note 1- Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015. The accounting and reporting policies we follow with respect to our derivative instruments and hedging activities are presented below.

Derivative Financial Instruments and Hedging Activities

Derivative financial instruments are carried on the consolidated balance sheets as other assets or other liabilities, as applicable, at estimated fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative financial instrument is determined by whether it has been designated and qualifies as part of a hedging relationship and, further, by the type of hedging relationship. We present derivative financial instruments at fair value in the consolidated balance sheets on a net basis when a right of offset exists, based on transactions with a single counterparty and any cash collateral paid to and/or received from that counterparty for derivative contracts that are subject to legally enforceable master netting arrangements.

For derivative instruments that are designated and qualify as cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item (i.e., the ineffective portion), if any, is recognized in current earnings during the period of change. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change.

For derivatives designated as hedging instruments at inception, statistical regression analysis is used at inception and for each reporting period thereafter to assess whether the derivative used has been and is expected to be highly effective in offsetting changes in the fair value or cash flows of the hedged item. All components of each derivative instrument’s gain or loss are included in the assessment of hedge effectiveness. Net hedge ineffectiveness is recorded in “other noninterest income” on the consolidated statements of income.

Further information on our derivative instruments and hedging activities is included in “Note 9 - Derivative Financial Instruments and Hedging Activities.”

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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 will require both types of 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. We have not yet selected a transition method nor have we determined the impact of adoption on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. The ASU requires that all excess tax benefits and tax deficiencies be recognized as income tax expense or benefit in the income statement and should be classified along with other income tax cash flows as an operating activity instead of a financing activity as currently required under GAAP. The ASU also simplifies accounting for forfeitures by allowing an entity to make an entity-wide accounting policy election either to estimate the number of forfeitures expected to occur or to recognize the effects of forfeitures when they occur in compensation cost. Additionally, cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity, and to qualify for equity classification, an employer can now withhold up to the maximum statutory tax rate instead of the minimum statutory tax rate as currently required by GAAP. ASU 2016-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. We have not yet selected a transition method nor have we determined the impact of adoption on our consolidated financial statements.

2. Acquisition

On December 17, 2014, we acquired 100% of the outstanding stock of OmniAmerican Bancorp, Inc. and its wholly-owned subsidiary OmniAmerican Bank (collectively, “Omni”) headquartered in Fort Worth, Texas. Omni operated 14 banking offices in Fort Worth, Texas and surrounding areas. We acquired Omni to further expand our presence in the growing Fort Worth market. The total merger consideration for the Omni merger was $298.3 million. The operations of Omni were merged into ours as of the date of the acquisition.

The fair value of assets acquired, adjusted for subsequent measurement period adjustments, excluding goodwill, totaled $1.36 billion, including total loans of $763.5 million and total investment securities of $428.4 million. Total fair value of the liabilities assumed, adjusted for subsequent measurement period adjustments, totaled $1.13 billion, including deposits of $801.3 million. We recognized $69.5 million in goodwill associated with the Omni acquisition. The goodwill resulting from the acquisition represents consideration paid in excess of the net assets acquired and the value expected from the opportunities to strategically grow our franchise in the greater Fort Worth market area and to enhance our operations through customer synergies and efficiencies, thereby providing enhanced customer service. Goodwill is not expected to be deductible for tax purposes.

We recognized a core deposit intangible of $8.6 million in connection with the Omni acquisition, which will be amortized using an accelerated method over a 10 year period consistent with expected future cash flows.

The Omni acquisition was accounted for using the purchase 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 Omni, see “Note 2 - Acquisition” in our Annual Report on Form 10-K for the year ended December 31, 2015.

The following table reflects our goodwill for the periods presented (in thousands).



	March 31, 2016		December 31, 2015

Goodwill	$	91,520	$	91,520

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3. Earnings Per Share

Earnings per share on a basic and diluted basis have been calculated as follows (in thousands, except per share amounts):



	Three Months Ended March 31,
	2016		2015
Basic and Diluted Earnings:
Net income	$	13,516	$	9,379
Basic weighted-average shares outstanding	25,186		25,322
Add: Stock awards	66		81
Diluted weighted-average shares outstanding	25,252		25,403

Basic Earnings Per Share:	$	0.54	$	0.37

Diluted Earnings Per Share:	$	0.54	$	0.37

For the three-month periods ended March 31, 2016 and 2015, there were approximately 95,000 and 10,000 anti-dilutive shares, respectively.

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4. Accumulated Other Comprehensive (Loss) Income

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



	Three Months Ended March 31, 2016
							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	$	(239	)	$	—		$	(44	)	$	(18,400	)	$	(18,683	)
Other comprehensive (loss) income:
Other comprehensive income (loss) before reclassifications	27,744			(2,244		)	—			—			25,500
Reclassified from accumulated other comprehensive income	(2,384		)	—			(4		)	411			(1,977		)
Income tax (expense) benefit	(8,876		)	785			1			(143		)	(8,233		)
Net current-period other comprehensive income (loss), net of tax	16,484			(1,459		)	(3		)	268			15,290
Ending balance, net of tax	$	16,245		$	(1,459	)	$	(47	)	$	(18,132	)	$	(3,393	)



	Three Months Ended March 31, 2015
						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	$	6,238		$	—	$	7		$	(21,815	)	$	(15,570	)
Other comprehensive (loss) income:
Other comprehensive income before reclassifications	9,520			—		—			—			9,520
Reclassified from accumulated other comprehensive income	(2,194		)	—		(4		)	531			(1,667		)
Income tax (expense) benefit	(2,564		)	—		1			(186		)	(2,749		)
Net current-period other comprehensive income (loss), net of tax	4,762			—		(3		)	345			5,104
Ending balance, net of tax	$	11,000		$	—	$	4		$	(21,470	)	$	(10,466	)

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The reclassifications out of accumulated other comprehensive loss into net income are presented below (in thousands):



	Three Months Ended March 31,
	2016			2015

Unrealized losses on securities transferred to held to maturity:
Amortization of unrealized losses ⁽¹⁾	$	(57	)	$	(282	)
Tax benefit	20			99
Net of tax	(37		)	(183		)

Unrealized gains and losses on available for sale securities:
Realized net gain on sale of securities ⁽²⁾	$	2,441		$	2,476
Tax expense	(854		)	(867		)
Net of tax	1,587			1,609

Amortization of pension plan:
Net actuarial loss ⁽³⁾	$	(411	)	$	(531	)
Prior service credit ⁽³⁾	4			4
Total before tax	(407		)	(527		)
Tax benefit	142			185
Net of tax	(265		)	(342		)
Total reclassifications for the period, net of tax	$	1,285		$	1,084

(1) Included in interest income on the consolidated statements of income.

(2) Listed as net gain on sale of securities available for sale on the consolidated statements of income.

(3) 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

The amortized cost, gross unrealized gains and losses, carrying value, and estimated fair value of investment and mortgage-backed securities as of March 31, 2016 and December 31, 2015 are reflected in the tables below (in thousands):



	March 31, 2016
			Recognized in OCI						Not recognized in OCI
	Amortized		Gross Unrealized		Gross Unrealized		Carrying		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Value		Gains		Losses		Fair Value
Investment Securities:
State and Political Subdivisions	$	270,091	$	10,172	$	471	$	279,792	$	—	$	—	$	279,792
Other Stocks and Bonds	12,774		80		45		12,809		—		—		12,809
Other Equity Securities	6,048		52		—		6,100		—		—		6,100
Mortgage-backed Securities: ⁽¹⁾
Residential	553,121		12,042		153		565,010		—		—		565,010
Commercial	456,552		12,118		—		468,670		—		—		468,670
Total	$	1,298,586	$	34,464	$	669	$	1,332,381	$	—	$	—	$	1,332,381

HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	387,936	$	4,480	$	9,094	$	383,322	$	17,387	$	1,179	$	399,530
Mortgage-backed Securities: ⁽¹⁾
Residential	34,187		—		44		34,143		2,380		1		36,522
Commercial	371,258		1,192		5,336		367,114		14,942		—		382,056
Total	$	793,381	$	5,672	$	14,474	$	784,579	$	34,709	$	1,180	$	818,108

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	December 31, 2015
			Recognized in OCI						Not recognized in OCI
	Amortized		Gross Unrealized		Gross Unrealized		Carrying		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Value		Gains		Losses		Fair Value
Investment Securities:
U.S. Treasury	$	103,906	$	61	$	380	$	103,587	$	—	$	—	$	103,587
State and Political Subdivisions	236,534		8,323		611		244,246		—		—		244,246
Other Stocks and Bonds	12,772		63		45		12,790		—		—		12,790
Other Equity Securities	6,052		—		36		6,016		—		—		6,016
Mortgage-backed Securities: ⁽¹⁾
Residential	580,621		9,120		1,239		588,502		—		—		588,502
Commercial	512,116		466		7,231		505,351		—		—		505,351
Total	$	1,452,001	$	18,033	$	9,542	$	1,460,492	$	—	$	—	$	1,460,492

HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	389,997	$	4,772	$	9,273	$	385,496	$	13,061	$	1,363	$	397,194
Mortgage-backed Securities: ⁽¹⁾
Residential	31,430		—		51		31,379		2,018		1		33,396
Commercial	371,727		1,233		5,539		367,421		4,232		2,480		369,173
Total	$	793,154	$	6,005	$	14,863	$	784,296	$	19,311	$	3,844	$	799,763

(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 may transfer securities from available for sale (“AFS”) to held to maturity (“HTM”) due to overall balance sheet strategies. Our management has the current intent and ability to hold the transferred securities until maturity. Any net unrealized gain or loss on the transferred securities included in accumulated other comprehensive income at the time of transfer will be amortized over the remaining life of the underlying security as an adjustment of the yield on those securities. AFS securities transferred with losses included in accumulated other comprehensive income 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, 2016.

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The following tables represent the fair value and unrealized loss on securities as of March 31, 2016 and December 31, 2015 (in thousands):



	As of March 31, 2016
	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	$	6,134	$	16	$	17,650	$	455	$	23,784	$	471
Other Stocks and Bonds	2,955		45		—		—		2,955		45
Mortgage-backed Securities:
Residential	57,543		147		2,699		6		60,242		153
Total	$	66,632	$	208	$	20,349	$	461	$	86,981	$	669
HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	4,197	$	40	$	47,304	$	1,139	$	51,501	$	1,179
Mortgage-backed Securities:
Residential	540		1		—		—		540		1
Total	$	4,737	$	41	$	47,304	$	1,139	$	52,041	$	1,180

	As of December 31, 2015
	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:
U.S. Treasury	$	64,172	$	380	$	—	$	—	$	64,172	$	380
State and Political Subdivisions	15,550		116		19,270		495		34,820		611
Other Stocks and Bonds	2,954		45		—		—		2,954		45
Other Equity Securities	6,016		36		—		—		6,016		36
Mortgage-backed Securities:
Residential	229,514		1,215		3,817		24		233,331		1,239
Commercial	422,316		7,039		5,110		192		427,426		7,231
Total	$	740,522	$	8,831	$	28,197	$	711	$	768,719	$	9,542
HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	24,340	$	214	$	62,240	$	1,149	$	86,580	$	1,363
Mortgage-backed Securities:
Residential	1,717		1		—		—		1,717		1
Commercial	193,710		2,439		2,481		41		196,191		2,480
Total	$	219,767	$	2,654	$	64,721	$	1,190	$	284,488	$	3,844

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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 HTM or AFS 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 the noncredit portion to other comprehensive income. 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, 2016.

The majority of the unrealized loss positions are comprised of highly rated 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, 2016.

Interest income recognized on securities for the periods presented (in thousands):



	Three Months Ended March 31,
	2016		2015
U.S. Treasury	$	127	$	116
U.S. Government Agency Debentures	—		32
State and Political Subdivisions	5,355		5,870
Other Stocks and Bonds	58		52
Other Equity Securities	29		32
Mortgage-backed Securities	9,391		8,462
Total interest income on securities	$	14,960	$	14,564

Of the approximately $2.4 million in net securities gains from the AFS portfolio for the three months ended March 31, 2016, there were $2.6 million in realized gains and $202,000 in realized losses. Of the $2.5 million in net securities gains from the AFS portfolio for the three months ended March 31, 2015, there were $2.5 million in realized gains and $54,000 in realized losses. There were no sales from the HTM portfolio during the three months ended March 31, 2016 or 2015. We calculate realized gains and losses on sales of securities under the specific identification method.

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The amortized cost, carrying value and fair value of securities at March 31, 2016, are presented below by contractual maturity. 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, 2016
	Amortized Cost		Fair Value
AVAILABLE FOR SALE	(in thousands)
Investment Securities:
Due in one year or less	$	18,483	$	18,576
Due after one year through five years	21,036		22,078
Due after five years through ten years	30,220		31,318
Due after ten years	213,126		220,629
	282,865		292,601
Mortgage-backed Securities and Other Equity Securities:	1,015,721		1,039,780
Total	$	1,298,586	$	1,332,381



	March 31, 2016
	Carrying Value		Fair Value
HELD TO MATURITY	(in thousands)
Investment Securities:
Due in one year or less	$	5,233	$	5,144
Due after one year through five years	22,189		22,649
Due after five years through ten years	77,787		80,387
Due after ten years	278,113		291,350
	383,322		399,530
Mortgage-backed Securities:	401,257		418,578
Total	$	784,579	$	818,108

Investment and MBS with carrying values of $1.13 billion and $1.33 billion were pledged as of March 31, 2016 and December 31, 2015, respectively, to collateralize Federal Home Loan Bank of Dallas, (“FHLB”) advances, repurchase agreements, and public funds or for other purposes as required by law.

Securities with limited marketability, such as FHLB stock and other investments, are carried at cost, which approximates fair value and are assessed for other-than-temporary impairment. These securities have no maturity date.

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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, 2016		December 31, 2015
Real Estate Loans:
Construction	$	464,750	$	438,247
1-4 Family Residential	644,826		655,410
Commercial	657,962		635,210
Commercial Loans	233,857		242,527
Municipal Loans	286,217		288,115
Loans to Individuals	155,619		172,244
Total Loans⁽¹⁾	2,443,231		2,431,753
Less: Allowance for Loan Losses	21,799		19,736
Net Loans	$	2,421,432	$	2,412,017


(1)	Includes approximately $525.4 million and $581.1 million of loans acquired with the Omni acquisition as of March 31, 2016 and December 31, 2015, respectively. The allowance for loan loss recorded on acquired loans totaled $519,000 and $629,000 as of March 31, 2016 and December 31, 2015, respectively.

Real Estate Construction Loans

Our construction loans are collateralized by property located primarily in the market areas we serve. A majority of our construction loans will be owner-occupied upon completion. Construction loans for speculative projects are financed, but these typically have secondary sources of repayment and 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 residential 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 loan 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 consists of $582.8 million of commercial real estate loans, $69.9 million of loans secured by multi-family properties and $5.3 million of loans secured by farm land. Commercial real estate loans primarily include loans collateralized by commercial office buildings, retail, medical facilities and offices, warehouse facilities, hotels and churches. 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, other than the medical industry. Loans to borrowers in the medical industry include all loan types listed above for commercial loans. Collateral for these loans varies depending on the type of loan and financial strength of the borrower. The primary source of repayment for loans in the medical community is cash flow from continuing operations.

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 should assist 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, the bank utilizes historical 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. 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. 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 full collection of the loan balance appears unlikely at the time of review, 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 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 to the total population of loans in the pool. The historical gross loss ratios are updated based on actual charge-off experience quarterly and adjusted for qualitative factors. Our pools of similar loans include consumer loans and loans secured by 1-4 residential family loans.

Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of the 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

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loans and problems affecting the credit 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 would 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 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 must be accorded such credits due 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 asset 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 asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution 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 further 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 Omni purchased portfolio specifically in regards to changes in 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, 2016
	Real Estate
	Construction			1-4 Family Residential			Commercial			Commercial Loans			Municipal Loans			Loans to Individuals			Total
Balance at beginning of period	$	4,350		$	2,595		$	4,577		$	6,596		$	725		$	893		$	19,736
Provision (reversal) for loan losses	(42		)	(551		)	(116		)	2,620			(5		)	410			2,316
Loans charged off	—			(19		)	—			(273		)	—			(848		)	(1,140		)
Recoveries of loans charged off	269			130			6			21			—			461			887
Balance at end of period	$	4,577		$	2,155		$	4,467		$	8,964		$	720		$	916		$	21,799



	Three Months Ended March 31, 2015
	Real Estate
	Construction		1-4 Family Residential			Commercial		Commercial Loans			Municipal Loans		Loans to Individuals			Total
Balance at beginning of period ⁽¹⁾	$	2,456	$	2,822		$	3,025	$	3,279		$	716	$	994		$	13,292
Provision (reversal) for loan losses	275		573			269		2,065			108		558			3,848
Loans charged off	—		(6		)	—		(57		)	—		(1,023		)	(1,086		)
Recoveries of loans charged off	43		11			66		29			—		723			872
Balance at end of period	$	2,774	$	3,400		$	3,360	$	5,316		$	824	$	1,252		$	16,926


(1)	Loans acquired with the Omni acquisition were measured at fair value on December 17, 2014 with no carryover of allowance for loan loss.

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, 2016
	Real Estate
	Construction		1-4 Family Residential		Commercial		Commercial Loans		Municipal Loans		Loans to Individuals		Total
Ending balance – individually evaluated for impairment ⁽¹⁾	$	31	$	23	$	56	$	6,422	$	13	$	92