Edgar Filing: SOUTHSIDE BANCSHARES INC

Document

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 June 30, 2018



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

For the transition period from ____________ to ____________

Commission file number: 0-12247

SOUTHSIDE BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



TEXAS		75-1848732
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1201 S. Beckham Avenue, Tyler, Texas		75701
(Address of principal executive offices)		(Zip Code)

903-531-7111

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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



Large accelerated filer x	Accelerated filer o
Non-accelerated filer o	(Do not check if a smaller reporting company)
	Smaller reporting company o
	Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

The number of shares of the issuer’s common stock, par value $1.25, outstanding as of July 23, 2018 was 35,089,372 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	46
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	70
ITEM 4. CONTROLS AND PROCEDURES	71
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	71
ITEM 1A. RISK FACTORS	71
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	71
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	71
ITEM 4. MINE SAFETY DISCLOSURES	71
ITEM 5. OTHER INFORMATION	71
ITEM 6. EXHIBITS	72
EXHIBIT INDEX	72
SIGNATURES	73

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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)

	June 30, 2018			December 31, 2017
	June 30, 2018			December 31, 2017
ASSETS
Cash and due from banks	$	78,534		$	79,171
Interest earning deposits	138,685			111,541
Federal funds sold	14,850			7,980
Total cash and cash equivalents	232,069			198,692
Securities available for sale, at estimated fair value	2,037,994			1,538,755
Securities held to maturity, at carrying value (estimated fair value of $159,055 and $921,800, respectively)	164,276			909,506
FHLB stock, at cost	42,994			55,729
Equity investments	12,037			5,821
Loans held for sale	4,566			2,001
Loans:
Loans	3,270,883			3,294,356
Less: Allowance for loan losses	(25,072		)	(20,781		)
Net loans	3,245,811			3,273,575
Premises and equipment, net	132,578			133,640
Goodwill	201,246			201,246
Other intangible assets, net	20,287			22,993
Interest receivable	27,100			28,491
Deferred tax asset, net	15,377			12,204
Bank owned life insurance	97,059			100,368
Other assets	16,779			15,076
Total assets	$	6,250,173		$	6,498,097

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest bearing	$	1,038,907		$	1,037,401
Interest bearing	3,469,834			3,478,046
Total deposits	4,508,741			4,515,447
Federal funds purchased and repurchase agreements	8,287			9,498
FHLB borrowings	776,467			1,017,361
Subordinated notes, net of unamortized debt issuance costs	98,326			98,248
Trust preferred subordinated debentures, net of unamortized debt issuance costs	60,243			60,241
Unsettled trades to purchase securities	2,279			—
Other liabilities	44,020			43,162
Total liabilities	5,498,363			5,743,957

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

Shareholders’ equity:
Common stock: ($1.25 par value, 80,000,000 shares authorized and 37,822,784 shares issued at June 30, 2018 and 40,000,000 shares authorized and 37,802,352 shares issued at December 31, 2017)	47,278			47,253
Paid-in capital	759,562			757,439
Retained earnings	48,843			32,851
Treasury stock, at cost (2,738,968 at June 30, 2018 and 2,802,019 at December 31, 2017)	(46,551		)	(47,105		)
Accumulated other comprehensive loss	(57,322		)	(36,298		)
Total shareholders’ equity	751,810			754,140
Total liabilities and shareholders’ equity	$	6,250,173		$	6,498,097

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						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Interest income
Loans	$	39,301		$	28,090		$	78,131		$	55,344
Investment securities – taxable	51			267			278			644
Investment securities – tax-exempt	6,353			6,157			12,734			12,711
Mortgage-backed securities	10,210			10,818			21,104			20,863
FHLB stock and equity investments	411			299			825			597
Other interest earning assets	471			378			919			738
Total interest income	56,797			46,009			113,991			90,897
Interest expense
Deposits	8,581			5,138			16,032			9,419
FHLB borrowings	3,007			3,551			6,639			7,015
Subordinated notes	1,407			1,398			2,805			2,791
Trust preferred subordinated debentures	658			494			1,227			961
Other borrowings	33			4			44			7
Total interest expense	13,686			10,585			26,747			20,193
Net interest income	43,111			35,424			87,244			70,704
Provision for loan losses	1,281			1,346			5,016			2,444
Net interest income after provision for loan losses	41,830			34,078			82,228			68,260
Noninterest income
Deposit services	6,261			5,255			12,440			10,369
Net (loss) gain on sale of securities available for sale	(332		)	(75		)	(1,159		)	247
Gain on sale of loans	173			505			288			1,206
Trust income	1,931			899			3,691			1,789
Bank owned life insurance income	1,185			635			1,817			1,269
Brokerage services	506			682			956			1,229
Other	1,283			1,392			2,584			2,857
Total noninterest income	11,007			9,293			20,617			18,966
Noninterest expense
Salaries and employee benefits	16,633			14,984			35,192			30,991
Occupancy expense	3,360			2,897			6,943			5,760
Acquisition expense	1,026			473			1,858			473
Advertising, travel & entertainment	775			548			1,460			1,131
ATM and debit card expense	243			889			589			1,816
Professional fees	952			1,050			2,022			1,989
Software and data processing expense	939			688			1,962			1,413
Telephone and communications	478			476			1,016			1,002
FDIC insurance	484			445			981			886
Amortization expense on intangibles	1,328			410			2,706			841
Other	3,056			2,677			6,212			5,093
Total noninterest expense	29,274			25,537			60,941			51,395
Income before income tax expense	23,563			17,834			41,904			35,831
Income tax expense	3,360			3,353			5,450			6,361
Net income	$	20,203		$	14,481		$	36,454		$	29,470

Earnings per common share – basic	$	0.58		$	0.49		$	1.04		$	1.01
Earnings per common share – diluted	$	0.57		$	0.49		$	1.04		$	1.00
Dividends paid per common share	$	0.30		$	0.28		$	0.58		$	0.53

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						Six Months Ended
	June 30,						June 30,
	2018			2017			2018			2017
Net income	$	20,203		$	14,481		$	36,454		$	29,470
Other comprehensive (loss) income:
Securities available for sale and transferred securities:
Change in net unrealized holding (losses) gains on available for sale securities during the period	(10,371		)	13,221			(48,154		)	18,106
Unrealized net gain on securities transferred from held to maturity to available for sale under the transition guidance enumerated in ASU 2017-12	—			—			11,881			—
Change in net unrealized losses on securities transferred from held to maturity to available for sale	—			—			401			—
Reclassification adjustment for net loss on equity investments, reclassified to retained earnings with adoption of ASU 2016-01	—			—			107			—
Reclassification adjustment for amortization related to available for sale and held to maturity debt securities	1,252			213			1,390			701
Reclassification adjustment for net loss (gain) on sale of available for sale securities, included in net income	332			75			1,159			(247		)
Derivatives:
Change in net unrealized gain (loss) on effective cash flow hedge interest rate swap derivatives	1,725			(1,768		)	5,970			(1,848		)
Change in net unrealized gains on interest rate swap derivatives terminated during the period	—			—			—			273
Reclassification adjustment from other comprehensive income (loss) related to derivatives designated as cash flow hedge	(331		)	223			(458		)	593
Pension plans:
Amortization of net actuarial loss and prior service credit, included in net periodic benefit cost	618			414			1,091			803
Other comprehensive (loss) income, before tax	(6,775		)	12,378			(26,613		)	18,381
Income tax benefit (expense) related to items of other comprehensive income (loss)	1,423			(4,332		)	5,589			(6,433		)
Other comprehensive (loss) income, net of tax	(5,352		)	8,046			(21,024		)	11,948
Comprehensive income	$	14,851		$	22,527		$	15,430		$	41,418

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

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED) (in thousands, except share and per share data)

	Common Stock		Paid In Capital		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
Balance at December 31, 2016	$	39,320	$	535,240	$	30,098		$	(47,891	)	$	(38,493	)	$	518,274
Net income	—		—		29,470			—			—			29,470
Other comprehensive income	—		—		—			—			11,948			11,948
Issuance of common stock for dividend reinvestment plan (21,474 shares)	27		694		—			—			—			721
Stock compensation expense	—		913		—			—			—			913
Net issuance of common stock under employee stock plans (60,078 shares)	60		820		(49		)	59			—			890
Cash dividends paid on common stock ($0.53 per share)	—		—		(15,151		)	—			—			(15,151		)
Stock dividend declared (719,515 shares)	899		24,061		(24,960		)	—			—			—
Balance at June 30, 2017	$	40,306	$	561,728	$	19,408		$	(47,832	)	$	(26,545	)	$	547,065

Balance at December 31, 2017	$	47,253	$	757,439	$	32,851		$	(47,105	)	$	(36,298	)	$	754,140
Net income	—		—		36,454			—			—			36,454
Other comprehensive loss	—		—		—			—			(21,024		)	(21,024		)
Issuance of common stock for dividend reinvestment plan (20,432 shares)	25		695		—			—			—			720
Stock compensation expense	—		965		—			—			—			965
Net issuance of common stock under employee stock plans (63,051 shares)	—		463		(52		)	554			—			965
Cash dividends paid on common stock ($0.58 per share)	—		—		(20,325		)	—			—			(20,325		)
Cumulative effect of ASU 2016-01	—		—		(85		)	—			—			(85		)
Balance at June 30, 2018	$	47,278	$	759,562	$	48,843		$	(46,551	)	$	(57,322	)	$	751,810

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)

	Six Months Ended
	June 30,
	2018			2017
OPERATING ACTIVITIES:
Net income	$	36,454		$	29,470
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and net amortization	7,078			4,846
Securities premium amortization (discount accretion), net	7,557			8,756
Loan (discount accretion) premium amortization, net	(1,712		)	(677		)
Provision for loan losses	5,016			2,444
Stock compensation expense	965			913
Deferred tax expense	2,438			17
Net loss (gain) on sale of securities available for sale	1,159			(247		)
Net loss on premises and equipment	132			55
Gross proceeds from sales of loans held for sale	13,578			39,582
Gross originations of loans held for sale	(12,159		)	(34,977		)
Net loss (gain) on other real estate owned	258			(1		)
Net change in:
Interest receivable	1,391			1,963
Other assets	16,612			2,479
Interest payable	247			60
Other liabilities	(8,484		)	(5,935		)
Net cash provided by operating activities	70,530			48,748

INVESTING ACTIVITIES:
Securities available for sale:
Purchases	(195,005		)	(272,410		)
Sales	315,656			328,854
Maturities, calls and principal repayments	78,042			62,242
Securities held to maturity:
Purchases	—			(1,521		)
Maturities, calls and principal repayments	1,767			11,316
Proceeds from redemption of FHLB stock and other investments	13,377			114
Purchases of FHLB stock and other investments	(914		)	(477		)
Net loan paydowns (originations)	19,722			(54,362		)
Purchases of premises and equipment	(5,154		)	(3,926		)
Proceeds from sales of premises and equipment	1,905			5
Proceeds from sales of other real estate owned	771			134
Proceeds from sales of repossessed assets	287			272
Net cash provided by investing activities	230,454			70,241

(continued)

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

	Six Months Ended
	June 30,
	2018			2017
FINANCING ACTIVITIES:
Net change in deposits	$	(6,866	)	$	90,953
Net (decrease) increase in federal funds purchased and repurchase agreements	(1,211		)	1,327
Proceeds from FHLB borrowings	1,718,000			1,631,476
Repayment of FHLB borrowings	(1,958,890		)	(1,763,027		)
Proceeds from stock option exercises	1,084			1,022
Cash paid to tax authority related to tax withholding on share-based awards	(119		)	(132		)
Proceeds from the issuance of common stock for dividend reinvestment plan	720			721
Cash dividends paid	(20,325		)	(15,151		)
Net cash used in financing activities	(267,607		)	(52,811		)

Net increase in cash and cash equivalents	33,377			66,178
Cash and cash equivalents at beginning of period	198,692			169,654
Cash and cash equivalents at end of period	$	232,069		$	235,832

SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:

Interest paid	$	26,499		$	20,134
Income taxes paid	$	—		$	5,500

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Loans transferred to other repossessed assets and real estate through foreclosure	$	764		$	263
Loans transferred from portfolio to held for sale	$	3,984		$	—
Transfer of held to maturity securities to available for sale securities	$	743,421		$	—
Adjustment to pension liability	$	(1,091	)	$	(803	)
Stock dividend (2.5% for 2017)	$	—		$	24,960
Unsettled trades to purchase securities	$	(2,279	)	$	(24,883	)

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, 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, 2017.

Accounting Changes and Reclassifications

Certain prior period amounts have been reclassified to conform to current year presentation.

We adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” as modified by subsequently issued ASUs 2015-14, 2016-08, 2016-10, 2016-12 and 2016-20, on January 1, 2018, the effective date of the guidance, using the modified retrospective approach. As the majority of the Company’s revenues are not subject to the new guidance, the adoption of ASU 2014-09 did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows. We did adjust the presentation of revenue received from our brokerage services, merchant services, as well as our interchange income associated with debit card services, which were all deemed to be services offered in an agent capacity. These lines of revenue will now be presented on a net basis with the fee income disclosed net of the related costs in the noninterest income section of the consolidated statements of income. In connection with the adoption, for the three and six months ended June 30, 2018, we netted $988,000 and $1.8 million of debit card expense against deposit services income and $151,000 and $302,000 of brokerage expense against brokerage income, respectively. Due to the implementation of the guidance under the modified retrospective method, prior periods have not been adjusted and are not comparative. Refer to our revenue recognition discussion below and “Note 1 - Summary of Significant Accounting and Reporting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2017 for more information related to our revenue recognition policies.

We adopted ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities,” on January 1, 2018, the effective date of the guidance. ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale (“AFS”) securities in combination with the entity’s other deferred tax assets. The guidance requires companies to apply the requirements in the year of adoption, through cumulative adjustment, while the guidance related to equity securities without readily determinable fair values should be applied prospectively. Adoption of this guidance resulted in a cumulative adjustment to retained earnings of $85,000, net of tax, on January 1, 2018 and an equity security with a carrying value of $5.9 million that was previously recognized in securities AFS, at estimated fair value on our consolidated balance sheet to instead be recognized in equity investments, with subsequent changes in fair value being

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recognized in income. Also in conjunction with the adoption, our fair value measurement of financial instruments will be based upon an exit price notion as required in ASC 820. The guidance was applied on a prospective approach resulting in prior periods no longer being comparable.

We adopted ASU 2017-07, “Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” on January 1, 2018. ASU 2017-07 requires employers to present the service cost component of net periodic postretirement benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. Employers are required to present the other components of the net periodic benefit cost separately from the line item that includes the service cost and outside of any subtotal of operating income, if one is presented. The guidance requires companies to apply the requirements retrospectively to all prior periods presented. We elected to use the practical expedient that permits us to use the amounts in our pension plan disclosures in our employee benefit footnote for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements, which resulted in an increase of $69,000 and $157,000 in salaries and employee benefits expense and a decrease of $69,000 and $157,000 in other noninterest expense for the three and six months ended June 30, 2017, respectively.

We early adopted ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” on January 1, 2018. ASU 2017-12 (i) expands hedge accounting for nonfinancial and financial risk components and amends measurement methodologies to more closely align hedge accounting with a company’s risk management activities, (ii) decreases the complexity of preparing and understanding hedge results by eliminating the separate measurement and reporting of hedge ineffectiveness, (iii) enhances transparency, comparability, and understanding of hedge results through enhanced disclosures and changing the presentation of hedge results to align the effects of the hedging instrument and the hedged item, and (iv) reduces the cost and complexity of applying hedge accounting by simplifying the manner in which assessments of hedge effectiveness may be performed. The guidance also permits a transition election to reclassify held to maturity (“HTM”) securities to AFS securities if a portion of those securities would qualify to be hedged under the new “last-of-layer” approach. The guidance requires companies to apply the requirements to existing hedging relationships on the date of adoption, and the effect of the adoption should be reflected as of the beginning of the fiscal year of adoption. The guidance did not have an impact on our derivatives that qualified as hedges on the date of adoption and thus no adjustment was made to retained earnings. In conjunction with the adoption of ASU 2017-12, we made the transition election to reclassify approximately $743.4 million in book value of securities from HTM to AFS that qualified for the last-of-layer method described in ASU 2017-12.

During the three months ended June 30, 2018, we entered into partial term fair value hedges, as allowed under the recently adopted ASU 2017-12, for certain of our fixed rate callable AFS municipal securities. These hedges are expected to be effective in offsetting changes in the fair value of the hedged securities. Gains and losses on derivative instruments designated as fair value hedges, as well as the change in fair value on the hedged item, are recorded in interest income in the consolidated statements of income.

Revenue Recognition

Our revenue consists of net interest income on financial assets and financial liabilities and noninterest income. The classifications of our revenue are presented in the consolidated statements of income. On January 1, 2018, we adopted ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the modified retrospective method. The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

ASU 2014-09 permits an entity to recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset would have been one year or less. We generally expense sales commissions when incurred because the amortization period is within one year or less. These costs are recorded within salaries and employee benefits on the consolidated statements of income.

Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; generally this occurs with the transfer of control of goods or services. Under ASU 2014-09’s practical expedient to recognize revenue equal to the amounts for which we have a right to invoice, revenue is measured as the amount of consideration we expect to receive in exchange for the transfer of those goods or services.

The following summarizes our revenue recognition policies as they relate to revenue from contracts with customers under ASU 2014-09:

•

Deposit services. Service charges on deposit accounts include fees for banking services provided, overdrafts and non-sufficient funds. Revenue is generally recognized in accordance with published deposit account agreements for retail accounts or contractual agreements for commercial accounts. Our deposit services also include our ATM and debit card interchange revenue that is presented net of the associated costs. Interchange revenue is generated by our deposit customers’ usage and volume of activity. Interchange rates are not controlled by the Company, which effectively acts as processor that collects and remits payments associated with customer debit card transactions.

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•

Trust income. Trust income includes fees and commissions from investment management, administrative and advisory services primarily for individuals, and to a lesser extent, partnerships and corporations. Revenue is recognized on an accrual basis at the time the services are performed and when we have a right to invoice and are based on either the market value of the assets managed or the services provided.


•	Brokerage services. Brokerage services income includes fees and commissions charged when we arrange for another party to transfer brokerage services to a customer. The fees and commissions under this agent relationship are based upon stated fee schedules based upon the type of transaction, volume, and value of the services provided.


•	Other noninterest income. Other noninterest income includes among other things, merchant services income. Merchant services revenue is derived from third party vendors that process credit card transactions on behalf of our merchant customers. Merchant services revenue is primarily comprised of residual fee income based on the referred merchant’s processing volumes and/or margin.

Securities

Available for Sale (“AFS”). Debt securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield on alternative investments are classified as AFS. These assets are carried at fair value with changes recorded in other comprehensive income. Fair value is determined using quoted market prices as of the close of business on the balance sheet date. If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services. Securities that are hedged with qualifying derivatives are carried at fair value with the change in fair value on both the hedged instrument and the securities recorded in interest income in the consolidated statements of income.

Held to Maturity (“HTM”). Debt securities that management has the positive intent and ability to hold until maturity are classified as HTM and are carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts.

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

Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires a lessee to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new ASU 2016-02 will require both finance (formerly known as “capital”) and operating leases to be recognized on the balance sheet. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The guidance requires companies to apply the requirements in the year of adoption using a modified retrospective approach. We are currently evaluating the impact this guidance will have on our consolidated financial statements, and we anticipate our assessment to be completed during the fiscal year 2018.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. ASU 2016-13 also modifies the impairment model for 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 cumulative adjustment with some aspects of the update requiring a prospective transition approach. We are currently evaluating the potential impact of the pending adoption of ASU 2016-13 on our consolidated financial statements. 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. The team is currently completing the gap analysis/data collection and anticipates running parallel models in early 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

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testing dates after January 1, 2017. The guidance requires companies to apply the requirements prospectively in the year of adoption. ASU 2017-04 is not expected to have a significant impact on our consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” Under current GAAP, premiums on callable debt securities are generally amortized over the contractual life of the security. ASU 2017-08 requires the premium on callable debt securities to be amortized to the earliest call date. If the debt security is not called at the earliest call date, the holder of the debt security would be required to reset the effective yield on the debt security based on the payment terms required by the debt security. ASU 2017-08 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We have elected to adopt on January 1, 2019. The guidance requires companies to apply the requirements on a modified retrospective basis through a cumulative adjustment directly to retained earnings as of the beginning of the period of adoption. We have evaluated an estimate of the potential impact of the pending adoption of ASU 2017-08 on our consolidated financial statements. Based on our existing municipal securities portfolio, we believe the change to amortizing premiums to the earliest call date will increase amortization expense recorded through interest income for the year ended December 31, 2019 by approximately $3.4 million, net of tax.

2. Acquisition

On November 30, 2017, we acquired 100% of the outstanding stock of Diboll State Bancshares, Inc. and its wholly-owned subsidiary First Bank & Trust East Texas (collectively, “Diboll”) headquartered in Diboll, Texas. Diboll operated 17 banking offices in Diboll and surrounding areas. We acquired Diboll to further expand our presence in the East Texas market. The operations of Diboll were merged into the Company as of the date of the acquisition.

The Diboll acquisition was accounted for using the acquisition method of accounting and accordingly, purchased assets, including identifiable intangible assets and assumed liabilities were recorded at their respective acquisition date fair values. The purchase price allocation is preliminary and is subject to final determination and valuation of the fair value of assets acquired and liabilities assumed. As of December 31, 2017, the Company recognized $109.7 million in initial goodwill associated with the Diboll acquisition. Our consolidated goodwill totaled $201.2 million as of June 30, 2018 and December 31, 2017. For more information concerning the fair value of the assets acquired and liabilities assumed in relation to the acquisition of Diboll, see “Note 2 - Acquisition” in our Annual Report on Form 10-K for the year ended December 31, 2017.

3. Earnings Per Share

Earnings per share on a basic and diluted basis are calculated as follows (in thousands, except per share amounts).



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Basic and Diluted Earnings:
Net income	$	20,203	$	14,481	$	36,454	$	29,470
Basic weighted-average shares outstanding	35,062		29,318		35,042		29,303
Add: Stock awards	171		201		175		208
Diluted weighted-average shares outstanding	35,233		29,519		35,217		29,511
Basic Earnings Per Share:
Net Income	$	0.58	$	0.49	$	1.04	$	1.01
Diluted Earnings Per Share:
Net Income	$	0.57	$	0.49	$	1.04	$	1.00

For the three- and six-month periods ended June 30, 2018, there were approximately 53,000 and 47,000 anti-dilutive shares, respectively. For the three- and six-month periods ended June 30, 2017, there were approximately 52,000 and 51,000 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 June 30, 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	$	(35,594	)	$	9,652		$	(134	)	$	(25,894	)	$	(51,970	)
Other comprehensive income (loss):
Other comprehensive (loss) income before reclassifications	(10,371		)	1,725			—			—			(8,646		)
Reclassified from accumulated other comprehensive income	1,584			(331		)	(2		)	620			1,871
Income tax benefit (expense)	1,845			(293		)	1			(130		)	1,423
Net current-period other comprehensive (loss) income, net of tax	(6,942		)	1,101			(1		)	490			(5,352		)
Ending balance, net of tax	$	(42,536	)	$	10,753		$	(135	)	$	(25,404	)	$	(57,322	)

	Six Months Ended June 30, 2018
							Pension Plans
	Unrealized Gains (Losses) on Securities			Unrealized Gains (Losses) on Derivatives			Net Prior Service (Cost) Credit			Net Gain (Loss)			Total
Beginning balance, net of tax	$	(16,295	)	$	6,399		$	(133	)	$	(26,269	)	$	(36,298	)
Other comprehensive income (loss):
Other comprehensive (loss) income before reclassifications	(35,872		)	5,970			—			—			(29,902		)
Reclassified from accumulated other comprehensive income ⁽¹⁾	2,656			(458		)	(4		)	1,095			3,289
Income tax benefit (expense)	6,975			(1,158		)	2			(230		)	5,589
Net current-period other comprehensive (loss) income, net of tax	(26,241		)	4,354			(2		)	865			(21,024		)
Ending balance, net of tax	$	(42,536	)	$	10,753		$	(135	)	$	(25,404	)	$	(57,322	)


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

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	Three Months Ended June 30, 2017
							Pension Plans
	Unrealized Gains (Losses) on Securities			Unrealized Gains (Losses) on Derivatives			Net Prior Service (Cost) Credit			Net Gain (Loss)			Total
Beginning balance, net of tax	$	(20,425	)	$	4,961		$	(134	)	$	(18,993	)	$	(34,591	)
Other comprehensive income (loss):
Other comprehensive income (loss) before reclassifications	13,221			(1,768		)	—			—			11,453
Reclassified from accumulated other comprehensive income	288			223			(2		)	416			925
Income tax (expense) benefit	(4,728		)	541			—			(145		)	(4,332		)
Net current-period other comprehensive income (loss), net of tax	8,781			(1,004		)	(2		)	271			8,046
Ending balance, net of tax	$	(11,644	)	$	3,957		$	(136	)	$	(18,722	)	$	(26,545	)

	Six Months Ended June 30, 2017
							Pension Plans
	Unrealized Gains (Losses) on Securities			Unrealized Gains (Losses) on Derivatives			Net Prior Service (Cost) Credit			Net Gain (Loss)			Total
Beginning balance, net of tax	$	(23,708	)	$	4,595		$	(133	)	$	(19,247	)	$	(38,493	)
Other comprehensive income (loss):
Other comprehensive income (loss) before reclassifications	18,106			(1,575		)	—			—			16,531
Reclassified from accumulated other comprehensive income	454			593			(4		)	807			1,850
Income tax (expense) benefit	(6,496		)	344			1			(282		)	(6,433		)
Net current-period other comprehensive income (loss), net of tax	12,064			(638		)	(3		)	525			11,948
Ending balance, net of tax	$	(11,644	)	$	3,957		$	(136	)	$	(18,722	)	$	(26,545	)

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



	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017

Unrealized losses on securities transferred:
Amortization of unrealized losses ⁽¹⁾	$	(1,252	)	$	(213	)	$	(1,390	)	$	(701	)
Tax benefit	263			75			292			245
Net of tax	$	(989	)	$	(138	)	$	(1,098	)	$	(456	)

Unrealized gains and losses on available for sale securities:
Realized net (loss) gain on sale of securities ⁽²⁾	$	(332	)	$	(75	)	$	(1,159	)	$	247
Tax benefit (expense)	70			26			243			(86		)
Net of tax	$	(262	)	$	(49	)	$	(916	)	$	161

Derivatives:
Realized net gain (loss) on interest rate swap derivatives ⁽³⁾	$	309		$	(245	)	$	415		$	(624	)
Tax (expense) benefit	(65		)	86			(87		)	218
Net of tax	$	244		$	(159	)	$	328		$	(406	)

Amortization of unrealized gains on terminated interest rate swap derivatives ⁽³⁾	$	22		$	22		$	43		$	31
Tax expense	(5		)	(8		)	(9		)	(11		)
Net of tax	$	17		$	14		$	34		$	20

Amortization of pension plan:
Net actuarial loss ⁽⁴⁾	$	(620	)	$	(416	)	$	(1,095	)	$	(807	)
Prior service credit ⁽⁴⁾	2			2			4			4
Total before tax	(618		)	(414		)	(1,091		)	(803		)
Tax benefit	129			145			228			281
Net of tax	(489		)	(269		)	(863		)	(522		)
Total reclassifications for the period, net of tax	$	(1,479	)	$	(601	)	$	(2,515	)	$	(1,203	)

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

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

(3) Included in interest expense for FHLB borrowings on the consolidated statements of income.


(4)	These accumulated other comprehensive income components are included in the computation of net periodic pension cost (income) presented in “Note 8 - Employee Benefit Plans.”

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5. Securities

Debt securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of investment and mortgage-backed securities available for sale and held to maturity as of June 30, 2018 and December 31, 2017 are reflected in the tables below (in thousands):



	June 30, 2018
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Fair Value
Investment Securities:
State and Political Subdivisions	$	806,824	$	7,064	$	17,880	$	796,008
Other Stocks and Bonds	3,000		32		—		3,032
Mortgage-backed Securities: ⁽¹⁾
Residential	714,270		2,394		17,626		699,038
Commercial	551,945		522		12,551		539,916
Total	$	2,076,039	$	10,012	$	48,057	$	2,037,994

HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	3,202	$	—	$	40	$	3,162
Mortgage-backed Securities: ⁽¹⁾
Residential	60,080		181		2,194		58,067
Commercial	100,994		128		3,296		97,826
Total	$	164,276	$	309	$	5,530	$	159,055

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	December 31, 2017
	Amortized		Gross Unrealized		Gross Unrealized		Estimated
AVAILABLE FOR SALE	Cost		Gains		Losses		Fair Value
Investment Securities:
U.S. Government Agency Debentures	$	108,869	$	—	$	—	$	108,869
State and Political Subdivisions	392,760		3,895		3,991		392,664
Other Stocks and Bonds	5,024		31		—		5,055
Other Equity Securities ⁽²⁾	6,027		—		107		5,920
Mortgage-backed Securities: ⁽¹⁾
Residential	720,930		4,476		7,377		718,029
Commercial	308,357		761		900		308,218
Total	$	1,541,967	$	9,163	$	12,375	$	1,538,755

HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	413,632	$	10,879	$	2,583	$	421,928
Mortgage-backed Securities: ⁽¹⁾
Residential	129,044		1,631		239		130,436
Commercial	366,830		3,812		1,206		369,436
Total	$	909,506	$	16,322	$	4,028	$	921,800


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


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

From time to time, we have transferred securities from 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 $15.6 million ($12.4 million, net of tax) at June 30, 2018 and $17.4 million ($13.8 million, net of tax) at December 31, 2017. 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 six months ended June 30, 2018 or the year ended December 31, 2017.

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

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The following tables represent the estimated fair value and unrealized loss on investment and mortgage-backed securities AFS and HTM as of June 30, 2018 and December 31, 2017 (in thousands):



	As of June 30, 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	$	285,278	$	5,260	$	226,698	$	12,620	$	511,976	$	17,880
Mortgage-backed Securities:
Residential	518,512		10,797		107,118		6,829		625,630		17,626
Commercial	457,975		11,548		12,605		1,003		470,580		12,551
Total	$	1,261,765	$	27,605	$	346,421	$	20,452	$	1,608,186	$	48,057
HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	2,671	$	40	$	—	$	—	$	2,671	$	40
Mortgage-backed Securities:
Residential	53,097		2,009		2,243		185		55,340		2,194
Commercial	77,355		2,155		11,964		1,141		89,319		3,296
Total	$	133,123	$	4,204	$	14,207	$	1,326	$	147,330	$	5,530

	As of December 31, 2017
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
AVAILABLE FOR SALE
Investment Securities:
State and Political Subdivisions	$	32,341	$	121	$	172,006	$	3,870	$	204,347	$	3,991
Other Equity Securities ⁽¹⁾	5,920		107		—		—		5,920		107
Mortgage-backed Securities:
Residential	429,742		3,232		102,973		4,145		532,715		7,377
Commercial	146,796		419		13,134		481		159,930		900
Total	$	614,799	$	3,879	$	288,113	$	8,496	$	902,912	$	12,375
HELD TO MATURITY
Investment Securities:
State and Political Subdivisions	$	85,608	$	807	$	56,736	$	1,776	$	142,344	$	2,583
Mortgage-backed Securities:
Residential	24,707		157		2,736		82		27,443		239
Commercial	136,491		782		13,552		424		150,043		1,206
Total	$	246,806	$	1,746	$	73,024	$	2,282	$	319,830	$	4,028


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

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We review those securities in an unrealized loss position for significant differences between fair value and the cost basis to evaluate if a classification of other-than-temporary impairment is warranted. In estimating other-than-temporary impairment losses, management considers, among other things, the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. We consider an other-than-temporary impairment to have occurred when there is an adverse change in expected cash flows. When it is determined that a decline in fair value of AFS and HTM securities is other-than-temporary, the carrying value of the security is reduced to its estimated fair value, with a corresponding charge to earnings for the credit portion and a charge to other comprehensive income for the noncredit portion. Based upon the length of time and the extent to which fair value is less than cost, we believe that none of the securities with an unrealized loss have other-than-temporary impairment at June 30, 2018.

The majority of the securities in an unrealized loss position are highly rated Texas municipal securities and U.S. Agency mortgage-backed securities (“MBS”) where the unrealized loss is a direct result of the change in interest rates and spreads. For those securities in an unrealized loss position, we do not currently intend to sell the securities and it is not more likely than not that we will be required to sell the securities before the anticipated recovery of their amortized cost basis. To the best of management’s knowledge and based on our consideration of the qualitative factors associated with each security, there were no securities in our investment and MBS portfolio with an other-than-temporary impairment at June 30, 2018.

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




	Three Months Ended June 30,
	2018		2017
U.S. Treasury	$	23	$	204
U.S. Government Agency Debentures	—		—
State and Political Subdivisions	6,353		6,157
Other Stocks and Bonds	28		35
Other Equity Securities	—		28
Mortgage-backed Securities	10,210		10,818
Total interest income on securities	$	16,614	$	17,242



	Six Months Ended June 30,
	2018		2017
U.S. Treasury	$	131	$	519
U.S. Government Agency Debentures	89		—
State and Political Subdivisions	12,734		12,711
Other Stocks and Bonds	58		69
Other Equity Securities⁽¹⁾	—		56
Mortgage-backed Securities	21,104