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 results of Diboll's operations for November 30 - December 31, 2017 are included in the consolidated financial statements and are not separately quantifiable subsequent to the business combination.

Pursuant to the merger agreement, on November 30, 2017, we issued 5.5 million shares of our common stock and paid $23.9 million in cash for all outstanding shares of Diboll State Bancshares Inc. common stock. In accordance with the merger agreement, each outstanding share of common stock of Diboll State Bancshares, Inc. was converted into (a) 6.5021 shares of common stock of the Company and (b) $28.12 in cash (the “Per Share Merger Consideration”). Pursuant to the Diboll State Bancshares, Inc. Incentive Stock Option 2014 Plan and predecessor plans, and the individual award agreements granted thereunder, all outstanding equity awards terminated as of the effective time of the acquisition and became null and void. Holders of stock options granted under such plans were provided an opportunity to exercise such stock options or take advantage of the cashless exercise feature of such equity awards prior to the effective time of the acquisition. The cash consideration is net of the aggregate after-tax amount paid by Diboll to holders of options to purchase Diboll common stock who utilized the cashless exercise feature immediately prior to the acquisition as outlined in the merger agreement. Based on our closing stock price on November 30, 2017 of $36.20, the total merger consideration for the Diboll merger was $224.3 million.

The components of the consideration paid are shown in the following table (in thousands):



Fair value of consideration transferred:
	Common stock issued	$	200,364
	Cash	23,941
Total consideration transferred		$	224,305

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 as reported at December 31, 2017 was preliminary and was subject to final determination and valuation of the fair value of assets acquired and liabilities assumed. The fair value of assets acquired, adjusted for subsequent measurement period adjustments, excluding goodwill, totaled $1.03 billion, including total loans of $621.3 million and total investment securities of $234.4 million. Total fair value of the liabilities assumed totaled $910.7 million, including deposits of $899.3 million.

Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. In 2017, the Company recognized initial goodwill of $109.7 million. As of December 31, 2018, total goodwill related to the Diboll acquisition was $109.6 million, after recording, within the measurement period, an immaterial adjustment to goodwill based on the filing of the short-period Federal Income Tax return for Diboll and its subsidiaries. The measurement period for the Diboll acquisition ended during the fourth quarter of 2018. The goodwill resulting from the acquisition represents the value expected from the expansion of our markets into the Southeast Texas region and the enhancement of our operations through customer synergies and efficiencies, thereby providing enhanced customer service. Goodwill is not expected to be deductible for tax purposes.

The following table reflects the changes in the carrying amount of our goodwill for the year ended December 31, 2018 (in thousands):



	Goodwill
Balance as of December 31, 2017	$	201,246
Less: measurement period adjustments	(130		)
Balance as of December 31, 2018	$	201,116

The estimated fair values of the assets acquired and liabilities assumed as of the closing date of the transaction adjusted for the subsequent measurement period adjustments are shown in the following table (in thousands):



	As Originally Reported ⁽¹⁾			Measurement Period Adjustments			Adjusted Balances
Cash, cash equivalents and amounts due from banks	$	115,598		$	—		$	115,598
Other investments	610			—			610
Securities available for sale	234,447			—			234,447
Loans	621,318			—			621,318
Property and equipment	26,256			—			26,256
Other assets	7,052			—			7,052
Core deposit intangible	14,700			—			14,700
Trust relationship intangible	5,400			—			5,400
Goodwill	109,726			(130		)	109,596
Deposits	(899,307		)	—			(899,307		)
Deferred tax liability, net	(7,802		)	84			(7,718		)
Other liabilities	(3,693		)	46			(3,647		)
	$	224,305		$	—		$	224,305


(1)	The estimated fair value as of the acquisition date, November 30, 2017, as previously reported in our Form 10-K for the year ended December 31, 2017.

The determination of estimated fair values of the acquired loans required the Company to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status and credit risk ratings, the acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (purchased credit impaired “PCI”), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (purchased non-impaired). Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Diboll’s historical experience and the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which we considered to be Level 3 fair value measurements. Deposit liabilities assumed in the acquisition of Diboll were segregated into two categories: time-deposits (i.e., deposit accounts with a stated maturity) and demand deposits, both using Level 2 fair value measurements. In determining fair value of time deposits, the Company discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration. For demand deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. Acquisition date fair values for securities available for sale were determined using Level 1 or Level 2 inputs consistent with the methods discussed further in “Note 13 - Fair Value Measurement”. The remaining acquisition date fair values represent either Level 2 fair value measurements (other investments) or Level 3 fair value measurements (property and equipment, core deposit intangible and trust intangible).

We recognized a core deposit intangible of $14.7 million and a trust relationship intangible of $5.4 million which will be amortized using an accelerated method over a 9- and 13-year weighted average amortization period, respectively, consistent with expected future cash flows.

For the year ended December 31, 2017, the Company incurred a total of pre-tax acquisition related expenses associated with the Diboll acquisition of approximately $4.4 million which consisted primarily of $2.4 million of legal and consulting fees and $1.9 million of software expenses due to canceling of contracts. These expenses were recognized in the consolidated statements of income in acquisition expense.

We incurred costs of $277,000 directly related to the issuance of the shares related to the acquisition which were offset against additional paid-in-capital in the consolidated statements of changes in equity. We also recorded non-solicitation agreements for $240,000 that will be amortized using the straight-line method over three years in connection with the acquisition.

Loans acquired with Diboll were measured at fair value at the acquisition date with no carryover of any allowance for loan losses. Loans were segregated into those loans considered to be performing and those considered PCI. PCI loans are loans acquired with evidence of deteriorated credit quality for which it was probable, at acquisition, that all contractually required cash flows would not be collected.

The table below details the PCI loan portfolio at the Diboll acquisition date (in thousands):



	Purchased Credit Impaired Loans at Acquisition Date
Contractually required principal and interest payments	$	59,286
Nonaccretable difference	4,560
Cash flows expected to be collected	54,726
Accretable difference	15,389
Fair value of loans acquired with a deterioration of credit quality	$	39,337

Acquired loans that were considered performing at the Diboll acquisition date and therefore not subject to ASC 310-30 are shown below (in thousands):



	Fair Value at Acquisition Date		Contractual Amounts Receivable		Cash Flows Not Expected to be Collected at Acquisition Date ⁽¹⁾
Real Estate Loans:
Construction	$	40,122	$	56,905	$	330
1-4 Family Residential	82,654		130,167		26,894
Commercial	319,623		484,529		97,431
Commercial Loans	82,083		87,688		1,226
Municipal Loans	7,848		9,998		28
Loans to Individuals	49,651		54,687		1,490
Total Loans	$	581,981	$	823,974	$	127,399


(1)	Cash flows not expected to be collected relate to estimated credit losses and expected prepayments.

Unaudited pro forma net income for the years ended December 31, 2017 and 2016 would have been $64.1 million and $58.0 million, respectively, and revenues would have been $270.9 million and $257.8 million for the same years, respectively, had the acquisition occurred as of January 1, 2016.