(2) BUSINESS COMBINATIONS

Mergers and Acquisition

On April 4, 2016, DNB Financial Corporation (the “Company” or “DNBF”), the parent company of DNB First, N.A. (“DNB First”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) with East River Bank (“ERB”). Under the transaction, ERB merged with and into DNB First. The merger was consummated on October 1, 2016. The acquisition was an opportunity for DNB to strengthen its competitive position as one of the premier community banks headquartered in Southeastern Pennsylvania. Additionally, the ERB acquisition enhanced DNB's footprint in Southeastern Pennsylvania. The goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations DNB and ERB.

Pursuant to the Merger Agreement, each outstanding share of ERB common stock was converted into the right to receive, at the election of the ERB shareholder (subject to certain conditions, including conditions relating to pro-ration): (i) 0.6562 shares of DNB common stock or (ii) $18.65 in cash. The Merger Agreement provided that election of shares of DNB stock or cash was subject to pro-ration such that 2,085,662 ERB shares of common stock, or approximately 85.3% of the current outstanding ERB shares, would be exchanged for DNB common stock with the remaining ERB shares to be exchanged for cash and that the aggregate cash consideration payable to ERB shareholders was $6.7 million. The Merger Agreement also provided that options to purchase ERB common stock outstanding be exchanged for a cash payment equal to the difference between the per share cash consideration under the Merger Agreement and the corresponding exercise price of such option. Options to acquire an aggregate of 248,000 shares of ERB common stock were exchanged for a cash payment of $1.9 million. Additionally, $2,399 of cash was paid in lieu of fractional shares.

The acquisition of ERB was accounted for as a business combination using the acquisition method of accounting, which includes estimating the fair value of assets acquired, liabilities assumed and consideration paid as of the acquisition date. The assets and liabilities of ERB were recorded on the consolidated statement of financial condition at their estimated fair values as of October 1, 2016, and ERB’s results of operations have been included in the consolidated income statement since that date.

Included in the purchase price was goodwill and a core deposit intangible of $15,590,000 and $508,000, respectively. The core deposit intangible will be amortized over a ten-year period using a sum of the year’s digits basis. The goodwill is not taxable and will not be amortized, but will be measured annually for impairment or more frequently if circumstances require. Core deposit intangible amortization expense projected for the next five years beginning in 2017 is estimated to be $90,000, $81,000, $72,000, $62,000, and $53,000 per year, respectively, and $127,000 in total for years after 2021. DNB does not expect any further adjustments to the purchase price as it was finalized as of December 31, 2016.

The allocation of the purchase price is as follows:



(Dollars in thousands)
Assets acquired:
Cash and cash equivalents	$	3,116
AFS investment securities		3,027
Loans		306,396
Goodwill		15,590
Core deposit and other intangible		508
Other assets		10,838
Total assets acquired	$	339,475
Liabilities assumed:
Deposits	$	227,153
FHLBP borrowings		68,436
Other liabilities		576
Total liabilities assumed	$	296,165
Consideration transferred	$	43,310

Cash paid	$	8,604
Fair value of common stock issued (1,368,527 shares - fair value per share of $25.36)		34,706

The following table summarizes the estimated fair value of the assets acquired and liabilities and equity assumed.



(Dollars in thousands)
Total purchase price	$	43,310

Net assets acquired:
Cash and cash equivalents	$	3,116
AFS investment securities		3,027
Restricted stock		2,933
Loans		306,396
Premises and equipment		204
Deferred income taxes		1,713
Accrued interest receivable		1,098
Core deposit and other intangibles		508
Other assets		4,890
Deposits		(227,153)
FHLBP borrowings		(68,436)
Accrued interest payable		(129)
Other liabilities		(447)
Net assets acquired	$	27,720

Goodwill	$	15,590

The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $312,279,000. The table below illustrates the fair value adjustments made to the amortized cost basis in order to present a fair value of the loans acquired. The credit adjustment on impaired loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that has been deemed uncollectible based on the Company’s expectations of future cash flows for each respective loan.



(Dollars in thousands)
Gross amortized cost basis at October 1, 2016	$	312,279
Interest rate fair value adjustment on pools of homogeneous loan		(200)
Credit fair value adjustment on pools of homogeneous loans		(4,846)
Credit fair value adjustment on impaired loans		(837)
Fair value of purchased loans at October 1, 2016	$	306,396

For loans acquired without evidence of credit quality deterioration, DNB prepared the interest rate loan fair value and credit fair value adjustments. Loans were grouped into homogenous pools by characteristics such as loan type, term, collateral and rate. Market rates for similar loans were obtained from various internal and external data sources and reviewed by management for reasonableness. The average of these rates was used as the fair value interest rate a market participant would utilize. A present value approach was utilized to calculate the interest rate fair value discount of $200,000.

Additionally for loans acquired without credit deterioration, a credit fair value adjustment was calculated using a two part credit fair value analysis: 1) expected lifetime credit migration losses; and 2) estimated fair value adjustment for certain qualitative factors. The expected lifetime losses were calculated using historical losses observed at the Bank, ERB and peer banks. DNB also estimated an environmental factor to apply to each loan type. The environmental factor represents potential discount which may arise due to general credit and economic factors. A credit fair value discount of $4.8 million was determined. Both the interest rate and credit fair value adjustments relate to loans acquired with evidence of credit quality deterioration will be substantially recognized as interest income on a level yield amortization method based upon the expected life of the loans.

The information about the acquired ERB loans accounted for under ASC 310-30 as of October 1, 2016 is as follows:



(Dollars in thousands)
Contractually required principal and interest at acquisition	$	3,142
Contractual cash flows not expected to be collected (nonaccretable discount)		(1,124)
Expected cash flows at acquisition	$	2,018
Interest component of expected cash flows (accretable discount)		(348)
Fair value of acquired loans	$	1,670

The following table presents pro forma information as if the merger between the company and ERB had been completed on January 1, 2015. The pro forma information does not necessarily reflect the results of operations that would have occurred had DNB merged with ERB at the beginning of 2015. Supplemental pro forma earnings for 2016 were adjusted to exclude $4.7 million of merger related costs incurred for the year ended December 31, 2016. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies, or other factors. The pro forma data is intended for informational purposes and is not indicative of the future results of operations.


	(Unaudited)
	Years Ended December 31,
(Dollars in thousands, except per share data)	2016		2015
Net interest income after provision for credit losses	$	34,056	$	32,281
Non-interest income		6,777		5,565
Non-interest expense		29,245		27,169
Net income available to common stockholders		8,537		7,737
Net income per common share - basic		2.01		1.88
Net income per common share - diluted		1.98		1.84

The amount of total revenue, consisting of interest income plus noninterest income specifically related to ERB for the period beginning October 1, 2016, included in the consolidated statements of income of DNB for the year ended 2016 is incalculable due to the fact that East River Bank and its operations are no longer accounted for on a stand-alone basis.