Table of Contents


     
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
(Mark One)
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SeptemberJune 30, 20172018
OR
oTRANSITION 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 OctoberJuly 23, 20172018 was 29,433,43735,089,372 shares.
 



TABLE OF CONTENTS
 
PART I.  FINANCIAL INFORMATION 
PART II.  OTHER INFORMATION 


Table of Contents


PART I.   FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share amounts)
 June 30,
2018
 December 31,
2017
 September 30,
2017
 December 31,
2016
 
ASSETS        
Cash and due from banks $57,947
 $59,363
 $78,534
 $79,171
Interest earning deposits 120,996
 102,251
 138,685
 111,541
Federal funds sold 5,570
 8,040
 14,850
 7,980
Total cash and cash equivalents 184,513
 169,654
 232,069
 198,692
Securities available for sale, at estimated fair value 1,292,072
 1,479,600
 2,037,994
 1,538,755
Securities held to maturity, at carrying value (estimated fair value of $928,507 and $944,282, respectively) 909,844
 937,487
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 61,845
 61,084
 42,994
 55,729
Other investments 5,439
 5,508
Equity investments 12,037
 5,821
Loans held for sale 2,177
 7,641
 4,566
 2,001
Loans:  
  
  
  
Loans 2,682,766
 2,556,537
 3,270,883
 3,294,356
Less: Allowance for loan losses (19,871) (17,911) (25,072) (20,781)
Net Loans 2,662,895
 2,538,626
Net loans 3,245,811
 3,273,575
Premises and equipment, net 107,099
 106,003
 132,578
 133,640
Goodwill 91,520
 91,520
 201,246
 201,246
Other intangible assets, net 3,379
 4,608
 20,287
 22,993
Interest receivable 18,792
 25,183
 27,100
 28,491
Deferred tax asset, net 21,842
 28,891
 15,377
 12,204
Unsettled trades to sell securities 11,843
 
Bank owned life insurance 99,616
 97,775
 97,059
 100,368
Other assets 11,554
 10,187
 16,779
 15,076
Total assets $5,484,430
 $5,563,767
 $6,250,173
 $6,498,097
  
  
LIABILITIES AND SHAREHOLDERS’ EQUITY  
  
  
  
Deposits:  
  
  
  
Noninterest bearing $781,701
 $704,013
 $1,038,907
 $1,037,401
Interest bearing 2,782,474
 2,829,063
 3,469,834
 3,478,046
Total deposits 3,564,175
 3,533,076
 4,508,741
 4,515,447
Short-term obligations:  
  
Federal funds purchased and repurchase agreements 9,083
 7,097
 8,287
 9,498
FHLB advances 990,500
 866,518
Total short-term obligations 999,583
 873,615
Long-term obligations:  
  
FHLB advances 152,056
 443,128
FHLB borrowings 776,467
 1,017,361
Subordinated notes, net of unamortized debt issuance costs 98,209
 98,100
 98,326
 98,248
Long-term debt, net of unamortized debt issuance costs 60,240
 60,236
Total long-term obligations 310,505
 601,464
Trust preferred subordinated debentures, net of unamortized debt issuance costs 60,243
 60,241
Unsettled trades to purchase securities 16,673
 160
 2,279
 
Other liabilities 37,471
 37,178
 44,020
 43,162
Total liabilities 4,928,407
 5,045,493
 5,498,363
 5,743,957
      
  
Off-balance-sheet arrangements, commitments and contingencies (Note 13) 

 

 

 

      
  
Shareholders’ equity:  
  
  
  
Common stock ($1.25 par value, 40,000,000 shares authorized, 32,256,777 shares issued at September 30, 2017 and 31,455,951 shares issued at December 31, 2016) 40,321
 39,320
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 563,553
 535,240
 759,562
 757,439
Retained earnings 25,677
 30,098
 48,843
 32,851
Treasury stock, at cost (2,823,340 shares at September 30, 2017 and 2,913,064 shares at December 31, 2016) (47,291) (47,891)
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 (26,237) (38,493) (57,322) (36,298)
Total shareholders’ equity 556,023
 518,274
 751,810
 754,140
Total liabilities and shareholders’ equity $5,484,430
 $5,563,767
 $6,250,173
 $6,498,097
The accompanying notes are an integral part of these consolidated financial statements.


1

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data)
Three Months Ended Nine Months EndedThree Months Ended Six Months Ended
September 30, September 30,June 30, June 30,
2017 2016 2017 20162018 2017 2018 2017
Interest income              
Loans$29,322
 $25,740
 $84,666
 $79,738
$39,301
 $28,090
 $78,131
 $55,344
Investment securities – taxable58
 251
 702
 572
51
 267
 278
 644
Investment securities – tax-exempt5,670
 5,467
 18,381
 15,959
6,353
 6,157
 12,734
 12,711
Mortgage-backed securities10,567
 9,399
 31,430
 28,156
10,210
 10,818
 21,104
 20,863
FHLB stock and other investments329
 186
 926
 588
FHLB stock and equity investments411
 299
 825
 597
Other interest earning assets527
 89
 1,265
 220
471
 378
 919
 738
Total interest income46,473
 41,132
 137,370
 125,233
56,797
 46,009
 113,991
 90,897
Interest expense 
  
  
  
 
  
  
  
Deposits5,420
 3,604
 14,839
 10,375
8,581
 5,138
 16,032
 9,419
Short-term obligations3,382
 1,122
 7,927
 2,724
Long-term obligations2,711
 2,476
 8,940
 7,210
FHLB borrowings3,007
 3,551
 6,639
 7,015
Subordinated notes1,407
 1,398
 2,805
 2,791
Trust preferred subordinated debentures658
 494
 1,227
 961
Other borrowings33
 4
 44
 7
Total interest expense11,513
 7,202
 31,706
 20,309
13,686
 10,585
 26,747
 20,193
Net interest income34,960
 33,930
 105,664
 104,924
43,111
 35,424
 87,244
 70,704
Provision for loan losses960
 1,631
 3,404
 7,715
1,281
 1,346
 5,016
 2,444
Net interest income after provision for loan losses34,000
 32,299
 102,260
 97,209
41,830
 34,078
 82,228
 68,260
Noninterest income 
  
  
  
 
  
  
  
Deposit services5,476
 5,335
 15,845
 15,519
6,261
 5,255
 12,440
 10,369
Net gain on sale of securities available for sale627
 2,343
 874
 5,512
Net (loss) gain on sale of securities available for sale(332) (75) (1,159) 247
Gain on sale of loans347
 818
 1,553
 2,334
173
 505
 288
 1,206
Trust income873
 867
 2,662
 2,591
1,931
 899
 3,691
 1,789
Bank owned life insurance income636
 656
 1,905
 1,977
1,185
 635
 1,817
 1,269
Brokerage services561
 551
 1,790
 1,661
506
 682
 956
 1,229
Other888
 1,162
 3,745
 3,104
1,283
 1,392
 2,584
 2,857
Total noninterest income9,408
 11,732
 28,374
 32,698
11,007
 9,293
 20,617
 18,966
Noninterest expense 
  
  
  
 
  
  
  
Salaries and employee benefits14,395
 15,203
 45,229
 47,784
16,633
 14,984
 35,192
 30,991
Occupancy expense2,981
 4,569
 8,741
 10,897
3,360
 2,897
 6,943
 5,760
Acquisition expense1,026
 473
 1,858
 473
Advertising, travel & entertainment487
 588
 1,618
 1,995
775
 548
 1,460
 1,131
ATM and debit card expense1,024
 868
 2,840
 2,316
243
 889
 589
 1,816
Professional fees996
 1,148
 2,985
 3,964
952
 1,050
 2,022
 1,989
Software and data processing expense732
 736
 2,145
 2,224
939
 688
 1,962
 1,413
Telephone and communications459
 407
 1,461
 1,359
478
 476
 1,016
 1,002
FDIC insurance441
 643
 1,327
 1,926
484
 445
 981
 886
Amortization expense on intangibles1,328
 410
 2,706
 841
Other3,492
 4,263
 10,056
 11,180
3,056
 2,677
 6,212
 5,093
Total noninterest expense25,007
 28,425
 76,402
 83,645
29,274
 25,537
 60,941
 51,395
       
Income before income tax expense18,401
 15,606
 54,232
 46,262
23,563
 17,834
 41,904
 35,831
Income tax expense3,890
 2,741
 10,251
 8,486
3,360
 3,353
 5,450
 6,361
Net income$14,511
 $12,865
 $43,981
 $37,776
$20,203
 $14,481
 $36,454
 $29,470
       
Earnings per common share – basic$0.49
 $0.48
 $1.50
 $1.40
$0.58
 $0.49
 $1.04
 $1.01
Earnings per common share – diluted$0.49
 $0.48
 $1.49
 $1.39
$0.57
 $0.49
 $1.04
 $1.00
Dividends paid per common share$0.28
 $0.24
 $0.81
 $0.71
$0.30
 $0.28
 $0.58
 $0.53
The accompanying notes are an integral part of these consolidated financial statements.

2

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)
 Three Months Ended Nine Months Ended

September 30, September 30,
 2017 2016 2017 2016
Net income$14,511
 $12,865
 $43,981
 $37,776
Other comprehensive income: 
  
  
  
Securities available for sale and transferred securities:       
Change in net unrealized holding gains (losses) on available for sale securities during the period344
 (10,960) 18,450
 33,031
Reclassification adjustment for amortization of unrealized losses on securities transferred to held to maturity490
 16
 1,191
 160
Reclassification adjustment for net gain on sale of available for sale securities, included in net income(627) (2,343) (874) (5,512)
Derivatives:       
Change in net unrealized (loss) gain on effective cash flow hedge interest rate swap derivatives(236) 1,070
 (2,084) (5,125)
Change in net unrealized gains on interest rate swap derivatives terminated during the period
 
 273
 
Reclassification adjustment for net loss on interest rate swap derivatives, included in net income122
 521
 746
 1,338
Reclassification adjustment for amortization of unrealized gains on terminated interest rate swap derivatives(21) 
 (52) 
Pension plans:       
Amortization of net actuarial loss, included in net periodic benefit cost403
 458
 1,210
 1,371
Amortization of prior service credit, included in net periodic benefit cost(1) (10) (5) (6)
Other comprehensive income (loss), before tax474
 (11,248) 18,855
 25,257
Income tax (expense) benefit related to items of other comprehensive income(166) 3,937
 (6,599) (8,840)
Other comprehensive income (loss), net of tax308
 (7,311) 12,256
 16,417
Comprehensive income$14,819
 $5,554
 $56,237
 $54,193
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 securities1,252
 213
 1,390
 701
Reclassification adjustment for net loss (gain) on sale of available for sale securities, included in net income332
 75
 1,159
 (247)
Derivatives:       
Change in net unrealized gain (loss) on effective cash flow hedge interest rate swap derivatives1,725
 (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 cost618
 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.

3

Table of Contents


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, 2015$34,832
 $424,078
 $41,527
 $(37,692) $(18,683) $444,062
Net income
 
 37,776
 
 
 37,776
Other comprehensive income
 
 
 
 16,417
 16,417
Issuance of common stock for dividend reinvestment plan (33,622 shares)42
 950
 
 
 
 992
Purchase of common stock (443,426 shares)
 
 
 (10,199) 
 (10,199)
Stock compensation expense
 1,156
 
 
 
 1,156
Tax benefits related to stock awards
 79
 
 
 
 79
Net issuance of common stock under employee stock plans (39,468 shares)50
 345
 (49) 
 
 346
Cash dividends paid on common stock ($0.71 per share)
 
 (18,069) 
 
 (18,069)
Stock dividend declared (1,252,353 shares)1,565
 33,200
 (34,765) 
 
 
Balance at September 30, 2016$36,489
 $459,808
 $26,420
 $(47,891) $(2,266) $472,560
            
Balance at December 31, 2016$39,320
 $535,240
 $30,098
 $(47,891) $(38,493) $518,274
Net income
 
 43,981
 
 
 43,981
Other comprehensive income
 
 
 
 12,256
 12,256
Issuance of common stock for dividend reinvestment plan (33,000 shares)41
 1,057
 
 
 
 1,098
Stock compensation expense
 1,393
 
 
 
 1,393
Net issuance of common stock under employee stock plans (138,035 shares)61
 1,802
 (73) 600
 
 2,390
Cash dividends paid on common stock ($0.81 per share)
 
 (23,369) 
 
 (23,369)
Stock dividend declared (719,515 shares)899
 24,061
 (24,960) 
 
 
Balance at September 30, 2017$40,321
 $563,553
 $25,677
 $(47,291) $(26,237) $556,023
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.

4

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(in thousands)
Nine Months EndedSix Months Ended
September 30,June 30,
2017 20162018 2017
OPERATING ACTIVITIES:      
Net income$43,981
 $37,776
$36,454
 $29,470
Adjustments to reconcile net income to net cash provided by operations: 
  
 
  
Depreciation and net amortization7,251
 6,612
7,078
 4,846
Securities premium amortization (discount accretion), net13,502
 14,245
7,557
 8,756
Loan (discount accretion) premium amortization, net(818) (2,113)(1,712) (677)
Provision for loan losses3,404
 7,715
5,016
 2,444
Stock compensation expense1,393
 1,156
965
 913
Deferred tax expense453
 1,916
2,438
 17
Net tax benefit related to stock awards
 (79)
Net gain on sale of securities available for sale(874) (5,512)
Net loss (gain) on sale of securities available for sale1,159
 (247)
Net loss on premises and equipment77
 235
132
 55
Gross proceeds from sales of loans held for sale50,689
 67,144
13,578
 39,582
Gross originations of loans held for sale(45,225) (68,634)(12,159) (34,977)
Net (gain) loss on other real estate owned(1) 224
Net gain on sale of customer receivables
 (144)
Net loss (gain) on other real estate owned258
 (1)
Net change in: 
  
 
  
Interest receivable6,391
 5,242
1,391
 1,963
Other assets2,696
 (2,094)16,612
 2,479
Interest payable(923) 726
247
 60
Other liabilities(4,639) 2,182
(8,484) (5,935)
Net cash provided by operating activities77,357
 66,597
70,530
 48,748
      
INVESTING ACTIVITIES: 
  
 
  
Securities available for sale:      
Purchases(371,555) (761,900)(195,005) (272,410)
Sales486,460
 495,011
315,656
 328,854
Maturities, calls and principal repayments87,096
 160,676
78,042
 62,242
Securities held to maturity: 
  
 
  
Purchases(1,521) (29,725)
 (1,521)
Maturities, calls and principal repayments25,455
 22,029
1,767
 11,316
Proceeds from redemption of FHLB stock and other investments114
 3,644
13,377
 114
Purchases of FHLB stock and other investments(761) (4,433)(914) (477)
Net loan originations(127,240) (66,633)
Proceeds from sales of customer receivables
 3,314
Net loan paydowns (originations)19,722
 (54,362)
Purchases of premises and equipment(7,090) (5,189)(5,154) (3,926)
Proceeds from sales of premises and equipment8
 120
1,905
 5
Proceeds from sales of other real estate owned134
 1,918
771
 134
Proceeds from sales of repossessed assets341
 767
287
 272
Net cash provided by (used in) investing activities91,441
 (180,401)
Net cash provided by investing activities230,454
 70,241
      
(continued)      

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SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED) (continued)
(in thousands)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED) (continued)
(in thousands)
SOUTHSIDE BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED) (continued)
(in thousands)
Nine Months EndedSix Months Ended
September 30,June 30,
2017 20162018 2017
FINANCING ACTIVITIES:      
Net change in deposits$31,031
 $126,748
$(6,866) $90,953
Net increase in federal funds purchased and repurchase agreements1,986
 9,087
Proceeds from FHLB advances2,366,476
 6,548,551
Repayment of FHLB advances(2,533,551) (6,523,701)
Net proceeds from issuance of subordinated long-term debt
 98,083
Tax benefit related to stock awards
 79
Net (decrease) increase in federal funds purchased and repurchase agreements(1,211) 1,327
Proceeds from FHLB borrowings1,718,000
 1,631,476
Repayment of FHLB borrowings(1,958,890) (1,763,027)
Proceeds from stock option exercises2,527
 418
1,084
 1,022
Cash paid to tax authority from stock option exercises(137) (72)
Purchase of common stock
 (10,199)
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 plan1,098
 992
720
 721
Cash dividends paid(23,369) (18,069)(20,325) (15,151)
Net cash (used in) provided by financing activities(153,939) 231,917
Net cash used in financing activities(267,607) (52,811)
      
Net increase in cash and cash equivalents14,859
 118,113
33,377
 66,178
Cash and cash equivalents at beginning of period169,654
 80,975
198,692
 169,654
Cash and cash equivalents at end of period$184,513
 $199,088
$232,069
 $235,832
      
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION: 
  
 
  

      
Interest paid$32,629
 $19,583
$26,499
 $20,134
Income taxes paid$8,300
 $5,700
$
 $5,500
      
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: 
  
 
  

      
Loans transferred to other repossessed assets and real estate through foreclosure$407
 $5,434
$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$(1,205) $(1,365)$(1,091) $(803)
Stock dividend (2.5% and 5%, respectively)$24,960
 $34,765
Stock dividend (2.5% for 2017)$
 $24,960
Unsettled trades to purchase securities$(16,673) $(30,214)$(2,279) $(24,883)
Unsettled trades to sell securities$11,843
 $

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.
On May 4, 2017, our board of directors declared a 2.5% stock dividend to common stock shareholders of record as of May 30, 2017, which was paid on June 27, 2017. All share data has been adjusted to give retroactive recognition to stock dividends.
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, 2016.2017.  
Accounting Changes and Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation.
We adopted ASU 2016-09 “Compensation - Stock CompensationAccounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 718): Improvements to Employee Share-Based Payment Accounting,606) as modified by subsequently issued ASUs 2015-14, 2016-08, 2016-10, 2016-12 and 2016-20, on January 1, 2017 which requires all income tax effects related to settlements2018, the effective date of share-based payment awards be reported in earnings as an increase (or decrease) to income tax expense. Previously, income tax benefits at settlementthe guidance, using the modified retrospective approach. As the majority of an award were reported as an increase (or decrease) to additional paid-in capitalthe Company’s revenues are not subject to the extent that those benefitsnew 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 greater than (or less than)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 tax benefits recognized in earnings during the vesting period or exercisedisclosed net of the award. The requirement to report thoserelated costs in the noninterest income tax effects in earnings has been applied to settlements occurring on or after January 1, 2017, andsection of the impactconsolidated statements of applying that guidance reduced reported income tax expense by $213,000, or less than $0.01 on our diluted earnings per common shareincome. In connection with the adoption, for the three and six months ended SeptemberJune 30, 2017,2018, we netted $988,000 and $423,000, or $0.01 on our diluted earnings per common share for the nine months ended September 30, 2017. ASU 2016-09 also requires that all$1.8 million of debit card expense against deposit services income tax-related cash flows resulting from share-based payments be reported as operating activities in the statementand $151,000 and $302,000 of cash flows. Previously,brokerage expense against brokerage income, tax benefits at settlement of an award were reported as a reduction to operating cash flows and an increase to financing cash flowsrespectively. Due to the extent that those benefits exceeded the income tax benefits reported in earnings during the vesting period or exerciseimplementation of the award. We have elected to apply that change in cash flow on a prospective basis and therefore,guidance under the modified retrospective method, prior periods have not been adjusted. ASU 2016-09 also requires the classificationadjusted and are not comparative. Refer to our revenue recognition discussion below and “Note 1 - Summary of employee taxes paid when an employer withholds shares for tax withholding purposes be classified as a financing activity in the statement of cash flowSignificant Accounting and be applied retrospectively. The requirement to report the employee taxes paid is reflected in prior period presentationReporting Policies” in our consolidated statementAnnual 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 cash flows. In connectionFinancial 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 adoptionimpairment assessment of ASU 2016-09, we have also electedequity investments without readily determinable fair values by requiring a qualitative assessment to recognize forfeitures as they occur.
Terminated Derivative Financial Instruments
In accordance with ASC Topic 815, if a hedging itemidentify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is terminated priorrequired to maturitybe disclosed for a cash settlement,financial instruments measured at amortized cost on the existing gain or loss within accumulatedbalance 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 (“AOCI”) will continue to be reclassified into earnings during the period or periods in which the hedged forecasted transaction affects earnings unless it is probable that the forecasted transaction will not occur by the endportion of the originally specified time period. Iftotal change in the forecasted transaction is deemed probablefair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to not occur,measure the derivative gainliability 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 loss reported in AOCI shall be reclassified into earnings immediately. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges of forecasted transactions. Ataccompanying notes to the time of termination, we determinedfinancial statements and (vii) clarifies that an entity should evaluate the underlying hedged forecasted transactions were still probable of occurring. These transactions are reevaluatedneed for a valuation allowance on a monthly basis thereafter,deferred tax asset related to determine ifavailable for sale (“AFS”) securities in combination with the hedged forecasted transactions are still probableentity’s other deferred tax assets. The guidance requires companies to apply the requirements in the year of occurring. If atadoption, 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 subsequent evaluation, it is determinedcumulative 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 the transactions will not occur, any related gains or losses recorded in AOCI are immediatelywas previously recognized in earnings.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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The existing gainrecognized in AOCI related toincome. Also in conjunction with the terminated interest rate swap contractsadoption, our fair value measurement of financial instruments will be reclassified into earnings through straight-line accretionbased 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 forecasted transaction affects earnings.
Further informationitem, 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 hedging activities is included in “Note 10 - Derivative Financial Instrumentsfinancial liabilities and Hedging Activities.”
For a descriptionnoninterest income.  The classifications of our significant accounting and reporting policies, refer to “Note 1- Summaryrevenue are presented in the consolidated statements 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, 2016.
Accounting Pronouncements
In May 2014, the FASB issuedincome. On January 1, 2018, we adopted ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).This update statesusing the modified retrospective method. The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised 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.  This update affects entities that enter into contracts
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 customers toour customer are satisfied; generally this occurs with the transfer of control of goods or services or enter into contractsservices. 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 nonfinancial assets, unless those contracts are within the scope of other standards. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which defers the effective date of the previously issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) until the interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted. goods or services.
The guidance permits companiesfollowing summarizes our revenue recognition policies as they relate to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through cumulative adjustment.  We anticipate adopting the new standard using the modified retrospective method beginning January 1, 2018. Our revenue consists of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and noninterest income.  We have evaluated the impact this guidance will have in relation to our noninterest income derived from contracts with our customers as it relates tounder 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 trustalso 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 (includedincome. 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 noninterest income) which we havecomprehensive income.  Fair value is determined to beusing 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 scopeconsolidated statements of ASU 2014-09.  Theincome.
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 2014-09 is not expected2016-01, equity investments with readily determinable fair values are stated at fair value with unrealized gains and losses reported in income. For periods prior to haveJanuary 1, 2018, certain equity investments were classified as AFS and stated at fair value with unrealized gains and losses reported as a material impact on our consolidated financial statements. Weseparate component of accumulated other comprehensive income (“AOCI”), net of tax. Equity investments without readily determinable fair values are continuing to evaluate the impact of the additional disclosures required by this guidance.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 available for saleAFS 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 2017-07, “Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” 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. Only the service cost component will be eligible for

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capitalization in assets. 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. ASU 2017-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. We did not early adopt ASU 2017-07. The guidance requires companies to apply the requirements retrospectively to all prior periods presented. ASU 2017-07 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. Early adoption is permitted.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 are currently evaluatinghave evaluated an estimate of the potential impact of the pending adoption of ASU 2017-08 on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Subtopic 718): Scope of Modification Accounting.” ASU 2017-09 clarifies when changes to terms or conditions of a share-based payment award must be accounted for as a modification. Under the new guidance, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the fair value of the award, (ii) the vesting conditions of the award, and (iii) the classification of the award as either an equity or liability instrument. ASU 2017-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. We did not early adopt ASU 2017-09. The guidance requires companies to apply the requirements prospectively to awards modified on or after the adoption date. ASU 2017-09 is not expected to have a significant impact Based on our consolidated financial statements.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.

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” 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. ASU 2017-12 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 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. We are currently evaluating the potential impact of the pending adoption of ASU 2017-12 on our consolidated financial statements.
2.    Pending Acquisition
On June 12,November 30, 2017, we acquired 100% of the Company entered into an Agreement and Planoutstanding stock of Merger (the “Merger Agreement”) with Diboll State Bancshares, Inc., a Texas corporation (“Diboll”) and the holding company forits wholly-owned subsidiary First Bank & Trust East Texas a Texas banking association based(collectively, “Diboll”) headquartered in Diboll, Texas. AsDiboll 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 September 30, 2017, Diboll had $1.01 billion in assets and $908.7 million in deposits The Merger Agreement provides that, subject to the terms and conditions thereof, Diboll will merge with andwere 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 CompanyDiboll acquisition. Our consolidated goodwill totaled $201.2 million as of June 30, 2018 and December 31, 2017. For more information concerning the surviving corporation. On October 17, 2017, Diboll’s shareholders approved the Merger Agreement and the merger at a special meeting of shareholders. The merger of Southside Bank and Diboll’s subsidiary bank has previously received the approvalfair value of the Federal Deposit Insurance Corporationassets acquired and the Texas Department of Banking. The merger is expected to close during the fourth quarter of 2017, subject to receipt of regulatory approval from the Federal Reserve Board and the satisfaction of other customary closing conditions.
Pursuantliabilities assumed in relation to the Merger Agreement, the Company will issue 5,535,000 shares of Company common stock and up to $25.0 million in cash for all outstanding sharesacquisition of Diboll, common stock, subject to adjustment pursuant tosee “Note 2 - Acquisition” in our Annual Report on Form 10-K for the terms of the Merger Agreement.year ended December 31, 2017.


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3.     Earnings Per Share
Earnings per share on a basic and diluted basis has been adjusted to give retroactive recognition to stock dividends and isare calculated as follows (in thousands, except per share amounts):.
Three Months Ended
September 30,
 Nine Months Ended
September 30,
Three Months Ended
June 30,
 Six Months Ended
June 30,
2017 2016 2017 20162018 2017 2018 2017
Basic and Diluted Earnings:              
Net income$14,511
 $12,865
 $43,981
 $37,776
$20,203
 $14,481
 $36,454
 $29,470
Basic weighted-average shares outstanding29,370
 26,923
 29,326
 26,976
35,062
 29,318
 35,042
 29,303
Add: Stock awards200
 157
 205
 115
171
 201
 175
 208
Diluted weighted-average shares outstanding29,570
 27,080
 29,531
 27,091
35,233
 29,519
 35,217
 29,511
 
  
  
  
Basic Earnings Per Share:              
Net Income$0.49
 $0.48
 $1.50
 $1.40
$0.58
 $0.49
 $1.04
 $1.01
Diluted Earnings Per Share:              
Net Income$0.49
 $0.48
 $1.49
 $1.39
$0.57
 $0.49
 $1.04
 $1.00
For the three- and nine-monthsix-month periods ended SeptemberJune 30, 2017,2018, there were approximately 45,00053,000 and 49,00047,000 anti-dilutive shares, respectively. For the three- and nine-monthsix-month periods ended SeptemberJune 30, 2016,2017, there were approximately 3,00052,000 and 29,00051,000 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 September 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$(11,644) $3,957
 $(136) $(18,722) $(26,545)
Other comprehensive income (loss):         
Other comprehensive income (loss) before reclassifications344
 (236) 
 
 108
Reclassified from accumulated other comprehensive (loss) income(137) 101
 (1) 403
 366
Income (expense) tax benefit(72) 47
 
 (141) (166)
Net current-period other comprehensive income (loss), net of tax135
 (88) (1) 262
 308
Ending balance, net of tax$(11,509) $3,869
 $(137) $(18,460) $(26,237)
          
 Nine Months Ended September 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 reclassifications18,450
 (1,811) 
 
 16,639
Reclassified from accumulated other comprehensive income (loss)317
 694
 (5) 1,210
 2,216
Income tax (expense) benefit(6,568) 391
 1
 (423) (6,599)
Net current-period other comprehensive income (loss), net of tax12,199
 (726) (4) 787
 12,256
Ending balance, net of tax$(11,509) $3,869
 $(137) $(18,460) $(26,237)
 Three Months Ended June 30, 2018
    Pension Plans  
 Unrealized Gains (Losses) on Securities Unrealized Gains (Losses) on Derivatives 
Net Prior
 Service
 (Cost)
 Credit
 Net Gain (Loss) Total
Beginning balance, net of tax$(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 income1,584
 (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 September 30, 2016Three Months Ended June 30, 2017
   Pension Plans     Pension Plans  
Unrealized Gains (Losses) on Securities Unrealized Gains (Losses) on Derivatives 
Net Prior
 Service
 (Cost)
 Credit
 Net Gain (Loss) TotalUnrealized Gains (Losses) on Securities Unrealized Gains (Losses) on Derivatives 
Net Prior
 Service
 (Cost)
 Credit
 Net Gain (Loss) Total
Beginning balance, net of tax$26,389
 $(3,496) $(42) $(17,806) $5,045
$(20,425) $4,961
 $(134) $(18,993) $(34,591)
Other comprehensive income (loss):                  
Other comprehensive (loss) income before reclassifications(10,960) 1,070
 
 
 (9,890)
Reclassified from accumulated other comprehensive (loss) income(2,327) 521
 (10) 458
 (1,358)
Income tax benefit (expense)4,650
 (557) 4
 (160) 3,937
Net current-period other comprehensive (loss) income, net of tax(8,637) 1,034
 (6) 298
 (7,311)
Other comprehensive income (loss) before reclassifications13,221
 (1,768) 
 
 11,453
Reclassified from accumulated other comprehensive income288
 223
 (2) 416
 925
Income tax (expense) benefit(4,728) 541
 
 (145) (4,332)
Net current-period other comprehensive income (loss), net of tax8,781
 (1,004) (2) 271
 8,046
Ending balance, net of tax$17,752
 $(2,462) $(48) $(17,508) $(2,266)$(11,644) $3,957
 $(136) $(18,722) $(26,545)
                  
Nine Months Ended September 30, 2016Six Months Ended June 30, 2017

  Pension Plans  
  Pension Plans  
Unrealized Gains (Losses) on Securities Unrealized Gains (Losses) on Derivatives 
Net Prior
 Service
 (Cost)
 Credit
 Net Gain (Loss) TotalUnrealized 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) $(18,683)$(23,708) $4,595
 $(133) $(19,247) $(38,493)
Other comprehensive income (loss):                  
Other comprehensive income (loss) before reclassifications33,031
 (5,125) 
 
 27,906
18,106
 (1,575) 
 
 16,531
Reclassified from accumulated other comprehensive (loss) income(5,352) 1,338
 (6) 1,371
 (2,649)
Reclassified from accumulated other comprehensive income454
 593
 (4) 807
 1,850
Income tax (expense) benefit(9,688) 1,325
 2
 (479) (8,840)(6,496) 344
 1
 (282) (6,433)
Net current-period other comprehensive income (loss), net of tax17,991
 (2,462) (4) 892
 16,417
12,064
 (638) (3) 525
 11,948
Ending balance, net of tax$17,752
 $(2,462) $(48) $(17,508) $(2,266)$(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
September 30,
 Nine Months Ended
September 30,
Three Months Ended
June 30,
 Six Months Ended
June 30,
2017 2016 2017 20162018 2017 2018 2017
              
Unrealized losses on securities transferred to held to maturity:       
Unrealized losses on securities transferred:       
Amortization of unrealized losses (1)
$(490) $(16) $(1,191) $(160)$(1,252) $(213) $(1,390) $(701)
Tax benefit172
 6
 417
 56
263
 75
 292
 245
Net of tax$(318) $(10) $(774) $(104)$(989) $(138) $(1,098) $(456)
              
Unrealized gains and losses on available for sale securities:              
Realized net gain on sale of securities (2)
$627
 $2,343
 $874
 $5,512
Tax expense(220) (820) (306) (1,929)
Realized net (loss) gain on sale of securities (2)
$(332) $(75) $(1,159) $247
Tax benefit (expense)70
 26
 243
 (86)
Net of tax$407
 $1,523
 $568
 $3,583
$(262) $(49) $(916) $161
              
Derivatives:              
Realized net loss on interest rate swap derivatives (3)
$(122) $(521) $(746) $(1,338)
Tax benefit43
 182
 261
 468
Realized net gain (loss) on interest rate swap derivatives (3)
$309
 $(245) $415
 $(624)
Tax (expense) benefit(65) 86
 (87) 218
Net of tax$(79) $(339) $(485) $(870)$244
 $(159) $328
 $(406)
              
Amortization of unrealized gains on terminated interest rate swap derivatives (3)
$21
 $
 $52
 $
$22
 $22
 $43
 $31
Tax expense(7) 
 (18) 
(5) (8) (9) (11)
Net of tax$14
 $
 $34
 $
$17
 $14
 $34
 $20
              
Amortization of pension plan:              
Net actuarial loss (4)
$(403) $(458) $(1,210) $(1,371)$(620) $(416) $(1,095) $(807)
Prior service credit (4)
1
 10
 5
 6
2
 2
 4
 4
Total before tax(402) (448) (1,205) (1,365)(618) (414) (1,091) (803)
Tax benefit141
 156
 422
 477
129
 145
 228
 281
Net of tax(261) (292) (783) (888)(489) (269) (863) (522)
Total reclassifications for the period, net of tax$(237) $882
 $(1,440) $1,721
$(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 long-term obligationsFHLB 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, carrying value, and estimated fair value of investment and mortgage-backed securities available for sale and held to maturity as of SeptemberJune 30, 20172018 and December 31, 20162017 are reflected in the tables below (in thousands):
 September 30, 2017
   Recognized in OCI   Not recognized in OCI   June 30, 2018

 Amortized 
Gross
Unrealized
 Gross Unrealized Carrying Gross
Unrealized
 Gross Unrealized Estimated Amortized 
Gross
Unrealized
 Gross Unrealized Estimated
AVAILABLE FOR SALE Cost Gains Losses Value Gains Losses Fair Value Cost Gains Losses Fair Value
Investment Securities:             
        
State and Political Subdivisions $340,790
 $2,757
 $6,387
 $337,160
 $
 $
 $337,160
 $806,824
 $7,064
 $17,880
 $796,008
Other Stocks and Bonds 5,042
 73
 
 5,115
 
 
 5,115
 3,000
 32
 
 3,032
Other Equity Securities 6,031
 
 71
 5,960
 
 
 5,960
Mortgage-backed Securities: (1)
  
  
  
          
  
  
  
Residential 617,860
 6,319
 4,484
 619,695
 
 
 619,695
 714,270
 2,394
 17,626
 699,038
Commercial
322,577
 2,320
 755
 324,142
 
 
 324,142

551,945
 522
 12,551
 539,916
Total $1,292,300
 $11,469
 $11,697
 $1,292,072
 $
 $
 $1,292,072
 $2,076,039
 $10,012
 $48,057
 $2,037,994
                      
HELD TO MATURITY                      
Investment Securities:                      
State and Political Subdivisions $424,729
 $2,812
 $12,299
 $415,242
 $13,019
 $2,039
 $426,222
 $3,202
 $
 $40
 $3,162
Mortgage-backed Securities: (1)
  
  
  
                
Residential 132,426
 
 5,143
 127,283
 2,513
 181
 129,615
 60,080
 181
 2,194
 58,067
Commercial 370,167
 941
 3,789
 367,319
 5,925
 574
 372,670
 100,994
 128
 3,296
 97,826
Total $927,322
 $3,753
 $21,231
 $909,844
 $21,457
 $2,794
 $928,507
 $164,276
 $309
 $5,530
 $159,055



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 December 31, 2016
   Recognized in OCI   Not recognized in OCI   December 31, 2017
 Amortized 
Gross
Unrealized
 Gross Unrealized Carrying Gross
Unrealized
 Gross Unrealized Estimated Amortized 
Gross
Unrealized
 Gross Unrealized Estimated
AVAILABLE FOR SALE Cost Gains Losses Value Gains Losses Fair Value Cost Gains Losses Fair Value
Investment Securities:        
             
U.S. Treasury $74,016
 $
 $3,947
 $70,069
 $
 $
 $70,069
U.S. Government Agency Debentures $108,869
 $
 $
 $108,869
State and Political Subdivisions 394,050
 3,217
 12,070
 385,197


 
 385,197
 392,760
 3,895
 3,991
 392,664
Other Stocks and Bonds 6,587
 64
 

6,651


 
 6,651
 5,024
 31
 

5,055
Other Equity Securities 6,039
 
 119
 5,920
 
 
 5,920
Other Equity Securities (2)
 6,027
 
 107
 5,920
Mortgage-backed Securities: (1)
      
  
           
  
Residential 630,603
 6,434
 9,529

627,508


 
 627,508
 720,930
 4,476
 7,377

718,029
Commercial
386,109

1,201

3,055

384,255


 
 384,255

308,357

761

900

308,218
Total $1,497,404
 $10,916
 $28,720
 $1,479,600
 $
 $
 $1,479,600
 $1,541,967
 $9,163
 $12,375
 $1,538,755
                      
HELD TO MATURITY                      
Investment Securities:                      
State and Political Subdivisions $435,080
 $3,987
 $13,257
 $425,810
 $7,595
 $3,493
 $429,912
 $413,632
 $10,879
 $2,583
 $421,928
Mortgage-backed Securities: (1)
  
  
  
        
        
Residential 142,060
 
 5,748
 136,312
 1,534
 950
 136,896
 129,044
 1,631
 239
 130,436
Commercial 379,016
 1,067
 4,718
 375,365
 4,372
 2,263
 377,474
 366,830
 3,812
 1,206
 369,436
Total $956,156
 $5,054
 $23,723
 $937,487
 $13,501
 $6,706
 $944,282
 $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 may transferhave transferred securities from available for sale (“AFS”)AFS to held to maturity (“HTM”)HTM due to overall balance sheet strategies. During 2016, the Company transferred securities with a fair value of $157.1 million from AFS to HTM. The remaining net unamortized, unrealized loss on the transferred securities transferred from AFS to HTM was $10.2included in AOCI in the accompanying balance sheets totaled $15.6 million ($6.712.4 million, net of tax) at the dateJune 30, 2018 and $17.4 million ($13.8 million, net of transfer based on the fair value of the securities on the transfer date. Our management has the current intent and ability to hold the transferred securities until maturity.tax) at December 31, 2017. Any net unrealized gain or loss on the transferred securities included in accumulated other comprehensive incomeAOCI 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. AFS securitiesSecurities transferred with losses included in accumulated other comprehensive incomeAOCI 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 ninesix months ended SeptemberJune 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 SeptemberJune 30, 20172018 and December 31, 20162017 (in thousands):
As of September 30, 2017As of June 30, 2018
Less Than 12 Months More Than 12 Months TotalLess Than 12 Months More Than 12 Months Total
Fair Value 
Unrealized
Loss
 Fair Value 
Unrealized
Loss
 Fair Value 
Unrealized
Loss
Fair Value 
Unrealized
Loss
 Fair Value 
Unrealized
Loss
 Fair Value 
Unrealized
Loss
AVAILABLE FOR SALE                      
Investment Securities:                      
State and Political Subdivisions$67,886
 $991
 $153,073
 $5,396
 $220,959
 $6,387
$285,278
 $5,260
 $226,698
 $12,620
 $511,976
 $17,880
Other Equity Securities5,960
 71
 
 
 5,960
 71
Mortgage-backed Securities:                      
Residential161,949
 710
 110,503
 3,774
 272,452
 4,484
518,512
 10,797
 107,118
 6,829
 625,630
 17,626
Commercial36,549
 258
 13,122
 497
 49,671
 755
457,975
 11,548
 12,605
 1,003
 470,580
 12,551
Total$272,344
 $2,030
 $276,698
 $9,667
 $549,042
 $11,697
$1,261,765
 $27,605
 $346,421
 $20,452
 $1,608,186
 $48,057
HELD TO MATURITY 
  
  
  
  
  
 
  
  
  
  
  
Investment Securities:                      
State and Political Subdivisions$52,088
 $643
 $41,006
 $1,396
 $93,094
 $2,039
$2,671
 $40
 $
 $
 $2,671
 $40
Mortgage-backed Securities:                      
Residential3,795
 57
 2,922
 124
 6,717
 181
53,097
 2,009
 2,243
 185
 55,340
 2,194
Commercial36,340
 561
 895
 13
 37,235
 574
77,355
 2,155
 11,964
 1,141
 89,319
 3,296
Total$92,223
 $1,261
 $44,823
 $1,533
 $137,046
 $2,794
$133,123
 $4,204
 $14,207
 $1,326
 $147,330
 $5,530
                      
As of December 31, 2016As of December 31, 2017
Less Than 12 Months More Than 12 Months TotalLess Than 12 Months More Than 12 Months Total
Fair Value Unrealized
Loss
 Fair Value Unrealized
Loss
 Fair Value Unrealized
Loss
Fair Value Unrealized
Loss
 Fair Value Unrealized
Loss
 Fair Value Unrealized
Loss
AVAILABLE FOR SALE 
  
  
  
  
  
 
  
  
  
  
  
Investment Securities:                      
U.S. Treasury$70,069
 $3,947
 $
 $
 $70,069
 $3,947
State and Political Subdivisions264,485
 12,069
 887
 1
 265,372
 12,070
$32,341
 $121
 $172,006
 $3,870
 $204,347
 $3,991
Other Equity Securities5,920
 119
 
 
 5,920
 119
Other Equity Securities (1)
5,920
 107
 
 
 5,920
 107
Mortgage-backed Securities:                      
Residential369,903
 9,491
 6,199
 38
 376,102
 9,529
429,742
 3,232
 102,973
 4,145
 532,715
 7,377
Commercial245,422
 3,055
 
 
 245,422
 3,055
146,796
 419
 13,134
 481
 159,930
 900
Total$955,799
 $28,681
 $7,086
 $39
 $962,885
 $28,720
$614,799
 $3,879
 $288,113
 $8,496
 $902,912
 $12,375
HELD TO MATURITY 
  
  
  
  
  
 
  
  
  
  
  
Investment Securities:                      
State and Political Subdivisions$179,939
 $2,190
 $29,427
 $1,303
 $209,366
 $3,493
$85,608
 $807
 $56,736
 $1,776
 $142,344
 $2,583
Mortgage-backed Securities:                      
Residential107,024
 950
 
 
 107,024
 950
24,707
 157
 2,736
 82
 27,443
 239
Commercial186,854
 2,263
 
 
 186,854
 2,263
136,491
 782
 13,552
 424
 150,043
 1,206
Total$473,817
 $5,403
 $29,427
 $1,303
 $503,244
 $6,706
$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 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 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 SeptemberJune 30, 2017.2018.
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 SeptemberJune 30, 2017.2018.
Our equity securities consist of investments that are deemed to be qualified under the Community Reinvestment Act (CRA) of 1977. We primarily invest in securities issued by Fannie Mae, Freddie Mac, and Ginnie Mae. We evaluate the near-term prospects of our other equity securities in relation to the severity and duration of the current unrealized loss position. Based upon that evaluation, management does not consider the other equity securities to be other-than-temporarily impaired at September 30, 2017.

The following tables present interestInterest income recognized on securities for the periods presented (in thousands):
      
Three Months Ended
September 30,
Three Months Ended
June 30,
2017 20162018 2017
U.S. Treasury$
 $182
$23
 $204
U.S. Government Agency Debentures
 
State and Political Subdivisions5,670
 5,467
6,353
 6,157
Other Stocks and Bonds27
 39
28
 35
Other Equity Securities31
 30

 28
Mortgage-backed Securities10,567
 9,399
10,210
 10,818
Total interest income on securities$16,295
 $15,117
$16,614
 $17,242
Nine Months Ended
September 30,
Six Months Ended
June 30,
2017 20162018 2017
U.S. Treasury$519
 $330
$131
 $519
U.S. Government Agency Debentures89
 
State and Political Subdivisions18,381
 15,959
12,734
 12,711
Other Stocks and Bonds96
 154
58
 69
Other Equity Securities87
 88
Other Equity Securities (1)

 56
Mortgage-backed Securities31,430
 28,156
21,104
 20,863
Total interest income on securities$50,513
 $44,687
$34,116
 $34,218

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

Of the approximately $874,000$1.2 million in net securities gainloss from the AFS portfolio for the ninesix months ended SeptemberJune 30, 2017,2018, there were $4.7$1.5 million in realized gain positionsgains and $3.8$2.7 million in realized loss positions.losses.  Of the $5.5 million$247,000 in net securities gaingains from the AFS portfolio for the ninesix months ended SeptemberJune 30, 2016,2017, there were $6.2$3.6 million in realized gain positionsgains and $663,000$3.3 million in realized loss positions.losses. There were no sales from the HTM portfolio during the ninesix months ended SeptemberJune 30, 20172018 or 2016.2017. We calculate realized gains and losses on sales of securities under the specific identification method.  




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The amortized cost and estimated fair value of AFS securities and the carrying value and estimated fair values of HTM securities at SeptemberJune 30, 2017,2018, are presented below by contractual maturity (in thousands).  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.  MBS are presented in total by category due to the fact that MBS typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with varying maturities.  The characteristics of the underlying pool of mortgages, such as fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the security holder.  The term of a mortgage-backed pass-through security thus approximates the term of the underlying mortgages and can vary significantly due to prepayments.
September 30, 2017June 30, 2018
Amortized Cost Fair ValueAmortized Cost Fair Value
AVAILABLE FOR SALE  
Investment Securities:      
Due in one year or less$9,844
 $9,965
$34,236
 $34,098
Due after one year through five years15,651
 16,066
95,962
 97,415
Due after five years through ten years34,121
 34,655
167,654
 166,242
Due after ten years286,216
 281,589
511,972
 501,285
345,832
 342,275
809,824
 799,040
Mortgage-backed Securities and Other Equity Securities:946,468
 949,797
Mortgage-backed Securities1,266,215
 1,238,954
Total$1,292,300
 $1,292,072
$2,076,039
 $2,037,994

September 30, 2017June 30, 2018
Carrying Value Fair ValueAmortized Cost Fair Value
HELD TO MATURITY  
Investment Securities:      
Due in one year or less$23,631
 $23,372
$110
 $110
Due after one year through five years57,827
 58,663
1,122
 1,112
Due after five years through ten years110,903
 113,443
1,970
 1,940
Due after ten years222,881
 230,744

 
415,242
 426,222
3,202
 3,162
Mortgage-backed Securities:494,602
 502,285
161,074
 155,893
Total$909,844
 $928,507
$164,276
 $159,055

Investment securities and MBS with carrying values of $1.15$1.23 billion and $1.50$1.24 billion were pledged as of SeptemberJune 30, 20172018 and December 31, 2016, respectively,2017, respectively. Pledged securities may be used to collateralize one or more of the following: Federal Home Loan Bank of Dallas (“FHLB”) advances,borrowings, repurchase agreements, and public funds or for other purposes as required by law.

SecuritiesEquity Investments

Equity investments on our consolidated balance sheet include Community Reinvestment Act funds with limited marketability, sucha readily determinable fair value as FHLB stock and otherwell as equity investments are carriedwithout readily determinable fair values. At June 30, 2018, we had equity investments recorded in our consolidated balance sheet of $12.0 million. At December 31, 2017, we had $5.8 million in equity investments without readily determinable fair values recorded at cost, which approximatesapproximated their fair value.

Beginning January 1, 2018, upon adoption of ASU 2016-01, equity investments with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. For periods prior to January 1, 2018, these equity investments were classified as AFS and stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. Equity investments without readily determinable fair values are assessed quarterly for other-than-temporary impairment.  These securities have no maturity date.recorded at cost less any impairment, if any.

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At December 31, 2017, we had $5.9 million in equity investments included in AFS securities and recorded at fair value, with net unrealized losses of $85,000, net of tax, recognized in AOCI. On January 1, 2018, these unrealized losses were reclassified out of AOCI and into retained earnings with subsequent changes in fair value being recognized in net income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity investments during the three and six months ended June 30, 2018 (in thousands):

 Three Months Ended Six Months Ended
 June 30, 2018 June 30, 2018
Net (losses) recognized during the period on equity investments$(42) $(134)
Less: Net gains and (losses) recognized during the period on equity investments sold during the period
 
Unrealized (losses) recognized during the reporting period on equity investments still held at the reporting date$(42) $(134)

Equity investments are assessed quarterly for other-than-temporary impairment. Based upon that evaluation, management does not consider any of our equity investments to be other-than-temporarily impaired at June 30, 2018.

Federal Home Loan Bank Stock

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



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6.     Loans and Allowance for Probable Loan Losses

Loans in the accompanying consolidated balance sheets are classified as follows (in thousands):
    
September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Real Estate Loans:      
Construction$420,497
 $380,175
$487,286
 $475,867
1-4 Family Residential609,159
 637,239
791,359
 805,341
Commercial1,073,646
 945,978
1,245,936
 1,265,159
Commercial Loans166,919
 177,265
282,723
 266,422
Municipal Loans322,286
 298,583
345,595
 345,798
Loans to Individuals90,259
 117,297
117,984
 135,769
Total Loans (1)
2,682,766
 2,556,537
3,270,883
 3,294,356
Less: Allowance for Loan Losses (2)(1)
19,871
 17,911
25,072
 20,781
Net Loans$2,662,895
 $2,538,626
$3,245,811
 $3,273,575

(1)
Includes approximately $278.7 million and $372.4 million of loansLoans acquired with the OmniDiboll acquisition as of Septemberwere measured at fair value on November 30, 2017 and December 31, 2016, respectively.
(2)
with no carryover of allowance for loan loss. The allowance for loan loss recorded on purchase credit impaired (“PCI”) loans totaled $53,000 and $3,000$358,000 as of September June 30, 2017 and2018. There was no allowance for loan loss recorded on PCI loans as of December 31, 2016, respectively.2017.
Real Estate Construction Loans
Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment, and in some cases, additional collateral. Our construction loans have both adjustable and fixed interest rates during the construction period. Construction loans to individuals are typically priced and made with the intention of granting the permanent loan on the property. Speculative and commercial construction loans are subject to underwriting standards similar to that of the commercial portfolio.  Owner occupied 1-4 family residential construction loans are subject to the underwriting standards of the permanent loan.
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 lending efforts primarily on the origination of loans secured by first mortgages on owner occupied 1-4 family residences.  Substantially all of our 1-4 family residential originations are secured by properties located in or near our market areas.  
Our 1-4 family residential loans generally have maturities ranging from five to 30 years.  These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan.  Our 1-4 family residential loans are made at both fixed and adjustable interest rates.
Underwriting for 1-4 family residential loans includes debt-to-income analysis, credit history analysis, appraised value and down payment considerations. Changes in the market value of real estate can affect the potential losses in the portfolio.
Commercial Real Estate Loans
Commercial real estate loans as of SeptemberJune 30, 20172018 consisted of $975.2 million$1.13 billion of owner and non-owner occupied real estate, $95.5$96.4 million of loans secured by multi-family properties and $2.9$19.6 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. Management does not consider there to be a risk in any one industry type. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years.

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Commercial Loans
Our commercial loans are diversified loan types including short-term working capital loans for inventory and accounts receivable and short- and medium-term loans for equipment or other business capital expansion.  Management does not consider there to be a concentration of risk in any one industry type. In our commercial loan underwriting, we assess the creditworthiness, ability to repay, and the value and liquidity of the collateral being offered.  Terms of commercial loans are generally commensurate with the useful life of the collateral offered.
Municipal Loans
We have a specific lending department that makes loans to municipalities and school districts primarily throughout the state of Texas.  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 assists in limiting our exposure.
Allowance for Loan Losses
The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes.  First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in the historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral.  These recommendations are reviewed by senior loan administration, the special assets department, and the loan review department on a monthly basis.  Third, the loan review department independently reviews the portfolio on an annual basis.  The loan review department follows a board-approved annual loan review scope.  The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan.  The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater.  The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible.  If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list (“Watch List”) of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated quarterly based on actual charge-off experience and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans.
Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of our loans will require partial or full charge-off.  Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the

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loan.  Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, and geographic and industry loan concentration.
Credit Quality Indicators
We categorize loans into risk categories on an ongoing basis based on relevant information about the ability of borrowers to service their debt such as:  current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  We use the following definitions for risk ratings:
Pass (Rating 1 – 4) – This rating is assigned to all satisfactory loans.  This category, by definition, consists of acceptable credit.  Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Pass, if deficiencies are in the process of correction.  These loans are not included in the Watch List.
Pass Watch (Rating 5) – These loans require some degree of special treatment, but not due to credit quality.  This category does not include loans specially mentioned or adversely classified; however, particular attention is warranted to characteristics such as:
A lack of, or abnormally extended payment program;
A heavy degree of concentration of collateral without sufficient margin;
A vulnerability to competition through lesser or extensive financial leverage; and
A dependence on a single or few customers or sources of supply and materials without suitable substitutes or alternatives.
Special Mention (Rating 6) – A Special Mention loan has potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in our credit position at some future date.  Special Mention loans are not adversely classified and do not expose us to sufficient risk to warrant adverse classification.
Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful (Rating 8) – Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
All accruing loans are reserved for as a group of similar type credits and included in the general portion of the allowance for loan losses. Loans to individuals and 1-4 family residential loans, including loans not accruing, are collectively evaluated and included in the general portion of the allowance for loan losses. All loans considered troubled debt restructurings (“TDR”) are evaluated individually for impairment.
The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors.  These factors are likely to cause estimated losses to differ from historical loss experience and include:
Changes in lending policies or procedures, including underwriting, collection, charge-off, and recovery procedures;
Changes in local, regional and national economic and business conditions, including entry into new markets;
Changes in the volume or type of credit extended;
Changes in the experience, ability, and depth of lending management;
Changes in the volume and severity of past due, nonaccrual, restructured, or classified loans;
Changes in charge-off trends;
Changes in loan review or Board oversight;
Changes in the level of concentrations of credit; and
Changes in external factors, such as competition and legal and regulatory requirements.

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These factors are also considered for the non-PCI purchased Omni loan portfolio specifically in regards to changes in credit quality, past due, nonaccrual and charge-off trends.
The following tables detail activity in the allowance for loan losses by portfolio segment for the periods presented (in thousands):
                          
Three Months Ended September 30, 2017Three Months Ended June 30, 2018
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Balance at beginning of period$3,573
 $2,392
 $9,970
 $1,624
 $765
 $917
 $19,241
$3,597
 $2,377
 $14,089
 $2,385
 $851
 $921
 $24,220
Provision (reversal) for loan losses (1)(2)
(20) 34
 383
 189
 41
 333
 960
244
 403
 (57) 328
 8
 355
 1,281
Loans charged off
 (11) 
 (73) 
 (593) (677)
 (57) 
 (172) 
 (688) (917)
Recoveries of loans charged off
 10
 2
 89
 
 246
 347

 7
 4
 19
 
 458
 488
Balance at end of period$3,553
 $2,425
 $10,355
 $1,829
 $806
 $903
 $19,871
$3,841
 $2,730
 $14,036
 $2,560
 $859
 $1,046
 $25,072
Nine Months Ended September 30, 2017Six Months Ended June 30, 2018
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Balance at beginning of period (1)
$4,147
 $2,665
 $7,204
 $2,263
 $750
 $882
 $17,911
$3,676
 $2,445
 $10,821
 $2,094
 $860
 $885
 $20,781
Provision (reversal) for loan losses (1)(2)
(560) 46
 3,140
 (84) 56
 806
 3,404
179
 321
 3,209
 661
 (1) 647
 5,016
Loans charged off(35) (299) 
 (650) 
 (1,835) (2,819)(14) (57) 
 (257) 
 (1,356) (1,684)
Recoveries of loans charged off1
 13
 11
 300
 
 1,050
 1,375

 21
 6
 62
 
 870
 959
Balance at end of period$3,553
 $2,425
 $10,355
 $1,829
 $806
 $903
 $19,871
$3,841
 $2,730
 $14,036
 $2,560
 $859
 $1,046
 $25,072
                          
Three Months Ended September 30, 2016Three Months Ended June 30, 2017
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans 
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans 
 
Municipal
Loans
 
Loans to
Individuals
 Total
Balance at beginning of period$4,423
 $1,686
 $4,680
 $2,474
 $737
 $908
 $14,908
$3,407
 $2,317
 $8,787
 $2,259
 $746
 $969
 $18,485
Provision (reversal) for loan losses (1)(2)
734
 574
 556
 (682) 1
 448
 1,631
182
 74
 1,180
 (161) 19
 52
 1,346
Loans charged off
 (24) 
 (452) 
 (781) (1,257)(17) (1) 
 (574) 
 (496) (1,088)
Recoveries of loans charged off
 7
 6
 344
 
 354
 711
1
 2
 3
 100
 
 392
 498
Balance at end of period$5,157
 $2,243
 $5,242
 $1,684
 $738
 $929
 $15,993
$3,573
 $2,392
 $9,970
 $1,624
 $765
 $917
 $19,241

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Nine Months Ended September 30, 2016Six Months Ended June 30, 2017
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans (2)
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
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
$4,147
 $2,665
 $7,204
 $2,263
 $750
 $882
 $17,911
Provision (reversal) for loan losses (1)(2)
538
 (449) 648
 6,032
 (236) 1,182
 7,715
(540) 12
 2,757
 (273) 15
 473
 2,444
Loans charged off
 (43) 
 (11,375) 
 (2,283) (13,701)(35) (288) 
 (577) 
 (1,242) (2,142)
Recoveries of loans charged off269
 140
 17
 431
 249
 1,137
 2,243
1
 3
 9
 211
 
 804
 1,028
Balance at end of period$5,157
 $2,243
 $5,242
 $1,684
 $738
 $929
 $15,993
$3,573
 $2,392
 $9,970
 $1,624
 $765
 $917
 $19,241
(1) Loans acquired with the Diboll acquisition were measured at fair value on November 30, 2017 with no carryover of allowance for loan loss.
(1)(2)
Of the $960,000$1.3 million and $3.4$5.0 million recorded in provision for loan losses for the three and ninesix months ended SeptemberJune 30, 2017, $50,0002018, $358,000 related to provision expense on PCI loans. Of the $1.6$1.3 million and $2.4 million recorded in provision for loan losses for the three and six months ended SeptemberJune 30, 20162017, none related to provision expense on PCI loans. Of the $7.7 million recorded in provision for loan losses for the nine months ended September 30, 2016, approximately $1.4 million related to provision expense on PCI loans.
(2)
Of the $11.4 million in commercial charge-offs recorded for the nine months ended September 30, 2016, $10.9 million includes the partial charge-off of two large commercial borrowing relationships.

The following tables present the balance in the allowance for loan losses by portfolio segment based on impairment method (in thousands):
As of September 30, 2017As of June 30, 2018
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Ending balance – individually evaluated for impairment (1)
$7
 $12
 $15
 $175
 $10
 $100
 $319
$14
 $40
 $4,445
 $330
 $10
 $86
 $4,925
Ending balance – collectively evaluated for impairment3,546
 2,413
 10,340
 1,654
 796
 803
 19,552
3,827
 2,690
 9,591
 2,230
 849
 960
 20,147
Balance at end of period$3,553
 $2,425
 $10,355
 $1,829
 $806
 $903
 $19,871
$3,841
 $2,730
 $14,036
 $2,560
 $859
 $1,046
 $25,072
As of December 31, 2016As of December 31, 2017
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Ending balance – individually evaluated for impairment (1)
$13
 $16
 $17
 $923
 $11
 $106
 $1,086
$12
 $14
 $14
 $252
 $10
 $51
 $353
Ending balance – collectively evaluated for impairment4,134
 2,649
 7,187
 1,340
 739
 776
 16,825
3,664
 2,431
 10,807
 1,842
 850
 834
 20,428
Balance at end of period$4,147
 $2,665
 $7,204
 $2,263
 $750
 $882
 $17,911
$3,676
 $2,445
 $10,821
 $2,094
 $860
 $885
 $20,781

(1)
The allowance for loan loss on PCI loans totaled $358,000 as of June 30, 2018. There was approximately $53,000 and $3,000 ofno allowance for loan losses associated with PCI loans as of September 30, 2017 and December 31, 2016, respectively.2017.









23
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The following tables present the recorded investment in loans by portfolio segment based on impairment method (in thousands):
September 30, 2017June 30, 2018
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Loans individually evaluated for impairment$90
 $1,629
 $1,078
 $941
 $502
 $243
 $4,483
$118
 $1,612
 $30,967
 $1,419
 $502
 $260
 $34,878
Loans collectively evaluated for impairment420,286
 602,102
 1,071,148
 165,027
 321,784
 89,965
 2,670,312
486,262
 778,153
 1,193,051
 278,290
 345,093
 116,957
 3,197,806
Purchased credit impaired loans121
 5,428
 1,420
 951
 
 51
 7,971
906
 11,594
 21,918
 3,014
 
 767
 38,199
Total ending loan balance$420,497
 $609,159
 $1,073,646
 $166,919
 $322,286
 $90,259
 $2,682,766
$487,286
 $791,359
 $1,245,936
 $282,723
 $345,595
 $117,984
 $3,270,883
December 31, 2016December 31, 2017
Real Estate        Real Estate        
Construction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 TotalConstruction 
1-4 Family
Residential
 Commercial 
Commercial
Loans
 
Municipal
Loans
 
Loans to
Individuals
 Total
Loans individually evaluated for impairment$480
 $1,693
 $1,184
 $5,840
 $571
 $241
 $10,009
$86
 $1,581
 $895
 $1,429
 $502
 $205
 $4,698
Loans collectively evaluated for impairment379,526
 629,893
 942,818
 170,159
 298,012
 116,923
 2,537,331
475,505
 797,111
 1,232,327
 259,745
 345,296
 134,441
 3,244,425
Purchased credit impaired loans169
 5,653
 1,976
 1,266
 
 133
 9,197
276
 6,649
 31,937
 5,248
 
 1,123
 45,233
Total ending loan balance$380,175
 $637,239
 $945,978
 $177,265
 $298,583
 $117,297
 $2,556,537
$475,867
 $805,341
 $1,265,159
 $266,422
 $345,798
 $135,769
 $3,294,356

The following tables set forth credit quality indicators by class of loans for the periods presented (in thousands):
September 30, 2017June 30, 2018
Pass 
Pass Watch (1)
 
Special Mention (1)
 
Substandard (1)
 
Doubtful (1)
 TotalPass 
Pass Watch (1)
 
Special Mention (1)
 
Substandard (1)
 
Doubtful (1)
 Total
Real Estate Loans:                      
Construction$420,118
 $
 $
 $365
 $14
 $420,497
$479,518
 $765
 $6,088
 $861
 $54
 $487,286
1-4 Family Residential603,761
 35
 
 4,996
 367
 609,159
781,663
 639
 868
 6,616
 1,573
 791,359
Commercial961,054
 16,189
 43,423
 52,826
 154
 1,073,646
1,111,236
 20,946
 64,563
 48,361
 830
 1,245,936
Commercial Loans157,449
 955
 4,760
 3,480
 275
 166,919
274,827
 1,323
 3,712
 2,633
 228
 282,723
Municipal Loans320,854
 
 930
 502
 
 322,286
344,234
 
 859
 502
 
 345,595
Loans to Individuals89,419
 
 31
 466
 343
 90,259
116,922
 42
 48
 704
 268
 117,984
Total$2,552,655
 $17,179
 $49,144
 $62,635
 $1,153
 $2,682,766
$3,108,400
 $23,715
 $76,138
 $59,677
 $2,953
 $3,270,883
 December 31, 2016
 Pass 
Pass Watch (1)
 
Special Mention (1)
 
Substandard (1)
 
Doubtful (1)
 Total
Real Estate Loans:           
Construction$374,443
 $34
 $571
 $5,108
 $19
 $380,175
1-4 Family Residential632,937
 68
 
 3,380
 854
 637,239
Commercial885,049
 17,739
 10,587
 32,603
 
 945,978
Commercial Loans158,943
 1,187
 8,086
 9,012
 37
 177,265
Municipal Loans297,014
 
 998
 571
 
 298,583
Loans to Individuals115,952
 
 9
 629
 707
 117,297
Total$2,464,338
 $19,028
 $20,251
 $51,303
 $1,617
 $2,556,537


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 December 31, 2017
 Pass 
Pass Watch (1)
 
Special Mention (1)
 
Substandard (1)
 
Doubtful (1)
 Total
Real Estate Loans:           
Construction$471,446
 $3,329
 $77
 $982
 $33
 $475,867
1-4 Family Residential796,639
 559
 857
 6,610
 676
 805,341
Commercial1,136,576
 26,275
 25,301
 76,625
 382
 1,265,159
Commercial Loans247,430
 9,625
 3,956
 5,203
 208
 266,422
Municipal Loans344,366
 
 930
 502
 
 345,798
Loans to Individuals134,694
 20
 102
 707
 246
 135,769
Total$3,131,151
 $39,808
 $31,223
 $90,629
 $1,545
 $3,294,356

(1)Includes PCI loans comprised of $6,000$161,000 pass watch, $482,000$4.1 million special mention, $2.0$8.2 million substandard and $315,000$1.1 doubtful as of SeptemberJune 30, 2017.2018. Includes PCI loans comprised of $5,000$362,000 pass watch, $511,000$6.0 million special mention, $1.5$10.5 million substandard and $28,000$925,000 doubtful as of December 31, 2016.2017.

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Nonperforming Assets and Past Due Loans

Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected.  Additionally, some loans that are not delinquent or that are delinquent less than 90 days may be placed on nonaccrual status if it is probable that we will not receive contractual principal and interest payments in accordance with the terms of the respective loan agreement. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes.  Payments received on nonaccrual loans are applied to the outstanding principal balance. Payments of contractual interest are recognized as income only to the extent that full recovery of the principal balance of the loan is reasonably certain.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  Other factors, such as the value of collateral securing the loan and the financial condition of the borrower, are considered in judgments as to potential loan loss.

Nonaccrual loans and accruing loans past due more than 90 days include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

PCI loans are recorded at fair value at acquisition date. Although the PCI loans may be contractually delinquent, we do not classify these loans as past due or nonperforming when the timing and amount of expected cash flows can be reasonably estimated, as the loans were written down to fair value at the acquisition date and the accretable yield is recognized in interest income over the remaining life of the loan. However, subsequent to acquisition, we re-assess PCI loans for additional impairment and record additional impairment in the event we conclude it is probable that we will be unable to collect all cash flows originally expected to be collected at acquisition plus any additional cash flows expected to be collected due to changes in estimates after acquisition. All such PCI loans for which we recognize subsequent impairment are reported as impaired loans in the financial statements.



The following table sets forth nonperforming assets for the periods presented (in thousands):
At
September 30,
2017
 At
December 31,
2016
At
June 30,
2018
 At
December 31,
2017
Nonaccrual loans (1)
$3,095
 $8,280
$35,351
 $2,937
Accruing loans past due more than 90 days (1)

 6
7
 1
Restructured loans (2)
5,725
 6,431
5,860
 5,767
Other real estate owned298
 339
1,137
 1,613
Repossessed assets1
 49
68
 154
Total Nonperforming Assets$9,119
 $15,105
$42,423
 $10,472

(1)Excludes PCI loans measured at fair value at acquisition.acquisition if the timing and amount of cash flows expected to be collected from those sales can be reasonably estimated. The increase in nonaccrual loans was primarily the result of the addition of two large commercial real estate relationships consisting of three loans in the first quarter of 2018.
(2)Includes $3.0 million and $3.1$2.9 million in PCI loans restructured as of SeptemberJune 30, 20172018 and December 31, 2016, respectively.2017.

Foreclosed assets include other real estate owned and repossessed assets. For 1-4 family residential real estate properties, a loan is recognized as a foreclosed property once legal title to the real estate property has been received upon completion of foreclosure or the borrower has conveyed all interest in the residential property through a deed in lieu of foreclosure. As of September 30, 2017, thereThere were $27,000$344,000 and $154,000 in loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process. Asprocess as of June 30, 2018 and December 31, 2016, there were $28,000 in loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process.










25

Table of Contents

2017, respectively.

The following table sets forth the recorded investment in nonaccrual loans by class of loans for the periods presented (in thousands). The table excludes PCI loans measured at fair value at acquisition:

26

Table of Contents


Nonaccrual LoansNonaccrual Loans
September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Real Estate Loans:      
Construction$90
 $105
$119
 $86
1-4 Family Residential1,127
 1,067
1,795
 1,098
Commercial765
 808
32,146
 595
Commercial Loans641
 5,477
951
 903
Loans to Individuals472
 823
340
 255
Total$3,095
 $8,280
$35,351
 $2,937
Loans are considered impaired if, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for larger loans. The measurement of loss on impaired loans is generally based on the fair value of the collateral less selling costs if repayment is expected solely from the collateral or the present value of the expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions, such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation. Loans that are evaluated and determined not to meet the definition of an impaired loan are reserved for at the general reserve rate for its appropriate class.

At the time a loss is probable in the collection of contractual amounts, specific reserves are allocated.  Loans are charged off to the liquidation value of the collateral net of liquidation costs, if any, when deemed uncollectible or as soon as collection by liquidation is evident.

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Table of Contents



The following tables set forth impaired loans by class of loans for the periods presented (in thousands). Impaired loans include restructured and nonaccrual loans for which the allowance was measured in accordance with section 310-10 of ASC Topic 310, “Receivables.” There were no impaired loans recorded without an allowance as of SeptemberJune 30, 20172018 or December 31, 2016.2017.
 September 30, 2017
 Unpaid Contractual Principal Balance Recorded Investment 
Related
 Allowance for
 Loan Losses
Real Estate Loans:     
Construction$94
 $90
 $7
1-4 Family Residential4,351
 4,149
 12
Commercial1,531
 1,433
 15
Commercial Loans1,442
 1,304
 175
Municipal Loans502
 502
 10
Loans to Individuals276
 243
 100
Total (1)
$8,196
 $7,721
 $319


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Table of Contents

 June 30, 2018
 Unpaid Contractual Principal Balance Recorded Investment 
Related
 Allowance for
 Loan Losses
Real Estate Loans:     
Construction$347
 $308
 $14
1-4 Family Residential4,219
 4,007
 40
Commercial33,624
 32,999
 4,445
Commercial Loans3,257
 2,742
 330
Municipal Loans502
 502
 10
Loans to Individuals319
 288
 86
Total (1)
$42,268
 $40,846
 $4,925

December 31, 2016December 31, 2017
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
 
Related
 Allowance for
 Loan Losses
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
 
Related
 Allowance for
 Loan Losses
Real Estate Loans:          
Construction$486
 $480
 $13
$91
 $86
 $12
1-4 Family Residential4,487
 4,264
 16
4,141
 3,952
 14
Commercial1,631
 1,574
 17
1,353
 1,199
 14
Commercial Loans6,108
 5,941
 923
1,665
 1,605
 252
Municipal Loans571
 571
 11
502
 502
 10
Loans to Individuals277
 241
 106
237
 205
 51
Total (1)
$13,560
 $13,071
 $1,086
$7,989
 $7,549
 $353

(1)
Includes $3.2$6.0 million and $3.1$2.9 million of PCI loans that experienced deterioration in credit quality subsequent to the acquisition date as of SeptemberJune 30, 20172018 and December 31, 2016,2017, respectively.

The following tables present the aging of the recorded investment in past due loans by class of loans (in thousands):
 September 30, 2017
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 Greater than 90 Days Past Due 
Total Past
Due
 
Current (1)
 Total
Real Estate Loans:           
Construction$5,471
 $
 $75
 $5,546
 $414,951
 $420,497
1-4 Family Residential98
 340
 817
 1,255
 607,904
 609,159
Commercial577
 
 154
 731
 1,072,915
 1,073,646
Commercial Loans91
 177
 14
 282
 166,637
 166,919
Municipal Loans
 
 
 
 322,286
 322,286
Loans to Individuals411
 157
 192
 760
 89,499
 90,259
Total$6,648
 $674
 $1,252
 $8,574
 $2,674,192
 $2,682,766
 December 31, 2016
 30-59 Days Past Due 60-89 Days Past Due 
Greater than 90 Days
Past Due
 
Total Past
Due
 
Current (1)
 Total
Real Estate Loans:           
Construction$917
 $64
 $86
 $1,067
 $379,108
 $380,175
1-4 Family Residential6,225
 755
 600
 7,580
 629,659
 637,239
Commercial70
 154
 154
 378
 945,600
 945,978
Commercial Loans783
 300
 3,459
 4,542
 172,723
 177,265
Municipal Loans113
 
 
 113
 298,470
 298,583
Loans to Individuals1,550
 320
 185
 2,055
 115,242
 117,297
Total$9,658
 $1,593
 $4,484
 $15,735
 $2,540,802
 $2,556,537

(1)    Includes PCI loans measured at fair value at acquisition.






 June 30, 2018
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 Greater than 90 Days Past Due 
Total Past
Due
 
Current (1)
 Total
Real Estate Loans:           
Construction$501
 $25
 $104
 $630
 $486,656
 $487,286
1-4 Family Residential1,509
 1,098
 1,262
 3,869
 787,490
 791,359
Commercial1,327
 150
 532
 2,009
 1,243,927
 1,245,936
Commercial Loans947
 1,553
 355
 2,855
 279,868
 282,723
Municipal Loans
 
 
 
 345,595
 345,595
Loans to Individuals1,070
 262
 159
 1,491
 116,493
 117,984
Total$5,354
 $3,088
 $2,412
 $10,854
 $3,260,029
 $3,270,883

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 December 31, 2017
 30-59 Days Past Due 60-89 Days Past Due 
Greater than 90 Days
Past Due
 
Total Past
Due
 
Current (1)
 Total
Real Estate Loans:           
Construction$1,302
 $1,530
 $68
 $2,900
 $472,967
 $475,867
1-4 Family Residential8,508
 1,574
 862
 10,944
 794,397
 805,341
Commercial1,357
 24
 5
 1,386
 1,263,773
 1,265,159
Commercial Loans662
 400
 333
 1,395
 265,027
 266,422
Municipal Loans422
 
 
 422
 345,376
 345,798
Loans to Individuals1,526
 373
 93
 1,992
 133,777
 135,769
Total$13,777
 $3,901
 $1,361
 $19,039
 $3,275,317
 $3,294,356

(1)    Excludes PCI loans measured at fair value at acquisition if the timing and amount of cash flows expected to be collected from those sales can be reasonably estimated.

The following table sets forth average recorded investment and interest income recognized on impaired loans by class of loans for the periods presented (in thousands). The table excludes PCI loans measured at fair value at acquisition that have not experienced further deterioration in credit quality subsequent to the acquisition date:
              
Three Months EndedThree Months Ended
September 30, 2017 September 30, 2016June 30, 2018 June 30, 2017
Average Recorded Investment Interest Income Recognized 
Average Recorded Investment 
 Interest Income RecognizedAverage Recorded Investment Interest Income Recognized 
Average Recorded Investment 
 Interest Income Recognized
Real Estate Loans:              
Construction$62
 $
 $564
 $5
$140
 $1
 $344
 $
1-4 Family residential4,170
 26
 4,559
 42
3,955
 47
 4,476
 50
Commercial1,459
 2
 4,281
 21
31,916
 5
 1,158
 10
Commercial loans1,148
 28
 7,457
 13
2,024
 19
 3,050
 18
Municipal loans537
 7
 604
 8
502
 7
 571
 8
Loans to individuals250
 1
 275
 2
242
 3
 226
 1
Total$7,626
 $64
 $17,740
 $91
$38,779
 $82
 $9,825
 $87
Nine Months EndedSix Months Ended
September 30, 2017 September 30, 2016June 30, 2018 June 30, 2017
Average Recorded Investment Interest Income Recognized Average Recorded
Investment
 Interest Income RecognizedAverage Recorded Investment Interest Income Recognized Average Recorded
Investment
 Interest Income Recognized
Real Estate Loans:              
Construction$301
 $
 $519
 $17
$114
 $1
 $402
 $
1-4 Family Residential4,322
 134
 2,915
 124
3,945
 93
 4,390
 107
Commercial1,368
 27
 4,952
 64
20,595
 9
 1,322
 25
Commercial Loans3,320
 118
 15,990
 30
1,900
 36
 4,244
 36
Municipal Loans558
 23
 624
 26
502
 14
 571
 15
Loans to Individuals248
 4
 262
 6
221
 4
 248
 3
Total$10,117
 $306
 $25,262
 $267
$27,277
 $157
 $11,177
 $186


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Table of Contents


Troubled Debt Restructurings

The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.  Concessions may include interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. We may provide a combination of concessions which may include an extension of the amortization period, interest rate reduction, and/or converting the loan to interest-only for a limited period of time.

The following tables set forth the recorded balance of loans considered to be TDRs that were restructured and the type of concession during the periods presented (dollars in thousands):
          
 Three Months Ended September 30, 2017
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Loans to Individuals$
 $
 $8
 $8
 1
Total$
 $
 $8
 $8
 1

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Table of Contents


          
 Three Months Ended June 30, 2018
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Real Estate Loans:         
1-4 Family Residential$
 $80
 $
 $80
 1
Commercial Loans
 
 90
 90
 2
Loans to Individuals9
 
 13
 22
 3
Total$9
 $80
 $103
 $192
 6
Nine Months Ended September 30, 2017Six Months Ended June 30, 2018
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Real Estate Loans:         
1-4 Family Residential$
 $80
 $
 $80
 1
Commercial Loans$810
 $
 $
 $810
 3
132
 
 90
 222
 5
Loans to Individuals27
 
 56
 83
 6
106
 
 13
 119
 4
Total$837
 $
 $56
 $893
 9
$238
 $80
 $103
 $421
 10
          
 Three Months Ended September 30, 2016
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Real Estate Loans:         
1-4 Family Residential$
 $
 $30
 $30
 2
Total$
 $
 $30
 $30
 2
          
 Three Months Ended June 30, 2017
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Commercial Loans$797
 $
 $
 $797
 2
Loans to Individuals23
 
 40
 63
 3
Total$820
 $
 $40
 $860
 5
 Nine Months Ended September 30, 2016
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Real Estate Loans:         
Construction$375
 $
 $23
 $398
 2
1-4 Family Residential
 73
 2,737
 2,810
 5
Commercial2,068
 
 
 2,068
 1
Commercial Loans1,082
 
 
 1,082
 4
Loans to Individuals19
 
 72
 91
 6
Total$3,544
 $73
 $2,832
 $6,449
 18
 Six Months Ended June 30, 2017
 
Extend Amortization
 Period
 Interest Rate Reductions Combination Total Modifications Number of Loans
Commercial Loans$841
 $
 $
 $841
 3
Loans to Individuals29
 
 51
 80
 5
Total$870
 $
 $51
 $921
 8
The majority of loans restructured as TDRs during the ninesix months ended SeptemberJune 30, 20172018 and 20162017 were modified with maturity extensions. Interest continues to be charged on principal balances outstanding during the extended term. Therefore, the financial effects of the recorded investment of loans restructured as TDRs during the ninesix months ended SeptemberJune 30, 20172018 and 20162017 were not significant. Generally, the loans identified as TDRs were previously reported as impaired loans prior to restructuring and therefore the modification did not impact our determination of the allowance for loan losses.

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On an ongoing basis, the performance of the TDRs is monitored for subsequent payment default. Payment default for TDRs is recognized when the borrower is 90 days or more past due. For the three and ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, the amount of TDRs in default was not significant. Payment defaults for TDRs did not significantly impact the determination of the allowance for loan loss in either period presented.
At SeptemberJune 30, 20172018 and 2016,2017, there were no commitments to lend additional funds to borrowers whose terms had been modified in TDRs.


Purchased Credit Impaired Loans

The following table presents the outstanding principal balance and carrying value for PCI loans for the periods presented (in thousands):
 September 30, 2017 December 31, 2016
Outstanding principal balance$8,878
 $10,612
Carrying amount$7,971
 $9,197


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 June 30, 2018 December 31, 2017
Outstanding principal balance$44,040
 $52,426
Carrying amount$38,199
 $45,233

The following table presents the changes in the accretable yield during the periods for PCI loans (in thousands):
Three Months Ended
September 30,
 Nine Months Ended
September 30,
Three Months Ended
June 30,
 Six Months Ended
June 30,
2017 2016 2017 20162018 2017 2018 2017
Balance at beginning of period$3,758
 $1,598
 $2,480
 $2,493
$15,818
 $4,003
 $18,721
 $2,480
Changes in expected cash flows not affecting non-accretable differences
 
 (1,445) 
Reclassifications (to) from nonaccretable discount(79) 1,558
 1,735
 1,731
1,090
 (5) 770
 1,814
Accretion(156) (336) (692) (1,404)(803) (240) (1,941) (536)
Balance at end of period$3,523
 $2,820
 $3,523
 $2,820
$16,105
 $3,758
 $16,105
 $3,758


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7. Long-term ObligationsBorrowing Arrangements

Long-term obligations are summarized as follows (inInformation related to borrowings is provided in the table below (dollars in thousands):
 September 30,
2017
 December 31,
2016
Parent Company   
Subordinated notes: (1)
   
5.50% Subordinated Notes Due 2026, net of unamortized debt issuance costs (2)
$98,209
 $98,100
Total Subordinated notes98,209
 98,100
Long-term debt: (3)
   
Southside Statutory Trust III Due 2033, net of unamortized debt issuance costs (4)
20,548
 20,544
Southside Statutory Trust IV Due 2037 (5)
23,196
 23,196
Southside Statutory Trust V Due 2037 (6)
12,887
 12,887
Magnolia Trust Company I Due 2035 (7)
3,609
 3,609
Total Long-term debt60,240
 60,236
Total Parent Company158,449
 158,336
    
Subsidiaries   
FHLB advances (8)
152,056
 443,128
Total Subsidiaries152,056
 443,128
Total Long-term obligations$310,505
 $601,464

  June 30, 2018 December 31, 2017
Federal funds purchased and repurchase agreements:    
Balance at end of period $8,287
 $9,498
Average amount outstanding during the period (1) (5)
 8,696
 8,120
Maximum amount outstanding during the period (2)
 8,287
 9,498
Weighted average interest rate during the period (3) (5)
 1.0% 0.2%
Interest rate at end of period (4)
 0.8% 0.2%
     
FHLB borrowings:  
  
Balance at end of period $776,467
 $1,017,361
Average amount outstanding during the period (1) (5)
 809,879
 1,222,033
Maximum amount outstanding during the period (2)
 957,231
 1,414,453
Weighted average interest rate during the period (3) (5)
 1.7% 1.2%
Interest rate at end of period (4)
 2.0% 1.4%
     
Subordinated notes, net of unamortized debt issuance costs:    
Balance at end of period $98,326
 $98,248
Average amount outstanding during the period (1) (5)
 98,287
 98,172
Maximum amount outstanding during the period (2)
 98,326
 98,248
Weighted average interest rate during the period (3) (5)
 5.8% 5.7%
Interest rate at end of period (4)
 5.5% 5.5%
     
Trust preferred subordinated debentures, net of unamortized debt issuance costs: 

 

Balance at end of period $60,243
 $60,241
Average amount outstanding during the period (1) (5)
 60,242
 60,238
Maximum amount outstanding during the period (2)
 60,243
 60,241
Weighted average interest rate during the period (3) (5)
 4.1% 3.3%
Interest rate at end of period (4)
 4.4% 3.6%
(1)This long-term debt consistsThe average amount outstanding during the period was computed by dividing the total daily outstanding principal balances by the number of subordinated notes with a remaining maturity greater than one year that qualify underdays in the risk-based capital guidelines as Tier 2 capital, subject to certain limitations.period.
(2)
This debt carries a fixed rate of 5.50% through September 29, 2021 and thereafter, adjusts quarterlyThe maximum amount outstanding at a rate equal to three-month LIBOR plus 429.7 basis points.
any month-end during the period.
(3)This long-term debt consistsThe weighted average interest rate during the period was computed by dividing the actual interest expense (annualized for interim periods) by the average amount outstanding during the period. The weighted average interest rate on the FHLB borrowings includes the effect of trust preferred securities that qualify under the risk-based capital guidelines as Tier 1 capital, subject to certain limitations.interest rate swaps.
(4)
This debt carries an adjustable rate of 4.275% through December 30, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 294 basis points.
Stated rate.
(5)
This debt carries an adjustable rate of 2.61111% through October 29, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 130 basis points.
(6)
This debt carries an adjustable rate of 3.57% through December 14, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 225 basis points.
(7)
This debt carries an adjustable rate of 3.11444% through November 23, 2017 and adjusts quarterly at a rate equal to three-month LIBOR plus 180 basis points.
(8)At September 30, 2017, the weighted average cost of these advances was 1.8%.  Long-term FHLB advances have maturities ranging from October 2018 through July 2028.Interim period averages are annualized.

On September 19, 2016, the Company issued $100.0 million aggregate principal amount of fixed-to-floating rate subordinated notes that mature on September 30, 2026. This debt initially bears interest at a fixed rate of 5.50% through September 29, 2021 and thereafter, adjusts quarterly at a floating rate equal to three-month LIBOR plus 429.7 basis points. The proceeds from the sale of the subordinated notes were used for general corporate purposes, which included advances to the Bank to finance its

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activities. The unamortized discount and debt issuance costs reflected in the carrying amountMaturities of the subordinated notes totaled approximately $1.8 millionfixed rate obligations based on scheduled repayments at SeptemberJune 30, 2017 and $1.9 million at December 31, 2016.2018 are as follows (in thousands):
  Payments Due by Period
  Less than 1 Year 1-2 Years 2-3 Years 3-4 Years 4-5 Years Thereafter Total
Federal funds purchased and repurchase agreements $8,031
 $256
 $
 $
 $
 $
 $8,287
FHLB borrowings 348,007
 400,665
 21,590
 
 
 6,205
 776,467
Subordinated notes, net of unamortized debt issuance costs 
 
 
 
 
 98,326
 98,326
Trust preferred subordinated debentures, net of unamortized debt issuance costs 
 
 
 
 ��
 60,243
 60,243
Total obligations $356,038
 $400,921
 $21,590
 $
 $
 $164,774
 $943,323

The unamortized debt issuance costs reflected in the carrying amountFHLB borrowings represent borrowings with fixed and floating interest rates ranging from 1.37% to 4.799% and with remaining maturities of the Southside Statutory Trust III junior subordinated debentures totaled $71,000 at September 30, 2017 and $75,000 at December 31, 2016.

five days to 10.1 years.  FHLB borrowings may be collateralized by FHLB stock, nonspecified loans and/or securities.
From time to time, the Company may enter into various variable rate advancesadvance agreements with the FHLB. These advancesadvance agreements totaled $310.0 million at June 30, 2018 and $280.0 million at September 30, 2017 and $250.0 million at December 31, 2016.2017. Two of the variable rate advancesadvance agreements have interest rates of three-month LIBOR plus 0.021%, and one has an interest rate of three-month LIBOR minus 25 basis points.0.003%. The remaining advancesadvance agreements have interest rates ranging from one-month LIBOR plus 0.17%0.072% to one-month LIBOR plus 0.278%0.164%. In connection with obtaining some of these advances,variable rate advance agreements, the Company also entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that effectively converted the variable rate advancesadvance agreements to fixed interest rates ranging from 0.932% to 2.345%2.832% and original terms ranging from fourfive years to ten years. The cash flows from the swaps are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the one-month and three-month LIBOR interest rates. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges having a total notional value of $40.0 million. At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. These transactions are reevaluated on a monthly basis thereafter, to determine if the hedged forecasted transactions are still probable of occurring. If at a subsequent evaluation it is determined that the transactions will not occur, any related gains or losses recorded in AOCI are immediately recognized in earnings. Refer to “Note 10 - Derivative Financial Instruments and Hedging Activities” in our consolidated financial statements included in this report for a detailed description of our hedging policy and methodology related to derivative instruments.
Southside Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB – The Independent Bankers Bank and Comerica Bank for $40.0 million, $15.0 million and $7.5 million, respectively. There were no federal funds purchased at June 30, 2018 or December 31, 2017.  Southside Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit, and at June 30, 2018, we had one outstanding letter of credit for $195,000. At June 30, 2018, the amount of additional funding Southside Bank could obtain from FHLB, collateralized by FHLB stock, nonspecified loans and securities, was approximately $1.08 billion, net of FHLB stock purchases required.  Southside Bank currently has no outstanding letters of credit from FHLB held as collateral for its public fund deposits.
Southside Bank enters into sales of securities under agreements to repurchase (“repurchase agreements”). These repurchase agreements totaled $8.3 million and $9.5 million at June 30, 2018 and December 31, 2017, respectively, and had maturities of less than two years.  These repurchase agreements are secured by investment securities and are stated at the amount of cash received in connection with the transaction.


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8.     Employee Benefit Plans

The components of net periodic benefit cost (income) related to our employee benefit plans are as follows (in thousands):
                        
 Three Months Ended September 30, Three Months Ended June 30,
 Defined Benefit
Pension Plan
 Defined Benefit Pension Plan Acquired Restoration
Plan
 Defined Benefit
Pension Plan
 Defined Benefit Pension Plan Acquired Restoration
Plan
 2017 2016 2017 2016 2017 2016 2018 2017 2018 2017 2018 2017
Service cost $349
 $347
 $
 $
 $61
 $52
 $390
 $341
 $
 $
 $84
 $73
Interest cost 901
 928
 44
 53
 142
 133
 839
 888
 41
 44
 165
 151
Expected return on assets (1,513) (1,306) (53) (66) 
 
 (1,622) (1,513) (72) (53) 
 
Net loss amortization 328
 412
 
 
 75
 46
 372
 312
 
 
 248
 104
Prior service (credit) cost amortization (3) (12) 
 
 2
 2
 (4) (3) 
 
 2
 1
Net periodic benefit cost (income) $62
 $369
 $(9) $(13) $280
 $233
 $(25) $25
 $(31) $(9) $499
 $329
 Nine Months Ended September 30, Six Months Ended June 30,
 Defined Benefit
Pension Plan
 Defined Benefit Pension Plan Acquired Restoration
Plan
 Defined Benefit
Pension Plan
 Defined Benefit Pension Plan Acquired Restoration
Plan
 2017 2016 2017 2016 2017 2016 2018 2017 2018 2017 2018 2017
Service cost $1,048
 $1,031
 $
 $
 $185
 $155
 $774
 $699
 $
 $
 $147
 $124
Interest cost 2,701
 2,798
 133
 159
 425
 401
 1,696
 1,800
 82
 89
 298
 283
Expected return on assets (4,538) (3,917) (160) (199) 
 
 (3,242) (3,025) (145) (107) 
 
Net loss amortization 984
 1,232
 
 
 226
 139
 756
 656
 
 
 339
 151
Prior service (credit) cost amortization (10) (11) 
 
 5
 5
 (7) (7) 
 
 3
 3
Special and contractual termination benefits 
 1,549
 
 
 
 
Net periodic benefit cost (income) $185
 $2,682
 $(27) $(40) $841
 $700
 $(23) $123
 $(63) $(18) $787
 $561

The service cost component is recorded on our consolidated income statement as salaries and employee benefits in noninterest expense while all other components other than service cost are recorded in other noninterest expense.


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9.    Share-based Incentive Plans
2017 Incentive Plan
On May 10, 2017, our shareholders approved the Southside Bancshares, Inc. 2017 Incentive Plan (the “2017 Incentive Plan”), which is a stock-based incentive compensation plan.  A total of 2,050,0002,460,000 shares of our common stock were reserved and available for issuance pursuant to awards granted under the 2017 Incentive Plan, plusPlan. This amount includes a number of additional shares (not to exceed 410,000) underlying awards outstanding as of May 10, 2017 under the Company’s 2009 Incentive Plan that thereafter terminate or expire

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unexercised, or are cancelled, forfeited or lapse for any reason.  Under the 2017 Incentive Plan, we are authorized to grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, and qualified performance-based awards or any combination thereof to selected employees, officers, directors and consultants of the Company and its Affiliates. affiliates. As of June 30, 2018, there were 1,670,751 shares remaining available for grant for future awards. 
All share data for all periods presented has been adjusted to give retroactive recognition to stock dividends unless otherwise indicated. Reference to incentive plans refers to the 2017 Incentive Plan and predecessor incentive plans.
There have been no stock option awards granted during the nine months ended September 30, 2017.  During the nine months ended September 30, 2016, we granted 87,474356,849 nonqualified stock options (“NQSOs”) pursuant togranted during the 2009 Incentive Plansix months ended June 30, 2018 with an exercise price equal to the fair value of the shares at the date of grant with a weighted average exercise price of $25.97.$34.52.  During the six months ended June 30, 2017, there were no stock option awards granted. The NQSOs have contractual terms of 10 years and vest in equal annual installments over either a three- or four-year period. During the ninesix months ended SeptemberJune 30, 2017 and 2016,2018, we granted 3,707 and 18,31552,148 restricted stock units (“RSUs”), respectively, with a total value of $125,000 and $486,000, respectively.$1.8 million. During the six months ended June 30, 2017, there were no RSUs granted. The RSUs vest in equal annual installments over either a one-, three- or four-year period.
Historically, shares issued in connection with stock compensation awards have been issued from available authorized shares. Beginning in the second quarter of 2017, shares were issued from available treasury shares. Shares issued in connection with stock compensation awards along with other related information were as followsare presented in the following table without the retroactive recognition of stock dividends (in thousands, except per share amounts):
Three Months Ended
September 30,
 Nine Months Ended
September 30,
Three Months Ended
June 30,
 Six Months Ended
June 30,
2017 2016 2017 20162018 2017 2018 2017
New shares issued from available authorized shares
 16,300
 48,311
 39,468

 14,715
 
 48,311
New shares issued from available treasury shares77,957
 
 89,724
 
20,872
 11,767
 63,051
 11,767
Total77,957
 16,300
 138,035
 39,468
20,872
 26,482
 63,051
 60,078
              
Proceeds from stock option exercises$1,505
 $224
 $2,527
 $418
$283
 $383
 $1,084
 $1,022
For the three and ninesix months ended SeptemberJune 30, 2017,2018, we had share-based compensation expense of $480,000$509,000 and $1.4 million,$965,000, respectively. Share-based compensation expense for the three and ninesix months ended SeptemberJune 30, 20162017 was $397,000$419,000 and $1.2 million,$913,000, respectively.


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10.    Derivative Financial Instruments and Hedging Activities

Our hedging policy allows the use of interest rate derivative instruments to manage our exposure to interest rate risk or hedge specified assets and liabilities. These instruments may include interest rate swaps and interest rate caps and floors. All derivative instruments are carried on the balance sheet at their estimated fair value and are recorded in other assets or other liabilities, as appropriate.

Derivative instruments may be designated as cash flow hedges of variable rate assets or liabilities, or as cash flow hedges of forecasted transactions.transactions or fair value hedges of a recognized asset or liability. Gains and losses on derivative instruments designated as cash flow hedges are recorded in accumulated other comprehensive incomeAOCI to the extent that they are effective. The amount recorded in other comprehensive income is reclassified to earnings in the same periods that the hedged cash flows impact earnings. The ineffective portion of changes in fair value is reported in current earnings. 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. Gains and losses due to changes in fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the hedged item. Therefore, no gain or loss has been recognized due to hedge ineffectiveness.

From time to time, we enterhave entered into certain interest rate swap contracts on specific variable-ratevariable rate advance agreements with the FHLB. These interest rate swap contracts were designated as hedging instruments in cash flow hedges under ASC Topic 815. The objective of the interest rate swap contracts is to manage the expected future cash flows on $240.0$270.0 million of variable-ratevariable rate advance agreements with the FHLB. The cash flows from the swap are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the underlying LIBOR interest rate.

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 available for sale municipal securities. These partial term hedges of selected cash flows covering the time periods to the call dates of the hedged securities are expected to be effective in offsetting changes in the fair value of the hedged securities. As of June 30, 2018, hedged securities with a carrying amount of $23.6 million are included in our AFS securities portfolio in our consolidated balance sheets. Interest rate swaps designated as partial-term fair value hedges are utilized to mitigate the effect of changing interest rates on the hedged securities. The hedging strategy converts a portion of the fixed interest rates on the securities to LIBOR-based variable interest rates.
In accordance with ASC Topic 815, if a hedging item is terminated prior to maturity for a cash settlement, the existing gain or loss within accumulated other comprehensive incomeAOCI will continue to be reclassified into earnings during the period or periods in which the hedged forecasted transaction affects earnings unless it is probable that the forecasted transaction will not occur by the end of the originally specified time period. If the forecasted transaction is deemed probable to not occur, the derivative gain or loss reported in accumulated other comprehensive incomeAOCI shall be reclassified into earnings immediately. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges. At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. The existing gain in accumulated other comprehensive incomeAOCI will be reclassified into earnings in the same periods the hedged forecasted transaction affects earnings.
At September 30, 2017, net derivative assets included $5.6 million of cash collateral received from counterparties under master netting agreements and net derivative liabilities included $1.2 million of cash collateral held by a counterparty subject to a master netting agreement. At September 30, 2017, we had $110,000 of cash collateral receivable that was not offset against derivative liabilities.
From time to time, we may enter into certain interest rate swaps, cap and floor contracts that are not designated as hedging instruments. These interest rate derivative contracts relate to transactions in which we enter into an interest rate swap, cap, or floor with a customer while concurrently entering into an offsetting interest rate swap, cap, or floor with a third-party financial institution. We agree to pay interest to the customer on a notional amount at a variable rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay a third-party financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. These interest rate derivative contracts allow our customers to effectively convert a variable rate loan to a fixed rate loan. The changes in the fair value of the underlying derivative contracts primarily offset each other and do not significantly impact our results of operations. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change. We recognized swap fee income associated with these derivative contracts immediately based upon the difference in the bid/ask spread of the underlying transactions with the customer and the third-party financial institution. The swap fee income is included in other noninterest income in our consolidated statements of income.

At June 30, 2018, net derivative assets included $14.9 million of cash collateral received from counterparties under master netting agreements.
The notional amounts of the derivative instruments represent the contractual cash flows pertaining to the underlying agreements. These amounts are not exchanged and are not reflected in the consolidated balance sheets. The fair value of the interest rate swaps are presented at net in other assets and other liabilities when a right of offset exists, based on transactions with a single counterparty that are subject to a legally enforceable master netting agreement.

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The following tables present the notional and estimated fair value amount of derivative positions outstanding for the periods presented (in thousands):
 September 30, 2017 December 31, 2016 June 30, 2018 December 31, 2017
 Estimated Fair Value Estimated Fair Value Estimated Fair Value Estimated Fair Value
 
Notional
Amount
(1)
 Asset Derivative Liability Derivative 
Notional
Amount
(1)
 Asset Derivative Liability Derivative 
Notional
Amount
(1)
 Asset Derivative Liability Derivative 
Notional
Amount
(1)
 Asset Derivative Liability Derivative
Derivatives designated as hedging instrumentsDerivatives designated as hedging instruments          Derivatives designated as hedging instruments          
Interest rate contracts:                        
Swaps-Cash Flow Hedge-Financial institution counterparties $240,000
 $6,059
 $328
 $250,000
 $7,069
 $
 $270,000
 $13,455
 $
 $240,000
 $7,922
 $22
Swaps-Fair Value Hedge-Financial institution counterparties 21,100
 
 149
 
 
 
Derivatives designated as non-hedging instrumentsDerivatives designated as non-hedging instruments        Derivatives designated as non-hedging instruments        
Interest rate contracts:                        
Swaps-Financial institution counterparties 67,573
 73
 1,263
 2,182
 85
 
 84,810
 2,377
 360
 67,220
 92
 612
Swaps-Customer counterparties 67,573
 1,263
 73
 2,182
 
 85
 84,810
 360
 2,377
 67,220
 612
 92
Gross derivatives   7,395
 1,664
 
 7,154
 85
   16,192
 2,886
 
 8,626
 726
Offsetting derivative assets/liabilities   (401) (401)   
 
   (509) (509)   (114) (114)
Cash collateral received/posted   (5,570) (1,190)   (7,154) 
   (14,850) 
   (7,900) (520)
Net derivatives included in the consolidated balance sheets (2)
   $1,424
 $73
 
 $
 $85
   $833
 $2,377
 
 $612
 $92
(1)Notional amounts, which represent the extent of involvement in the derivatives market, are used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk, and are not reflected in the consolidated balance sheets.
(2)
Net derivative assets are included in “other assets”other assets and net derivative liabilities are included in “other liabilities”other liabilities on the consolidated balance sheets. Included in the fair value of net derivative assets and net derivative liabilities are credit valuation adjustments reflecting counterparty credit risk and our credit risk. We had net$473,000 credit exposure of $271,000 related to interest rate swaps with financial institutions and $1.3 million$360,000 related to interest rate swaps with customers at SeptemberJune 30, 2018. We had net credit exposure of $30,000 related to interest rate swaps with financial institutions and $612,000 related to interest rate swaps with customers at December 31, 2017. The credit risk associated with customer transactions is partially mitigated as these transactions are generally secured by the non-cash collateral securing the underlying transaction being hedged. We had no credit exposure related to interest rate swaps with financial or customer counterparties at December 31, 2016.
The summarized expected weighted average remaining maturity of the notional amount of interest rate swaps and the weighted average interest rates associated with the amounts expected to be received or paid on interest rate swap agreements are presented below (dollars in thousands). Variable rates received on pay fixed swaps are based on one-month or three-month LIBOR rates in effect at SeptemberJune 30, 20172018 and December 31, 2016:2017:
  June 30, 2018 December 31, 2017
    Weighted Average   Weighted Average
  Notional Amount 
Remaining Maturity
 (in years)
 Receive Rate 
Pay
Rate 
 Notional Amount Remaining Maturity
(in years)
 Receive Rate Pay
Rate
Swaps-Cash Flow Hedge                
Financial institution counterparties $270,000
 5.3 2.12% 1.58% $240,000
 5.3 1.44% 1.43%
Swaps-Fair Value Hedge                
Financial institution counterparties 21,100
 8.0 2.34
 3.00
 
 
 
 
Swaps-Non-Hedging                
Financial institution counterparties 84,810
 12.4 2.01
 2.50
 67,220
 12.7 1.39
 2.37
Customer counterparties 84,810
 12.4 2.50
 2.01
 67,220
 12.7 2.37
 1.39

  September 30, 2017 December 31, 2016
    Weighted Average   Weighted Average
  Notional Amount 
Remaining Maturity
 (in years)
 Receive Rate 
Pay
Rate 
 Notional Amount Remaining Maturity
(in years)
 Receive Rate Pay
Rate
Swaps-Cash Flow Hedge                
Financial institution counterparties $240,000
 5.5 1.24% 1.43% $250,000
 5.4 0.68% 1.31%
Swaps-Non-Hedging                
Financial institution counterparties 67,573
 13.0 1.23
 2.37
 2,182
 9.7 0.62
 1.57
Customer counterparties 67,573
 13.0 2.37
 1.23
 2,182
 9.7 1.57
 0.62


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11.  Fair Value Measurement
Fair value is the price that would be received to sellupon the sale of an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants.  A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.  The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs.  An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction.  Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
Valuation techniques including the market approach, the income approach and/or the cost approach are utilized to determine fair value.  Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability.  Valuation policies and procedures are determined by our investment department and reported to our Asset/Liability Committee (“ALCO”) for review.  An entity must consider all aspects of nonperforming risk, including the entity’s own credit standing, when measuring fair value of a liability.  Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  A fair value hierarchy for valuation inputs gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair value hierarchy is as follows:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Level 3 assets recorded at fair value on a nonrecurring basis at SeptemberJune 30, 20172018 and December 31, 2016,2017 included loans for which a specific allowance was established based on the fair value of collateral and commercial real estate for which fair value of the properties was less than the cost basis.  For both asset classes, the unobservable inputs were the additional adjustments applied by management to the appraised values to reflect such factors as non-current appraisals and revisions to estimated time to sell.  These adjustments are determined based on qualitative judgments made by management on a case-by-case basis and are not quantifiable inputs, although they are used in the determination of fair value.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Certain financial assets are measured at fair value in accordance with GAAP.  Adjustments to the fair value of these assets usually result from the application of fair value accounting or write-downs of individual assets.  Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.  There were no transfers between Level 1 and Level 2 during the ninesix months ended SeptemberJune 30, 20172018 or the year ended December 31, 2016.2017.

Securities Available for Sale and Equity Investments with readily determinable fair values – U.S. Treasury securities and other equity securitiesinvestments are reported at fair value utilizing Level 1 inputs.  Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs.  For these securities, we obtain fair value measurements from independent pricing services and obtain an understanding of the pricing methodologies used by these independent pricing services. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things, as stated in the pricing methodologies of the independent pricing services.

We review and validate the prices supplied by the independent pricing services for reasonableness by comparison to prices obtained from, in most cases, two additional third party sources. For securities where prices are outside a reasonable range, we

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further review those securities, based on internal ALCO approved procedures, to determine what a reasonable fair value measurement is for that security,those securities, given available data.

Derivatives – Derivatives are reported at fair value utilizing Level 2 inputs. We obtain fair value measurements from three sources including an independent pricing service and the counterparty to the derivatives designated as hedges.  The fair value measurements consider observable data that may include dealer quotes, market spreads, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the derivatives’ terms and conditions, among other things. We review the prices supplied by the sources for reasonableness.  In addition, we obtain a basic understanding of their underlying pricing methodology.  We validate prices supplied by the sources by comparison to one another.

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, which means that the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets and financial liabilities measured at fair value on a nonrecurring basis included foreclosed assets and impaired loans at SeptemberJune 30, 20172018 and December 31, 2016.2017.

Foreclosed Assets – Foreclosed assets are initially recorded at fair value less costs to sell.  The fair value measurements of foreclosed assets can include Level 2 measurement inputs such as real estate appraisals and comparable real estate sales information, in conjunction with Level 3 measurement inputs such as cash flow projections, qualitative adjustments, and sales cost estimates.  As a result, the categorization of foreclosed assets is Level 3 of the fair value hierarchy.  In connection with the measurement and initial recognition of certain foreclosed assets, we may recognize charge-offs through the allowance for loan losses.

Impaired Loans – Certain impaired loans may be reported at the fair value of the underlying collateral if repayment is expected solely from the collateral.  Collateral values are estimated using Level 3 inputs based on customized discounting criteria or appraisals.  At SeptemberJune 30, 20172018 and December 31, 2016,2017, the impact of loans with specific reserves based on the fair value of the collateral was reflected in our allowance for loan losses.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a recurring basis include reporting units measured at fair value and tested for goodwill impairment. 

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The following tables summarize assets measured at fair value on a recurring and nonrecurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):
As of September 30, 2017As of June 30, 2018
  Fair Value Measurements at the End of the Reporting Period Using  Fair Value Measurements at the End of the Reporting Period Using
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Recurring fair value measurements              
Investment Securities:              
State and Political Subdivisions$337,160
 $
 $337,160
 $
$796,008
 $
 $796,008
 $
Other Stocks and Bonds5,115
 
 5,115
 
3,032
 
 3,032
 
Other Equity Securities5,960
 5,960
 
 
Mortgage-backed Securities: (1)
          
    
Residential619,695
 
 619,695
 
699,038
 
 699,038
 
Commercial324,142
 
 324,142
 
539,916
 
 539,916
 
Equity Investments:       
Equity Investments (2)
5,780
 5,780
 
 
Derivative assets:              
Interest rate swaps7,395



7,395


16,192
 
 16,192
 
Total asset recurring fair value measurements$1,299,467
 $5,960
 $1,293,507
 $
$2,059,966
 $5,780
 $2,054,186
 $
              
Derivative liabilities:              
Interest rate swaps$1,664

$

$1,664

$
$2,886
 $
 $2,886
 $
Total liability recurring fair value measurements$1,664
 $
 $1,664
 $
$2,886
 $
 $2,886
 $
              
Nonrecurring fair value measurements 
  
  
  
 
  
  
  
Foreclosed assets$299
 $
 $
 $299
$1,205
 $
 $
 $1,205
Impaired loans (2)
6,737
 
 
 6,737
Impaired loans (3)
35,200
 
 
 35,200
Total asset nonrecurring fair value measurements$7,036
 $
 $
 $7,036
$36,405
 $
 $
 $36,405

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As of December 31, 2016As of December 31, 2017
  Fair Value Measurements at the End of the Reporting Period Using  Fair Value Measurements at the End of the Reporting Period Using
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Recurring fair value measurements              
Investment Securities:              
U.S. Treasury$70,069
 $70,069
 $
 $
U.S. Government Agency Debentures$108,869
 $
 $108,869
 $
State and Political Subdivisions385,197
 
 385,197
 
392,664
 
 392,664
 
Other Stocks and Bonds6,651
 
 6,651
 
5,055
 
 5,055
 
Other Equity Securities5,920
 5,920
 
 
Equity Investments (2)
5,920
 5,920
 
 
Mortgage-backed Securities: (1)
   
       
    
Residential627,508
 
 627,508
 
718,029
 
 718,029
 
Commercial384,255
 
 384,255
 
308,218
 
 308,218
 
Derivative assets:              
Interest rate swaps7,154
 
 7,154
 
8,626
 
 8,626
 
Total asset recurring fair value measurements$1,486,754
 $75,989
 $1,410,765
 $
$1,547,381
 $5,920
 $1,541,461
 $
              
Derivative liabilities:              
Interest rate swaps$85
 $
 $85
 $
$726
 $
 $726
 $
Total liability recurring fair value measurements$85
 $
 $85
 $
$726
 $
 $726
 $
              
Nonrecurring fair value measurements 
  
  
  
 
  
  
  
Foreclosed assets$388
 $
 $
 $388
$1,767
 $
 $
 $1,767
Impaired loans (2)(3)
9,693
 
 
 9,693
6,536
 
 
 6,536
Total asset nonrecurring fair value measurements$10,081
 $
 $
 $10,081
$8,303
 $
 $
 $8,303
(1)All mortgage-backed securities are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
(2)With the adoption of ASU 2016-01 on January 1, 2018, these investments are included in equity investments on our consolidated balance sheets. The guidance was applied on a prospective approach resulting in prior-periods no longer being comparable. See “Note 1 – Summary of Significant Accounting and Reporting Policies” for further information.
(3)Impaired loans represent collateral-dependent loans with a specific valuation allowance. Losses on these loans represent charge-offs which are netted against the allowance for loan losses.


Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, is required when it is practicable to estimate that value.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Such techniques and assumptions, as they apply to individual categories of our financial instruments, are as follows:

Cash and cash equivalents - The carrying amount for cash and cash equivalents is a reasonable estimate of those assets’ fair value.

Investment and mortgage - backedmortgage-backed securities held to maturity - Fair values for these securities are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services.

FHLB stock and other investments- The carrying amount of FHLB stock and other investments is a reasonable estimate of the fair value of those assets.

Equity investments - Equity investments with readily determinable fair values are presented at fair value based upon the currently available bid-and-ask quotations publicly available on a market or exchange. The carrying value of other equity investments without readily determinable fair values are measured at cost less impairment, if any, adjusted for observable price changes for an identical or similar investment of the same issuer. This carrying value is a reasonable estimate of the fair value of those assets.

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Loans receivable - With the adoption of ASU 2016-01 on January 1, 2018,we refined our methodology to estimate the fair value of our loan portfolio to an exit price notion with adjustments for liquidity, credit, and prepayment factors. The guidance was applied on a prospective approach resulting in prior-periods no longer being comparable. See “Note 1 – Summary of Significant Accounting and Reporting Policies” for further information. For adjustableDecember 31, 2017, adjustable rate loans that repricerepriced frequently and with no significant change in credit risk, the carrying amounts arewere a reasonable estimate of those assets’ fair value.  Thevalue and the fair value of fixed rate loans iswere estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Nonperforming loans arecontinue to be estimated using discounted cash flow analyses or the underlying value of the collateral where applicable.

Loans held for sale – The fair value of loans held for sale is determined based on expected proceeds, which are based on sales contracts and commitments.

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Deposit liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount on demand at the reporting date, which is the carrying value.  Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities.

Federal funds purchased and repurchase agreements - Federal funds purchased generally have original terms to maturity of one day and repurchase agreements generally have terms of less than one year, and therefore both are considered short-term borrowings. Consequently, their carrying value is a reasonable estimate of fair value.

FHLB advancesborrowings - The fair value of these advancesborrowings is estimated by discounting the future cash flows using rates at which advancesborrowings would be made to borrowers with similar credit ratings and for the same remaining maturities.

Subordinated notes - The fair value of the subordinated notes is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

Long-term debt - The fair value of the long-term debt is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities.

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The following tables present our financial assets and financial liabilities and unrecognized financial instruments measured on a nonrecurring basis at both their respective carrying amounts and estimated fair value (in thousands):

  Estimated Fair Value  Estimated Fair Value
September 30, 2017Carrying
Amount
 Total Level 1 Level 2 Level 3
June 30, 2018Carrying
Amount
 Total Level 1 Level 2 Level 3
Financial Assets:                  
Cash and cash equivalents$184,513
 $184,513
 $184,513
 $
 $
$232,069
 $232,069
 $232,069
 $
 $
Investment Securities:                  
Held to maturity, at carrying value415,242
 426,222
 
 426,222
 
3,202
 3,162
 
 3,162
 
Mortgage-backed Securities:                  
Held to maturity, at carrying value494,602
 502,285
 
 502,285
 
161,074
 155,893
 
 155,893
 
FHLB stock, at cost, and other investments67,284
 67,284
 
 67,284
 
FHLB stock, at cost42,994
 42,994
 
 42,994
 
Equity investments6,257
 6,257
 
 6,257
 
Loans, net of allowance for loan losses2,662,895
 2,666,081
 
 
 2,666,081
3,245,811
 3,198,589
 
 
 3,198,589
Loans held for sale2,177
 2,177
 
 2,177
 
4,566
 4,566
 
 4,566
 
Financial Liabilities:                  
Deposits$3,564,175
 $3,560,777
 $
 $3,560,777
 $
$4,508,741
 $4,498,948
 $
 $4,498,948
 $
Federal funds purchased and repurchase agreements9,083
 9,083
 
 9,083
 
8,287
 8,287
 
 8,287
 
FHLB advances1,142,556
 1,137,171
 
 1,137,171
 
FHLB borrowings776,467
 759,401
 
 759,401
 
Subordinated notes, net of unamortized debt issuance costs98,209
 102,569
 
 102,569
 
98,326
 97,462
 
 97,462
 
Long-term debt, net of unamortized debt issuance costs60,240
 48,422
 
 48,422
 
Trust preferred subordinated debentures, net of unamortized debt issuance costs60,243
 50,525
 
 50,525
 

  Estimated Fair Value  Estimated Fair Value
December 31, 2016Carrying
Amount
 Total Level 1 Level 2 Level 3
December 31, 2017Carrying
Amount
 Total Level 1 Level 2 Level 3
Financial Assets:                  
Cash and cash equivalents$169,654
 $169,654
 $169,654
 $
 $
$198,692
 $198,692
 $198,692
 $
 $
Investment Securities:                  
Held to maturity, at carrying value425,810
 429,912
 
 429,912
 
413,632
 421,928
 
 421,928
 
Mortgage-backed Securities:       
         
  
Held to maturity, at carrying value511,677
 514,370
 
 514,370
 
495,874
 499,872
 
 499,872
 
FHLB stock, at cost, and other investments66,592
 66,592
 
 66,592
 
FHLB stock, at cost55,729
 55,729
 
 55,729
 
Equity investments5,821
 5,821
 
 5,821
 
Loans, net of allowance for loan losses2,538,626
 2,630,009
 
 
 2,630,009
3,273,575
 3,269,316
 
 
 3,269,316
Loans held for sale7,641
 7,641
 
 7,641
 
2,001
 2,001
 
 2,001
 
Financial Liabilities:                  
Deposits$3,533,076
 $3,293,352
 $
 $3,293,352
 $
$4,515,447
 $4,506,133
 $
 $4,506,133
 $
Federal funds purchased and repurchase agreements7,097
 7,097
 
 7,097
 
9,498
 9,498
 
 9,498
 
FHLB advances1,309,646
 1,331,517
 
 1,331,517
 
FHLB borrowings1,017,361
 1,008,292
 
 1,008,292
 
Subordinated notes, net of unamortized debt issuance costs98,100
 101,627
 
 101,627
 
98,248
 99,665
 
 99,665
 
Long-term debt, net of unamortized debt issuance costs60,236
 45,147
 
 45,147
 
Trust preferred subordinated debentures, net of unamortized debt issuance costs60,241
 47,622
 
 47,622
 


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The fair value estimate of financial instruments for which quoted market prices are unavailable is dependent upon the assumptions used.  Consequently, those estimates cannot be substantiated by comparison to independent markets and, in many cases, could

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not be realized in immediate settlement of the instruments.  Accordingly, the aggregate fair value amounts presented in the above fair value tabletables do not necessarily represent their underlying value.

12.     Income Taxes

The income tax expense included in the accompanying statements of income consists of the following (in thousands):
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
 Three Months Ended
June 30,
 Six Months Ended
June 30,
 2017 2016 2017 2016 2018 2017 2018 2017
Current income tax expense $3,454
 $1,331
 $9,798
 $6,570
 $667
 $3,317
 $3,012
 $6,344
Deferred income tax (benefit) expense 436
 1,410
 453
 1,916
Deferred income tax expense 2,693
 36
 2,438
 17
Income tax expense $3,890
 $2,741
 $10,251
 $8,486
 $3,360
 $3,353
 $5,450
 $6,361

The Tax Cuts and Jobs Act (“Tax Act”) was enacted on December 22, 2017. The Tax Act reduces the U.S. federal corporate tax rate from 35% to 21%. We remeasured certain deferred tax assets and liabilities as of December 22, 2017 based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Tax Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. During the three and six months ended June 30, 2018, there were no material adjustments made to the provisional amounts recorded with the remeasurement.

The Tax Act repealed the existing Alternative Minimum Tax (“AMT”). As of June 30, 2018, we have a remaining AMT tax credit of $3.5 million. This remaining tax credit carryforward can be used to offset regular future tax liability. Additionally, this AMT credit is refundable in any taxable year after 2017 and before 2022 in an amount equal to 50% of the excess of the minimum tax credit for the taxable year over the amount of the credit allowable for the year against regular tax liability. We expect to realize the remaining AMT tax credit in 2018 to offset tax liability.

Net deferred tax assets totaled $21.8$15.4 million at SeptemberJune 30, 20172018 and $28.9$12.2 million at December 31, 2016.2017.  No valuation allowance for the net deferred tax assetsasset was recorded at SeptemberJune 30, 20172018 or December 31, 2016,2017, as management believes it is more likely than not that all of the net deferred tax assetsasset will be realized in future years. Unrecognized tax benefits were not material at SeptemberJune 30, 20172018 or December 31, 2016.

During the first quarter of 2017, we adopted a new accounting standard that impacted how the income tax effects associated with stock-based compensation are recognized. See “Note 1 - Summary of Significant Accounting and Reporting Policies” for additional information.2017.

We recognized income tax expense of $3.9$3.4 million and $10.3$5.5 million, for an effective tax rate (“ETR”) of 21.1%14.3% and 18.9%13.0% for the three and ninesix months ended SeptemberJune 30, 2017,2018, respectively, compared to income tax expense of $2.7$3.4 million and $8.5$6.4 million, for an ETR of 17.6%18.8% and 18.3%17.8%, for the three and ninesix months ended SeptemberJune 30, 2016,2017, respectively. The higherlower ETR for the three and ninesix months ended SeptemberJune 30, 20172018 was mainly due to a decrease in tax-exempt income as a percentage of pre-tax income as comparedthe reduced corporate tax rate under the Tax Act from 35% to the same period in 2016, slightly offset by the effect of the adoption of the accounting standard mentioned above, reducing income tax expense by $213,000 and $423,000 and the ETR by 1.2% and 0.8%, respectively.21%. The ETR differs from the stated rate of 21% and 35% duringfor the comparable periodthree and six months ended June 30, 2018 and 2017, respectively, primarily due to the effect of tax-exempt income from municipal loans and securities, as well as bank owned life insurance. We file federal income tax returns in the U.S. federal jurisdictions and in certain state tax returns.states. We are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2014.2014 or Texas state tax examinations by tax authorities for years before 2013.

13.     Off-Balance-Sheet Arrangements, Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, we are a party to certain financial instruments with off-balance-sheet risk to meet the financing needs of our customers.  These off-balance-sheet instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements.  The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss that we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met.  Commitments generally have fixed expiration dates and may require the payment of fees.  Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters

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of credit is essentially the same as that involved in extending loan commitments to customers and similarly do not necessarily represent future cash obligations.

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Financial instruments with off-balance-sheet risk were as follows (in thousands):
At
September 30,
2017
 At
December 31,
2016
At
June 30,
2018
 At
December 31,
2017
Unused commitments: 
  
 
  
Commitments to extend credit$710,359
 $665,663
$791,154
 $804,715
Standby letters of credit9,746
 9,075
11,898
 14,890
Total$720,105
 $674,738
$803,052
 $819,605

We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower.  Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory, oil, gas and mineral interests, property, plant, and equipment.

Lease Commitments. We lease certain branch facilities and office equipment under operating leases.  It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire.

Securities. In the normal course of business we buy and sell securities. ThereAt June 30, 2018, there were $16.7$2.3 million and $160,000 of unsettled trades to purchase securities at September 30, 2017 and December 31, 2016, respectively. There were $11.8 millionno unsettled trades to sell securities as of September 30, 2017.securities. There were no unsettled trades to purchase securities and no unsettled trades to sell securities at December 31, 2016.2017.

Deposits. There were no unsettled issuances of brokered CDs at SeptemberJune 30, 20172018 or December 31, 2016.2017.

Litigation. We are a party toinvolved with various litigation in the normal course of business.  Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of our consolidated financial condition, changes in our financial condition, and results of our operations, and should be read and reviewed in conjunction with the financial statements, and the notes thereto, in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.
Forward-Looking Statements
Certain statements of other than historical fact that are contained in this report may be considered to be “forward-looking statements” within the meaning of and subject to the safe harbor protections of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date.  These statements may include words such as “expect,” “estimate,” “project,” “anticipate,” “appear,” “believe,” “could,” “should,” “may,” “will,” “would,” “seek,” “intend,” “probability,” “risk,” “goal,” “objective,” “plans,” “potential,” and similar expressions. Forward-looking statements are statements with respect to our beliefs, plans, expectations, objectives, goals, anticipations, assumptions and estimates about our future performance and are subject to significant known and unknown risks and uncertainties, which could cause our actual results to differ materially from the results discussed in the forward-looking statements.  For example, discussions about trends in asset quality, capital, liquidity, the pace of loan and revenue growth, the Company’s ability to sell nonperforming assets, expense reductions, planned operational efficiencies, earnings and certain market risk disclosures, including the impact of interest rates and other economic factors, are based upon information presently available to management and are dependent on choices about key model characteristics and assumptions and are subject to various limitations.  By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future.  Accordingly, our results could materially differ from those that have been estimated.  Other factors that could cause actual results to differ materially from those indicated by forward-looking statements include, but are not limited to, the following:
general economic conditions, either globally, nationally, in the State of Texas, or in the specific markets in which we operate, including, without limitation, the deterioration of the commercial real estate, residential real estate, construction and development, energy, oil, and gas credit and liquidity markets, which could cause an adverse change in our net interest margin, or a decline in the value of our assets, which could result in realized losses;
current or future legislation, regulatory changes or changes in monetary or fiscal policy that adversely affect the businesses in which we are engaged, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), the Federal Reserve’s actions with respect to interest rates, the capital requirements promulgated by the Basel Committee on Banking Supervision (“Basel Committee”) and other regulatory responses to economic conditions;
adverse changes in the status or financial condition of the Government-Sponsored Enterprises (the “GSEs”) which impact the GSEs’ guarantees or ability to pay or issue debt;
adverse changes in the credit portfolio of other U.S. financial institutions relative to the performance of certain of our investment securities;
economic or other disruptions caused by acts of terrorism in the United States, Europe or other areas;
technological changes, including potential cyber-security incidents;
our ability to identify and address cyber-security risks such as data security breaches, malware, "denial of service" attacks, "hacking" and identity theft, a failure of which could disrupt our business and result in the disclosure of and/or misuse or misappropriation of confidential or proprietary information, disruption or damage of our systems, increased costs, significant losses, or adverse effects to our reputation;
the risk that our enterprise risk management framework may not identify or address risks adequately, which may result in unexpected losses;
changes in the interest rate yield curve such as flat, inverted or steep yield curves, or changes in the interest rate environment that impact interest margins and may impact prepayments on our mortgage-backed securities (“MBS”) portfolio;
increases in our nonperforming assets;
our ability to maintain adequate liquidity to fund operations and growth;
any applicable regulatory limits or other restrictions on Southside Bank’s ability to pay dividends to us;
the failure of our assumptions underlying allowance for loan losses and other estimates;
the effectiveness of our derivative financial instruments and hedging activities to manage risk;
unexpected outcomes of, and the costs associated with, existing or new litigation involving us;

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changes impacting our balance sheet and leverage strategy;
risks related to actual mortgage prepayments diverging from projections;
risks related to actual U.S. Agency MBS prepayments exceeding projected prepayment levels;
risks related to U.S. Agency MBS prepayments increasing due to U.S. Government programs designed to assist homeowners to refinance their mortgage that might not otherwise have qualified;
our ability to monitor interest rate risk;

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risks related to the price per barrel of crude oil;
significant increases in competition in the banking and financial services industry;
changes in consumer spending, borrowing and saving habits;
technological changes, including potential cyber-security incidents;the risk that we may be required to take additional charges with respect to our deferred tax assets as a result of Tax Cuts and Jobs Act (“Tax Act”) in the event our estimates prove false;
execution of future or pending acquisitions, reorganization or disposition transactions, including the risk that the anticipated benefits of such transactions are not realized;
our ability to increase market share and control expenses;
our ability to develop competitive new products and services in a timely manner and the acceptance of such products and services by our customers;
the effect of changes in federal or state tax laws;
the effect of compliance with legislation or regulatory changes;
the effect of changes in accounting policies and practices;
credit risks of borrowers, including any increase in those risks due to changing economic conditions;
risks related to loans secured by real estate, including the risk that the value and marketability of collateral could decline; and
other risks and uncertainties discussed in Part“Part I - “ItemItem 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.

All written or oral forward-looking statements made by us or attributable to us are expressly qualified by this cautionary notice.  We disclaim any obligation to update any factors or to announce publicly the result of revisions to any of the forward-looking statements included herein to reflect future events or developments, unless otherwise required by law.
Critical Accounting Estimates
Our accounting and reporting estimates conform with U.S. generally accepted accounting principles (“GAAP”) and general practices within the financial services industry.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  We consider our critical accounting policies to include the following:
Allowance for Losses on Loans.  The allowance for losses on loans represents our best estimate of probable losses inherent in the existing loan portfolio.  The allowance for losses on loans is increased by the provision for losses on loans charged to expense and reduced by loans charged-off, net of recoveries.  The provision for losses on loans is determined based on our assessment of several factors:  reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on specific borrowers and industry groups, historical loan loss experience, the level of classified and nonperforming loans and the results of regulatory examinations.
The allowance for loan loss is based on the most current review of the loan portfolio and is a result of multiple processes.  The servicing officer has the primary responsibility for updating significant changes in a customer’s financial position.  Each officer prepares status updates on any credit deemed to be experiencing repayment difficulties which, in the officer’s opinion, would place the collection of principal or interest in doubt.  Our internal loan review department is responsible for an ongoing review of our loan portfolio with specific goals set for the loans to be reviewed on an annual basis.
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

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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 the necessary allowance and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
Loans are considered impaired if, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.  The measurement of loss on impaired loans is generally based on the fair value of the collateral if repayment is expected solely from the collateral or the present value of the expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions such

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as discount rates and methodologies, comparisons to recent sales prices of similar assets, and other assumptions consistent with those that would be utilized by unrelated third parties performing a valuation.
Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which collateral may be sold all may affect the required level of the allowance for losses on loans and the associated provision for loan losses.
The allowance for loan losses related to purchase credit impaired (“PCI”) loans is based on an analysis that is performed quarterly to estimate the expected cash flows for each loan deemed PCI. To the extent that the expected cash flows from a PCI loan have decreased since the acquisition date, we establish or increase the allowance for loan losses.
For acquired loans that are not deemed credit impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the economic life of the loan.
As of SeptemberJune 30, 2017,2018, our review of the loan portfolio indicated that a loan loss allowance of $19.9$25.1 million was appropriate to cover probable losses in the portfolio.
Refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Loss Experience and Allowance for Loan Losses” and “Note 6 – Loans and Allowance for Probable Loan Losses” in our Annual Report on Form 10-K for the year ended December 31, 20162017 for a detailed description of our estimation process and methodology related to the allowance for loan losses.
Estimation of Fair Value.  The estimation of fair value is significant to a number of our assets and liabilities.  In addition, GAAP requires disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements.  Fair values for securities are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves.  Fair values for most investment and MBS are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or estimates from independent pricing services.  Where there are price variances outside certain ranges from different pricing services for specific securities, those pricing variances are reviewed with other market data to determine which of the price estimates is appropriate for that period.  Fair values for our derivatives are based on measurements that consider observable data that may include dealer quotes, market spreads, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information, and the derivatives’ terms and conditions, among other things. We validate prices supplied by such sources by comparison to one another.
Business Combination.During a business combination consideration is first assigned to identifiable assets and liabilities, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as market share, customer and employee loyalty, asset lives, and the amount and timing of prospective cash flows and the discount rate applied to the cash flows. Assets and liabilities, including deposits, core deposit intangibles, property and equipment and loans, among others, are evaluated based upon the nature of the asset or liability, the business in which it is utilized, and the economic return it is generating or expected to generate.
Deposits, in a business combination, are evaluated based upon maturity and the weighted average rate to determine the present value or fair value.
Core Deposit Intangibles represent the cost savings derived from available core deposits relative to alternative financing. The cost of deposits on hand is evaluated against the Company’s primary source of funds, or FHLB advance agreements.
For loans acquired in a business combination, refer to “Allowance for Losses on Loans” in this section.
Other intangibles are evaluated based upon the nature of the underlying asset, life and the timing of prospective cash flows.

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Property and equipment obtained in a business combination is evaluated at the highest and best use of the asset. Functional and economic obsolescence is also evaluated.
Impairment of Investment Securities and Mortgage-backed Securities.  Investment securities and MBS classified as available for sale (“AFS”) are carried at fair value, and the impact of changes in fair value are recorded on our consolidated balance sheet as an unrealized gain or loss in “Accumulated Other Comprehensive (Loss) Income,other comprehensive (loss) income,” a separate component of shareholders’ equity.  Securities classified as AFS or held to maturity (“HTM”) are subject to our review to identify when a decline in value is other-than-temporary.  When it is determined that a decline in value 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 to other comprehensive income for the noncredit portion.  Factors considered in determining whether a decline in value is other-than-temporary include: (1) whether the decline is substantial, the duration of the decline and the reasons for the decline in value; (2) whether the decline is related to a credit event, a change in interest rate or a change in the market discount rate; (3) the financial condition and near-term prospects of the issuer; and (4) whether we have a current intent to sell the security and whether it is not more likely than not that we will be required to sell the security before the anticipated recovery of its amortized cost basis. For certain assets, we consider expected cash flows of the investment in determining if impairment exists.
Defined Benefit Pension Plan. The plan obligations and related assets of our defined benefit pension plan (the “Plan”) and the OmniAmerican Bank Defined Benefit Plan (the “Acquired Plan”) are describedpresented in “Note 11 – Employee Benefits” in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.  Entry into the Plan by new employees was frozen effective December 31, 2005.  Effective December 31, 2006, employee benefits under the Acquired Plan were frozen by Omni. In addition, no new participants may be added to the Acquired Plan. Plan assets,Assets in both plans, which consist primarily of marketable equity and debt instruments, are valued using observable market quotations.  Plan obligationsObligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions that are reviewed by management.  Key assumptions in measuring the Plan obligations of both plans include the discount rate the rate of salary increases and the estimated future return on assets in both plans. The rate of salary increases is another key assumption used in measuring the Plan assets.obligation. The rate of salary increases is not required to measure the obligations of the Acquired Plan since the benefits are frozen.  In determining the discount rate, we utilized a cash flow matching analysis to determine a range of appropriate discount rates for our defined benefit pension and restoration plans.  In developing the cash flow matching analysis, we constructed a portfolio of high quality noncallable bonds (rated AA- or better) to match as close as possible the timing of future benefit payments of the Plans at December 31, 2016.2017.  Based on this cash flow matching analysis, we were able to determine an appropriate discount rate.

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Salary increase assumptions for the Plan are based upon historical experience and our anticipated future actions. The expected long-term rate of return assumption reflects the average return expected based on the investment strategies and asset allocation on the assets invested to provide for the Plan’s liabilities. We consider broad equity and bond indices, long-term return projections, and actual long-term historical Plan performance when evaluating the expected long-term rate of return assumption. At SeptemberJune 30, 2017,2018, the weighted-average actuarial assumptions of the Plan were: a discount rate of 4.23%3.71%; assumed salary increases of 3.50%; and a long-term rate of return on Plan assets of 7.25%. Material changes in pension benefit costs may occur in the future due to changes in these assumptions.  Future annual amounts could be impacted by changes in the number of Plan participants in the plans, changes in the level of benefits provided, changes in the discount rates, changes in the expected long-term rate of return, changes in the level of contributions to the Planplans and other factors.
Non-GAAP Financial Measures

Certain non-GAAP measures are used by management to supplement the evaluation of our performance. These include the following fully-taxable equivalent measures: tax-equivalent netfully taxable-equivalent measures (“FTE”): Net interest income tax-equivalent net(FTE), Net interest margin (FTE) and tax-equivalent netNet interest spread (FTE), which include the effects of taxable-equivalent adjustments using a federal income tax rate of 21% and 35% for the three and six months ended June 30, 2018 and 2017, respectively, to increase tax-exempt interest income to a tax-equivalent basis. Whenever we present a non-GAAP financial measure in an SEC filing, we are also required to present the most directly comparable financial measure calculated and presented in accordance with GAAP and reconcile the differences between the non-GAAP financial measure andInterest income earned on certain assets is completely or partially exempt from federal income tax. As such, comparable GAAP measure. Tax-equivalent adjustments are reported in notes 2 and 3 to the “Average Balances with Average Yields and Rates” tables under “Results of Operations.”these tax-exempt instruments typically yield lower returns than taxable investments.

Tax-equivalent netNet interest income net(FTE), Net interest margin (FTE) and netNet interest spread.spread (FTE).  Net interest income on a tax-equivalent basis(FTE) is a non-GAAP measure that adjusts for the tax-favored status of net interest income from certain loans and investments.investments and is not permitted under GAAP in the Consolidated Statements of Income. We believe this measure to be the preferred industry measurement of net interest income and it enhances comparability of net interest income arising from taxable and tax-exempt sources. The most directly comparable financial measure calculated in accordance with GAAP is our net interest income. Net interest margin on a tax-equivalent basis(FTE) is the ratio of net interest income on a tax-equivalent basis divided by(FTE) to average interest-earning assets on a tax-equivalent basis.earning assets. The most directly comparable financial measure calculated in accordance with GAAP is our net interest margin. Net interest spread on a tax-equivalent basis(FTE) is the difference in the average yield on average interest-earningearning assets on a tax equivalenttax-equivalent basis and the average rate paid on average interest-bearinginterest bearing liabilities. The most directly comparable financial measure calculated in accordance with GAAP is our net interest spread.


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These non-GAAP financial measures should not be considered an alternativealternatives to GAAP-basis financial statements, and other bank holding companies may define or calculate these non-GAAP measures or similar measures differently. Whenever we present a non-GAAP financial measure in an SEC filing, we are also required to present the most directly comparable financial measure calculated and presented in accordance with GAAP and reconcile the differences between the non-GAAP financial measure and such comparable GAAP measure.
In the following table we present the reconciliation of net interest income to net interest income adjusted to a fully taxable-equivalent basis assuming a 21% and 35% marginal tax rate for the three and six months ended June 30, 2018 and 2017, respectively, for interest earned on tax-exempt assets such as municipal loans and investment securities (dollars in thousands), along with the calculation of net interest margin (FTE) and net interest spread (FTE).
Non-GAAP Reconciliations    
  Three Months Ended June 30, Six Months Ended June 30,
  2018 2017 2018 2017
Net interest income (GAAP) $43,111
 $35,424
 $87,244
 $70,704
Tax equivalent adjustments:        
Loans 583
 1,050
 1,165
 2,085
Investment securities (tax-exempt) 1,651
 3,229
 3,270
 6,604
Net interest income (FTE) (1)
 $45,345
 $39,703
 $91,679
 $79,393
         
Average earning assets $5,700,133
 $5,192,897
 $5,795,214
 $5,210,871
         
Net interest margin 3.03% 2.74% 3.04% 2.74%
Net interest margin (FTE) (1)
 3.19% 3.07% 3.19% 3.07%
         
Net interest spread 2.75% 2.56% 2.77% 2.58%
Net interest spread (FTE) (1)
 2.90% 2.89% 2.92% 2.91%
(1)These amounts are presented on a fully taxable-equivalent basis and are non-GAAP measures.
Management believes adjusting net interest income, net interest margin and net interest spread to a fully taxable-equivalent basis is a standard practice in the banking industry as these measures provide useful information to make peer comparisons. Tax-equivalent adjustments are reported in the respective earning asset categories as listed in the “Average Balances with Average Yields and Rates” tables under Results of Operations.


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Off-Balance-Sheet Arrangements, Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, we are a party to certain financial instruments with off-balance-sheet risk to meet the financing needs of our customers. These off-balance-sheet instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the financial statements. The contract or notional amounts of these instruments reflect the extent of involvement and exposure to credit loss that we have in these particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require the payment of fees. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers and similarly do not necessarily represent future cash obligations.

Financial instruments with off-balance-sheet risk were as follows (in thousands):
At
September 30,
2017
 At
December 31,
2016
At
June 30,
2018
 At
December 31,
2017
Unused commitments: 
  
 
  
Commitments to extend credit$710,359
 $665,663
$791,154
 $804,715
Standby letters of credit9,746
 9,075
11,898
 14,890
Total$720,105
 $674,738
$803,052
 $819,605

We apply the same credit policies in making commitments and standby letters of credit as we do for on-balance-sheet instruments.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower.  Collateral held varies but may include cash or cash equivalents, negotiable instruments, real estate, accounts receivable, inventory, oil, gas and mineral interests, property, plant, and equipment.

Lease Commitments. We lease certain branch facilities and office equipment under operating leases.  It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire.

Securities. In the normal course of business we buy and sell securities. ThereAt June 30, 2018, there were $16.7$2.3 million and $160,000 of unsettled trades to purchase securities at September 30, 2017 and December 31, 2016, respectively. There were $11.8 millionno unsettled trades to sell securities at September 30, 2017.securities. There were no unsettled trades to purchase securities and no unsettled trades to sell securities at December 31, 2016.2017.

Deposits. There were no unsettled issuances of brokered CDs at SeptemberJune 30, 20172018 or December 31, 2016.2017.

Litigation. We are a party to various litigation in the normal course of business.  Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

OVERVIEW

Operating Results

Net income increased $1.6$5.7 million, or 12.8%39.5%, for the three months ended SeptemberJune 30, 2017,2018, to $14.5$20.2 million compared to the same period in 2016.2017. The increase was primarily the result of a $5.3$10.8 million increase in interest income and a $3.4$1.7 million decreaseincrease in noninterest income partially offset by a $3.7 million increase in noninterest expense and a $0.7 million decrease in provision for loan losses, partially offset by a $4.3$3.1 million increase in interest expense, a $2.3 million decrease in noninterest income, and a $1.1 million increase in income tax expense. Earnings per diluted common share increased $0.01,$0.08, or 2.1%16.3%, to $0.49$0.57 for the three months ended SeptemberJune 30, 2017,2018, from $0.48$0.49 for the same period in 2016.2017.

During the nine months ended September 30, 2017, our net income increased $6.2 million, or 16.4%, to $44.0 million from $37.8 million for the same period in 2016. The increase was the result of a $12.1 million increase in interest income, a $7.2 million decrease in noninterest expense, and a $4.3 million decrease in provision for loan losses, partially offset by an $11.4 million

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During the six months ended June 30, 2018, our net income increased $7.0 million, or 23.7%, to $36.5 million from $29.5 million for the same period in 2017. The increase was primarily the result of a $23.1 million increase in interest expense, $4.3income, a $1.7 million decreaseincrease in noninterest income and a $1.8$0.9 million decrease in income tax expense, partially offset by a $9.5 million increase in income tax expense.noninterest expense, a $6.6 million increase in interest expense and a $2.6 million increase in provision for loan losses. Earnings per diluted common share increased $0.10,$0.04, or 7.2%,4.0% to $1.49$1.04 for the ninesix months ended SeptemberJune 30, 2017,2018, from $1.39$1.00 for the same period in 2016.2017.

Financial Condition

Our total assets decreased $79.3$247.9 million, or 1.4%3.8%, to $5.48$6.25 billion at SeptemberJune 30, 20172018 from $5.56$6.50 billion at December 31, 20162017 as a result of athe decrease in our securities portfolio and deferred tax asset partially offset by an increase into a lesser extent, our loan portfolio and interest earning deposits.portfolio. Our securities portfolio decreased by $215.2$246.0 million, or 8.9%10.0%, to $2.20 billion, compared to $2.42$2.45 billion at December 31, 2016 as we sold securities with longer durations in response2017 primarily due to changes in interest rates. Net deferred tax asset totaled $21.8sales of lower yielding AFS securities. Our FHLB stock decreased $12.7 million, at September 30, 2017, as comparedor 22.9%, to $28.9$43.0 million from $55.7 million at December 31, 2016. The $7.02017 due to FHLB borrowings paid off in 2018, reducing the required amount of FHLB stock that we must hold. Our interest earning deposits increased $27.1 million, decrease in deferred tax assets was due primarilyor 24.3%, to the decrease in the unrealized losses in the AFS securities portfolio.$138.7 million at June 30, 2018, compared to $111.5 million at December 31, 2017.

Loans increased $126.2decreased $23.5 million, or 4.9%0.7%, to $2.68$3.27 billion compared to $2.56$3.29 billion at December 31, 2016.2017. The net increasedecrease in our loan portfolio was comprised primarily of increasesdecreases of $127.7$19.2 million of commercial real estate loans, $40.3$17.8 million of construction loans to individuals and $23.7 million of municipal loans, which were partially offset by decreases of $28.1$14.0 million of 1-4 family residential loans, $27.0partially offset by increases of $16.3 million of commercial loans to individuals, and $10.3$11.4 million of commercialconstruction loans.

Our nonperforming assets at SeptemberJune 30, 2017 decreased 39.6%2018 increased 305.1%, to $9.1$42.4 million and represented 0.17%0.68% of total assets, compared to $15.1$10.5 million, or 0.27%0.16% of total assets at December 31, 2016.2017.  Nonaccruing loans decreased $5.2increased $32.4 million, or 62.6%1,103.6%, to $3.1$35.4 million and the ratio of nonaccruing loans to total loans decreasedincreased to 0.12%1.08% at SeptemberJune 30, 20172018 compared to 0.32%0.09% at December 31, 2016.2017.  The increase in nonaccrual loans was primarily the result of the addition of two large commercial real estate relationships consisting of three loans during the first quarter of 2018. Restructured loans were $5.7$5.9 million at SeptemberJune 30, 2017, a decrease2018, an increase of $0.7 million,$93,000, or 11.0%1.6%, from $6.4$5.8 million at December 31, 2016.2017. Other Real Estate Owned (“OREO”) decreased to $298,000$1.1 million at SeptemberJune 30, 20172018 from $339,000$1.6 million at December 31, 2016.2017. Repossessed assets decreased to $1,000$68,000 at SeptemberJune 30, 20172018 from $49,000$154,000 at December 31, 2016.2017.  

Our deposits increased $31.1decreased $6.7 million, or 0.9%0.1%, to $3.56$4.51 billion at SeptemberJune 30, 20172018 from $3.53$4.52 billion at December 31, 2016.2017.  The increasedecrease in our deposits during 2018 was the result of a decrease in public fund deposits of $42.8 million, partially offset by an increase in private deposits of $36.1 million. Brokered deposits, included in our private deposits, increased $51.6 million for the six months ended June 30, 2018. Noninterest bearing deposits increased $1.5 million and interest bearing deposits decreased $8.2 million.

Total FHLB borrowings decreased $240.9 million, or 23.7%, to $776.5 million at June 30, 2018 from $1.02 billion at December 31, 2017, while our brokered deposits increased $51.6 million, or 82.3%, to $114.3 million at June 30, 2018 from $62.7 million at December 31, 2017, as we adjusted our overall interest rate risk objectives in response to the Diboll acquisition, the decreases in our securities portfolio and loan portfolio and the rising interest rate market.

Shareholders’ equity at June 30, 2018 totaled $751.8 million compared to $754.1 million at December 31, 2017. The decrease was primarily the result of an increase in brokered deposits and non-public fund deposits, partially offset by a decrease in public fund deposits. Our brokered deposits increased $41.3 million and non-public fund deposits increased $58.3 million, more than offsetting the decrease in public fund deposits of $68.5 million. For the nine months ended September 30, 2017, the mix of interest bearing and non-interest bearing deposits changed. The noninterest bearing deposits increased $77.7 million, and interest bearing deposits decreased $46.6 million.

Total FHLB advances decreased $167.1 million to $1.14 billion at September 30, 2017 from $1.31 billion at December 31, 2016.  Short-term FHLB advances increased $124.0 million to $990.5 million at September 30, 2017 from $866.5 million at December 31, 2016.  Long-term FHLB advances decreased $291.1 million to $152.1 million at September 30, 2017 from $443.1 million at December 31, 2016.

Shareholders’ equity at September 30, 2017 totaled $556.0 million compared to $518.3 million at December 31, 2016. The 7.3% increase was primarily the result of net income of $44.0 million recorded for the nine months ended September 30, 2017, a decrease in accumulated other comprehensive loss of $12.3$21.0 million and cash dividends paid of $20.3 million, partially offset by net income of $36.5 million recorded for the six months ended June 30, 2018, net issuance of common stock under employee stock plans of $2.4 million,$965,000, stock compensation expense of $1.4 million,$965,000 and common stock issued under our dividend reinvestment plan of $1.1 million.  These increases were partially offset by cash dividends paid of $23.4 million.$720,000.  

Key financial indicators management follows include, but are not limited to, numerous interest rate sensitivity and interest rate risk indicators, credit risk, operations risk, liquidity risk, capital risk, regulatory risk, competition risk, yield curve risk, U.S. Agency MBS prepayment risk and economic risk indicators.


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Balance Sheet Strategy
We utilize wholesale funding and securities to enhance our profitability and balance sheet composition by determining acceptable levels of credit, interest rate and liquidity risk consistent with prudent capital management.  This balance sheet strategy consists of borrowing a combination of long- and short-term funds from the FHLB and, when determined appropriate, issuing brokered CDs.  These funds are invested primarily in U.S. Agency MBS, and to a lesser extent, long-term municipal securities and U.S. Treasury securities.  Although U.S. Agency MBS often carry lower yields than traditional mortgage loans and other types of loans we make, these securities generally (i) increase the overall quality of our assets because of either the implicit or explicit guarantees of the U.S. Government, (ii) are more liquid than individual loans and (iii) may be used to collateralize our borrowings or other obligations.  While the strategy of investing a substantial portion of our assets in U.S. Agency MBS and municipal securities has historically resulted in lower interest rate spreads and margins, we believe the lower operating expenses and reduced credit risk,

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combined with the managed interest rate risk of this strategy, have enhanced our overall profitability over the last several years.  At this time, we utilize this balance sheet strategy with the goal of enhancing overall profitability by maximizing the use of our capital.
Risks associated with the asset structure we maintain include a lower net interest rate spread and margin when compared to our peers, changes in the slope of the yield curve, which can reduce our net interest rate spread and margin, increasedincrease interest rate risk, the length of interest rate cycles, changes in volatility spreads associated with the MBS and municipal securities, the unpredictable nature of MBS prepayments and credit risks associated with the municipal securities.  See “Part I - Item 1A.  Risk Factors – Risks Related to Our Business” in our Annual Report on Form 10-K for the year ended December 31, 2016,2017, for a discussion of risks related to interest rates.  Our asset structure, net interest spread and net interest margin require us to closely monitor our interest rate risk.  An additional risk is the change in fair value of the AFS securities portfolio as a result of changes in interest rates.  Significant increases in interest rates, especially long-term interest rates, could adversely impact the fair value of the AFS securities portfolio, which could also significantly impact our equity capital.  Due to the unpredictable nature of MBS prepayments, the length of interest rate cycles, and the slope of the interest rate yield curve, net interest income could fluctuate more than simulated under the scenarios modeled by our ALCO and described under “Item 3.  Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.
Determining the appropriate size of the balance sheet is one of the critical decisions any bank makes.  Our balance sheet is not merely the result of a series of micro-decisions, but rather the size is controlled based on the economics of assets compared to the economics of funding. The currentrelatively low, but currently increasing interest rate environment and investment and economic landscape requires that we monitor the interest rate sensitivity of the assets driving our growth and closely align ALCO objectives accordingly.
The management of our securities portfolio as a percentage of earning assets is guided by the current economics associated with increasing the securities portfolio, changes in our overall loan and deposit levels and changes in our wholesale funding levels.  If adequate quality loan growth is not available to achieve our goal of enhancing profitability by maximizing the use of capital, as described above, then we may purchase additional securities, if appropriate, which may cause securities as a percentage of earning assets to increase.  Should we determine that increasing the securities portfolio or replacing the current securities maturities and principal payments is not an efficient use of capital, we may decrease the level of securities through proceeds from maturities, principal payments on MBS or sales.  Our balance sheet strategy is designed such that our securities portfolio should help mitigate financial performance associated with potential business cycles that include slower loan growth and higher credit costs.
During the quarter ended September 30, 2017, we sold Texas municipalOur investment securities U.S. Agency collateralized mortgage obligations (“CMO”) and U.S. Agency commercial mortgage-backedMBS decreased from $2.45 billion at December 31, 2017 to $2.20 billion at June 30, 2018. The decrease was due to the flattening yield curve, higher funding costs and the realignment of the securities (“CMBS”)portfolio acquired in the Diboll acquisition to meet our balance sheet strategy and ALCO objectives in this developing interest rate environment.
During the six months ended June 30, 2018, we sold AFS securities that resulted in an overall gainloss on the sale of AFS securities of $627,000.$1.2 million. We primarily sold selected long-term CMBSU.S. Agency debentures and mortgage related securities, along with Texas Municipals.  During the fourth quarter of 2017, we recorded an impairment charge of $234,000 in connection with $109 million of impaired U.S. Agency debentures that we sold during January 2018. The sales of lower yielding low balance CMOs.  In addition, we primarily sold lower yielding Texas municipal securities.  These security salesfixed rate securities were designed to address risks from a flattening yield curve where short-term rates were rising and long-term rates were gradually decreasing. Also, we wanted tohelp alleviate margin compression brought on by the Federal Reserve raisingincrease in interest rates three times since December 2016, by selling lower yielding fixed rate securities.  Most of the longer duration sales of securities occurred during August and September as long-term rates fell, including the 10-year Treasury dropping below 2.05% in early September.Federal Reserve. During the quartersix months ended SeptemberJune 30, 2017,2018, sales of securities were partially offset by purchases of premium CMOs, CMBS,U.S. Agency mortgage related securities, U.S. Treasury securities and Texas municipal securities. We early-adopted ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities” on January 2, 2018, and in conjunction with the adoption, made the transition election to reclassify from HTM to AFS approximately $743.4 million in book value of securities with favorable expected returns and defensive risk profiles. Our total portfolio, comprised of investment and MBS, decreased from $2.42 billion at December 31, 2016 to $2.20 billion at September 30, 2017, which was partially offset by loan growth duringthat qualified for the second and third quarters.last-of-layer approach.
At SeptemberJune 30, 2017,2018, securities decreased as a percentage of assets to 40.1%35.2% as compared to 43.4%37.7% at December 31, 20162017 due to the $215.2$246.0 million, or 8.9%10.0%, decrease in the securities portfolio. The size of the securities portfolio increased during the last quarter of 2016 to offset the interest expense associated with the subordinated debt we issued in September 2016. Our balance sheet management strategy is dynamic and will be continually reevaluated as market conditions warrant.  As interest rates, yield curves, MBS prepayments, funding costs, security spreads and loan and deposit portfolios change, our determination of the proper types, amount and maturities of securities to own, as well as funding needs and funding sources, will continue to be reevaluated.  Should the economics of purchasing securities

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decrease, as it did in the first six months of this year, we may allow this part of the balance sheet to shrink through run-off or security sales.  However, should the economics become more attractive, we may strategically increase the securities portfolio and the balance sheet.
With respect to liabilities, we continue to utilize a combination of FHLB advancesborrowings and deposits to achieve our strategy of minimizing cost while achieving overall interest rate risk objectives as well as the liability management objectives of the ALCO. FHLB funding is the primary wholesale funding source we are currently utilizing.
Our FHLB borrowings decreased 12.8%23.7%, or $167.1$240.9 million, to $1.14 billion$776.5 million at SeptemberJune 30, 20172018 from $1.31$1.02 billion at December 31, 2016. During the nine months ended September 30, 2017, our long-term FHLB advances decreased 65.7%, or $291.1 million, to $152.1 million from $443.1 million at December 31, 2016.2017. From time to time, the Company may enter into various variable rate advancesadvance agreements with the FHLB. These advancesadvance agreements totaled $310.0 million at June 30, 2018 and $280.0 million at September 30, 2017 and $250.0 million at December 31,

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2016. 2017. Two of the variable rate advancesadvance agreements have interest rates of three-month LIBOR plus 0.021%, and one has an interest rate of three-month LIBOR minus 25 basis points.0.003%. The remaining advancesadvance agreements have interest rates ranging from one-month LIBOR plus 0.17%0.072% to one-month LIBOR plus 0.278%0.164%. In connection with obtaining some of these advances,variable rate advance agreements, the Company also entered into various interest rate swap contracts that are treated as cash flow hedges under ASC Topic 815, “Derivatives and Hedging” that effectively converted the variable rate advancesadvance agreements to fixed interest rates ranging from 0.932% to 2.345%2.832% and original terms ranging from fourfive years to ten years. The cash flows from the swaps are expected to be effective in hedging the variability in future cash flows attributable to fluctuations in the one-month and three-month LIBOR interest rates. During the first quarter of 2017, we terminated two interest rate swap contracts designated as cash flow hedges having a total notional value of $40.0 million. At the time of termination, we determined that the underlying hedged forecasted transactions were still probable of occurring. These transactions are reevaluated on a monthly basis thereafter, to determine if the hedged forecasted transactions are still probable of occurring. If at a subsequent evaluation it is determined that the transactions will not occur, any related gains or losses recorded in AOCI are immediately recognized in earnings. Refer to “Note 10 - Derivative Financial Instruments and Hedging Activities” in our consolidated financial statements included in this report for a detailed description of our hedging policy and methodology related to derivative instruments.
Our brokered CDs increased 88.2% from $35.5$60.2 million at December 31, 20162017 to $74.2$113.3 million at SeptemberJune 30, 2017, or 109.0%,2018, due to lower funding costs compared to other funding alternatives and ALCO objectives. At SeptemberJune 30, 2017,2018, approximately $68.5$110.3 million of our brokered CDs were non-callable with a weighted average cost of 93189 basis points and remaining maturities of less than seventwelve months. The remaining $5.7$3.0 million havehas a short-term callscall that we control and maturematures within twenty-seveneighteen months. Our wholesale funding policy currently allows maximum brokered CDsdeposits of $180.0$250.0 million; however, this amount could be increased to match changes in ALCO objectives.  The potential higher interest expense and lack of customer loyalty are risks associated with the use of brokered CDs.
During the ninesix months ended SeptemberJune 30, 2017,2018, the decrease in FHLB advances,borrowings, partially offset by the increase in brokered depositsCDs, resulted in a decrease in our total wholesale funding as a percentage of deposits, not including brokered deposits, to 35.0%20.3% at SeptemberJune 30, 20172018 from 38.5%24.3% at December 31, 2016.2017.


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Results of Operations

Our results of operations are dependent primarily on net interest income, which is the difference between the interest income earned on assets (loans and investments) and interest expense due on our funding sources (deposits and borrowings) during a particular period.  Results of operations are also affected by our noninterest income, provision for loan losses, noninterest expenses and income tax expense.  General economic and competitive conditions, particularly changes in interest rates, changes in interest rate yield curves, prepayment rates of MBS and loans, repricing of loan relationships, government policies and actions of regulatory authorities also significantly affect our results of operations.  Future changes in applicable law, regulations or government policies may also have a material impact on us.


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The “Average Balances with Average Yields and Rates”following table that follows provides an analysis ofpresents net interest income for the three months ended September 30, 2017 and 2016 and details the components of the change in net interest income for the three months ended September 30, 2017 compared to the same period in the prior year (dollars inperiods presented (in thousands).:
 Average Balances with Average Yields and Rates
 (unaudited)
 Three Months Ended
 September 30, 2017 September 30, 2016
 Avg Balance Interest Income Avg Yield/Rate Avg Balance Interest Income Avg Yield/Rate
ASSETS           
Loans (1) (2)
$2,657,562
 $30,378
 4.54% $2,436,349
 $26,750
 4.37%
Loans held for sale5,060
 47
 3.69% 6,718
 54
 3.20%
Securities:           
Investment securities (taxable) (4)
11,085
 58
 2.08% 61,238
 251
 1.63%
Investment securities (tax-exempt) (3) (4)
758,828
 9,214
 4.82% 690,635
 8,911
 5.13%
Mortgage-backed and related securities (4)
1,550,494
 10,567
 2.70% 1,492,271
 9,399
 2.51%
Total securities2,320,407
 19,839
 3.39% 2,244,144
 18,561
 3.29%
FHLB stock, at cost, and other investments66,994
 329
 1.95% 54,085
 186
 1.37%
Interest earning deposits144,700
 506
 1.39% 57,598
 89
 0.61%
Federal funds sold4,626
 21
 1.80% 
 
 
Total earning assets5,199,349
 51,120
 3.90% 4,798,894
 45,640
 3.78%
Cash and due from banks53,220
     49,418
    
Accrued interest and other assets360,073
     385,917
    
Less:  Allowance for loan losses(19,556)     (14,989)    
Total assets$5,593,086
     $5,219,240
    
LIABILITIES AND SHAREHOLDERS’ EQUITY           
Savings deposits$260,860
 117
 0.18% $248,364
 71
 0.11%
Time deposits988,380
 2,878
 1.16% 949,019
 2,073
 0.87%
Interest bearing demand deposits1,562,993
 2,425
 0.62% 1,634,898
 1,460
 0.36%
Total interest bearing deposits2,812,233
 5,420
 0.76% 2,832,281
 3,604
 0.51%
Short-term interest bearing liabilities1,095,968
 3,382
 1.22% 608,130
 1,122
 0.73%
Long-term interest bearing liabilities – FHLB Dallas149,512
 778
 2.06% 472,470
 1,857
 1.56%
Subordinated notes (5)
98,190
 1,413
 5.71% 12,823
 189
 5.86%
Long-term debt (6)
60,239
 520
 3.42% 60,234
 430
 2.84%
Total interest bearing liabilities4,216,142
 11,513
 1.08% 3,985,938
 7,202
 0.72%
Noninterest bearing deposits773,739
     702,539
    
Accrued expenses and other liabilities48,682
     55,783
    
Total liabilities5,038,563
     4,744,260
    
Shareholders’ equity554,523
     474,980
    
Total liabilities and shareholders’ equity$5,593,086
     $5,219,240
    
Net interest income (tax-equivalent basis) (7)
  $39,607
     $38,438
  
Net interest margin on average earning assets (tax-equivalent basis) (7)
    3.02%     3.19%
Net interest spread (tax-equivalent basis) (7)
    2.82%     3.06%
(1)Interest on loans includes net fees on loans that are not material in amount.
(2)Interest income includes taxable-equivalent adjustments of $1,103 and $1,064 for the three months ended September 30, 2017 and 2016, respectively. See “Non-GAAP Financial Measures.”
(3)Interest income includes taxable-equivalent adjustments of $3,544 and $3,444 for the three months ended September 30, 2017 and 2016, respectively. See “Non-GAAP Financial Measures.”
(4)For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.
(5)The unamortized discount and debt issuance costs reflected in the carrying amount of the subordinated notes totaled approximately $1.8 million and $220,000 for the three months ended September 30, 2017 and 2016, respectively.
(6)Represents issuance of junior subordinated debentures. In connection with the adoption of ASU 2015-03 that requires unamortized debt issuance costs be presented as a direct deduction from the related debt liability, our average long-term debt for the three months ended September 30, 2017 and 2016 reflect unamortized debt issuance costs of $72,000 and $77,000, respectively.
(7)See “Non-GAAP Financial Measures.”
Note: As of September 30, 2017 and 2016, loans totaling $3,095 and $8,536, respectively, were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.

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  Three Months Ended Six Months Ended
  June 30, June 30,
  2018 2017 2018 2017
      (in thousands)
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 other 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

Net Interest Income

Net interest income is one of the principal sources of a financial institution’s earnings stream and represents the difference or spread between interest and fee income generated from interest earning assets and the interest expense paid on deposits and borrowed funds.  Fluctuations in interest rates or interest rate yield curves, as well as repricing characteristics and volume and changes in the mix of interest earning assets and interest bearing liabilities, materially impact net interest income.
Net interest income for the three months ended June 30, 2018 increased $7.7 million, or 21.7%, to $43.1 million, compared to $35.4 million for the same period in 2017. The increase in net interest income for the three months ended June 30, 2018, compared to the same period in 2017, was due to the increase in interest income from our loan portfolio, partially offset by the increase in interest expense on our deposits. Total interest income increased $10.8 million, or 23.4%, to $56.8 million during the three months ended June 30, 2018, compared to $46.0 million during the same period in 2017. Total interest expense increased $3.1 million, or 29.3%, to $13.7 million during the three months ended June 30, 2018, compared to $10.6 million during the same period in 2017.
Net interest income for the six months ended June 30, 2018 increased $16.5 million, or 23.4%, to $87.2 million, compared to $70.7 million for the same period in 2017. The increase in net interest income for the six months ended June 30, 2018, compared to the same period in 2017, was due to the increase in interest income primarily from our loan portfolio, partially offset by the increase in interest expense on deposits. Total interest income increased $23.1 million, or 25.4%, to $114.0 million during the six months ended June 30, 2018, compared to $90.9 million during the same period in 2017. Total interest expense increased $6.6 million, or 32.5%, to $26.7 million during the six months ended June 30, 2018, compared to $20.2 million during the same period in 2017.

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The “Average Balances with Average Yields and Rates” table that follows shows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of the interest bearing liabilities (dollars in thousands) for the three months ended June 30, 2018 and 2017. The interest and related yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See "Non-GAAP Financial Measures" for more information, and for a reconciliation to GAAP.
 Average Balances with Average Yields and Rates
 (unaudited)
 Three Months Ended
 June 30, 2018 June 30, 2017
 Avg Balance Interest Avg Yield/Rate Avg Balance Interest Avg Yield/Rate
ASSETS           
Loans (1)
$3,285,756
 $39,865
 4.87% $2,557,093
 $29,080
 4.56%
Loans held for sale1,794
 19
 4.25% 5,914
 60
 4.07%
Securities:           
Investment securities (taxable) (2)
6,891
 51
 2.97% 58,168
 267
 1.84%
Investment securities (tax-exempt) (2)
802,611
 8,004
 4.00% 749,259
 9,386
 5.02%
Mortgage-backed and related securities (2)
1,439,810
 10,210
 2.84% 1,594,269
 10,818
 2.72%
Total securities2,249,312
 18,265
 3.26% 2,401,696
 20,471
 3.42%
FHLB stock, at cost, and equity investments54,729
 411
 3.01% 66,744
 299
 1.80%
Interest earning deposits92,291
 400
 1.74% 156,124
 364
 0.94%
Federal funds sold16,251
 71
 1.75% 5,326
 14
 1.05%
Total earning assets5,700,133
 59,031
 4.15% 5,192,897
 50,288
 3.88%
Cash and due from banks75,560
     50,961
    
Accrued interest and other assets473,142
     358,041
    
Less:  Allowance for loan losses(24,558)     (18,495)    
Total assets$6,224,277
     $5,583,404
    
LIABILITIES AND SHAREHOLDERS’ EQUITY           
Savings deposits$360,340
 208
 0.23% $262,009
 121
 0.19%
Time deposits1,175,230
 4,303
 1.47% 1,014,101
 2,723
 1.08%
Interest bearing demand deposits1,981,427
 4,070
 0.82% 1,616,036
 2,294
 0.57%
Total interest bearing deposits3,516,997
 8,581
 0.98% 2,892,146
 5,138
 0.71%
FHLB borrowings692,386
 3,007
 1.74% 1,213,016
 3,551
 1.17%
Subordinated notes, net of unamortized debt issuance costs98,306
 1,407
 5.74% 98,151
 1,398
 5.71%
Trust preferred subordinated debentures, net of unamortized debt issuance costs60,243
 658
 4.38% 60,238
 494
 3.29%
Other borrowings9,283
 33
 1.43% 7,884
 4
 0.20%
Total interest bearing liabilities4,377,215
 13,686
 1.25% 4,271,435
 10,585
 0.99%
Noninterest bearing deposits1,045,298
     729,564
    
Accrued expenses and other liabilities50,843
     39,819
    
Total liabilities5,473,356
     5,040,818
    
Shareholders’ equity750,921
     542,586
    
Total liabilities and shareholders’ equity$6,224,277
     $5,583,404
    
Net interest income (FTE)  $45,345
     $39,703
  
Net interest margin (FTE)    3.19%     3.07%
Net interest spread (FTE)    2.90%     2.89%
(1)Interest on loans includes net fees on loans that are not material in amount.
(2)For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.

Note: As of June 30, 2018 and 2017, loans totaling $35.4 million and $3.0 million, respectively, were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.


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Quarterly Analysis of Changes in Interest Income and Interest Expense
The following table comparespresents on a fully taxable-equivalent basis, a non-GAAP measure, the net change in net interest income and sets forth the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the average volume of interest earning assets and interest bearing liabilities and from changes in average yields/rates for the periods shown (in thousands):
 Three Months Ended September 30,
2017 Compared to 2016
 Average
Volume
 Average
Yield/Rate
 
Increase
(Decrease)
INTEREST INCOME:     
Loans (1)
$2,498
 $1,130
 $3,628
Loans held for sale(15) 8
 (7)
Investment securities (taxable)(248) 55
 (193)
Investment securities (tax-exempt) (1)
847
 (544) 303
Mortgage-backed securities376
 792
 1,168
FHLB stock, at cost and other investments51
 92
 143
Interest earning deposits227
 190
 417
Federal funds sold21
 
 21
Total interest income3,757
 1,723
 5,480
INTEREST EXPENSE:     
Savings deposits4
 42
 46
Time deposits89
 716
 805
Interest bearing demand deposits(67) 1,032
 965
Short-term interest bearing liabilities1,229
 1,031
 2,260
   Long-term interest bearing liabilities – FHLB Dallas(1,548) 469
 (1,079)
Subordinated notes1,229
 (5) 1,224
Long-term debt
 90
 90
Total interest expense936
 3,375
 4,311
Net interest income$2,821
 $(1,652) $1,169
(1)Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a taxable equivalent basis. See “Non-GAAP Financial Measures.”

Note:rates. Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes.changes (in thousands):

Net interest income for the three months ended September 30, 2017 increased $1.0 million, or 3.0%, to $35.0 million, compared to $33.9 million for the same period in 2016.
 Three Months Ended June 30, 2018 Compared to 2017
 Change Attributable to Total
Fully Taxable-Equivalent Basis:Average Volume Average Yield/Rate Change
Interest income on:     
Loans (1)
$8,735
 $2,050
 $10,785
Loans held for sale(44) 3
 (41)
Investment securities (taxable)(320) 104
 (216)
Investment securities (tax-exempt) (1)
633
 (2,015) (1,382)
Mortgage-backed securities(1,080) 472
 (608)
FHLB stock, at cost, and equity investments(61) 173
 112
Interest earning deposits(190) 226
 36
Federal funds sold43
 14
 57
Total earning assets7,716
 1,027
 8,743
Interest expense on:     
Savings deposits52
 35
 87
Time deposits480
 1,100
 1,580
Interest bearing demand deposits597
 1,179
 1,776
FHLB borrowings(1,871) 1,327
 (544)
Subordinated notes, net of unamortized debt issuance costs2
 7
 9
Trust preferred subordinated debentures, net of unamortized debt issuance costs
 164
 164
Other borrowings1
 28
 29
Total interest bearing liabilities(739) 3,840
 3,101
Net change$8,455
 $(2,813) $5,642
(1)Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a fully taxable-equivalent basis. See “Non-GAAP Financial Measures.”
The increase in nettotal interest income for the three months ended September 30, 2017, compared to the same period in 2016, was due to the increase in interest income of $5.3 million, or 13.0%, on loans and the securities portfolio, partially offset by the increase in interest expense of $4.3 million associated with our deposits and other interest bearing liabilities. Our net interest margin decreased to 3.02% for the three months ended September 30, 2017, compared to 3.19% for the same period in 2016 and our net interest spread decreased to 2.82%, compared to 3.06% for the same period in 2016. Both the decrease in net interest spread and margin was due to higher average rates paid on interest bearing liabilities, partially offset by the increase in the average yield on earning assets.
Total interest income increased $5.3 million, or 13.0%, to $46.5 million during the three months ended September 30, 2017, compared to $41.1 million during the same period in 2016. The increase wasprimarily attributable to the increase in average earning assets of $400.5$507.2 million, or 8.3%9.8%, to $5.20$5.70 billion for the three months ended SeptemberJune 30, 20172018 from $4.80$5.19 billion for the same period in 2016, combined with2017, and to a lesser extent, the increase in the average yield on earning assets to 3.90%4.15% for the three months ended SeptemberJune 30, 20172018 from 3.78%3.88% for the three months ended SeptemberJune 30, 2016.2017. The increase in average earning assets was primarily the result of the acquisition of Diboll in the fourth quarter of 2017, partially offset by decreases in the securities portfolio and interest earning deposits. The increase in the average yield on total earning assets during the three months

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ended SeptemberJune 30, 2017,2018 was the result of increases in the average yieldyields on mostall of the earning asset categories partially offset byexcept the mix in earning assets and the decrease in purchase accounting accretionaverage yield on loans.tax-exempt investment securities.
Total interest expense increased $4.3 million, or 59.9%, to $11.5 million during the three months ended September 30, 2017, compared to $7.2 million during the same period in 2016.  The increase in total interest expense for the three months ended SeptemberJune 30, 2018 was primarily attributable to the increase in the average rates paid on total interest bearing liabilities to 1.25% for the three months ended June 30, 2018 from 0.99% for the three months ended June 30, 2017, was attributableand to thea lesser extent, an increase in average interest bearing liabilities of $230.2$105.8 million, or 5.8%2.5%, to $4.22$4.38 billion during the three months ended SeptemberJune 30, 20172018 from $3.99$4.27 billion during the three months ended SeptemberJune 30, 2016, and an increase in the average rate paid on interest bearing liabilities to 1.08% for the three months ended September 30, 2017, from 0.72% for the three months ended September 30, 2016.2017.  The increase in average interest-bearing liabilities was primarily thealso a result of increases in short-term interest bearing liabilities and the subordinated notes,acquisition of Diboll during the fourth quarter of 2017, partially offset by a decrease in long-term interest bearing liabilities.FHLB borrowings. The increase in average rates paid on interest bearing liabilities was primarily due to overall higherrising interest rates during 2017 and 2018.
Our net interest margin (FTE) increased to 3.19% for the three months ended June 30, 2018, compared to 3.07% for the same period in 2017 and our net interest spread (FTE) increased slightly to 2.90%, compared to 2.89% for the remaining purchase accretion on the certificate of deposit premium amortizing during the third quarter of 2016.same period in 2017.

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The “Average Balances with Average Yields and Rates” table that follows provides an analysisshows average earning assets and interest bearing liabilities together with the average yield on the earning assets and the average rate of netthe interest incomebearing liabilities (dollars in thousands) for the ninesix months ended SeptemberJune 30, 20172018 and 20162017. The interest and details the components of the change in net interest incomerelated yields presented are on a fully taxable-equivalent basis and are therefore non-GAAP measures. See "Non-GAAP Financial Measures" for the nine months ended September 30, 2017 comparedmore information, and for a reconciliation to the same period in the prior year (dollars in thousands).GAAP.
Average Balances with Average Yields and RatesAverage Balances with Average Yields and Rates
(unaudited)(unaudited)
Nine Months EndedSix Months Ended
September 30, 2017 September 30, 2016June 30, 2018 June 30, 2017
Avg Balance Interest Income Avg Yield/Rate Avg Balance Interest Income Avg Yield/RateAvg Balance Interest Avg Yield/Rate Avg Balance Interest Avg Yield/Rate
ASSETS                      
Loans (1) (2)
$2,588,358
 $87,699
 4.53% $2,432,652
 $82,818
 4.55%
Loans (1)
$3,293,090
 $79,266
 4.85% $2,553,183
 $57,321
 4.53%
Loans held for sale5,992
 155
 3.46% 5,100
 126
 3.30%1,669
 30
 3.62% 6,466
 108
 3.37%
Securities:                      
Investment securities (taxable) (4)(2)
51,645
 702
 1.82% 41,708
 572
 1.83%23,022
 278
 2.44% 72,262
 644
 1.80%
Investment securities (tax-exempt) (3) (4)
762,543
 28,529
 5.00% 661,430
 26,041
 5.26%
Investment securities (tax-exempt) (2)
803,844
 16,004
 4.01% 764,431
 19,315
 5.10%
Mortgage-backed and related securities (4)(2)
1,571,685
 31,430
 2.67% 1,465,923
 28,156
 2.57%1,498,151
 21,104
 2.84% 1,582,455
 20,863
 2.66%
Total securities2,385,873
 60,661
 3.40% 2,169,061
 54,769
 3.37%2,325,017
 37,386
 3.24% 2,419,148
 40,822
 3.40%
FHLB stock, at cost, and other investments66,763
 926
 1.85% 54,051
 588
 1.45%
FHLB stock, at cost, and equity investments60,831
 825
 2.73% 66,646
 597
 1.81%
Interest earning deposits154,289
 1,216
 1.05% 55,378
 220
 0.53%99,848
 799
 1.61% 159,162
 710
 0.90%
Federal funds sold5,713
 49
 1.15% 
 
 
14,759
 120
 1.64% 6,266
 28
 0.90%
Total earning assets5,206,988
 150,706
 3.87% 4,716,242
 138,521
 3.92%5,795,214
 118,426
 4.12% 5,210,871
 99,586
 3.85%
Cash and due from banks52,568
     50,738
    76,789
     52,237
    
Accrued interest and other assets356,212
     378,000
    483,086
     354,283
    
Less: Allowance for loan losses(18,732)     (19,136)    (22,791)     (18,313)    
Total assets$5,597,036
     $5,125,844
    $6,332,298
     $5,599,078
    
LIABILITIES AND SHAREHOLDERS’ EQUITY                      
Savings deposits$258,568
 330
 0.17% $242,852
 204
 0.11%$357,073
 392
 0.22% $257,402
 213
 0.17%
Time deposits976,919
 7,828
 1.07% 946,986
 5,723
 0.81%1,172,658
 8,198
 1.41% 971,095
 4,950
 1.03%
Interest bearing demand deposits1,628,477
 6,681
 0.55% 1,693,135
 4,448
 0.35%1,995,214
 7,442
 0.75% 1,661,762
 4,256
 0.52%
Total interest bearing deposits2,863,964
 14,839
 0.69% 2,882,973
 10,375
 0.48%3,524,945
 16,032
 0.92% 2,890,259
 9,419
 0.66%
Short-term interest bearing liabilities1,038,326
 7,927
 1.02% 469,831
 2,724
 0.77%
Long-term interest bearing liabilities – FHLB Dallas220,007
 3,255
 1.98% 510,392
 5,770
 1.51%
Subordinated notes (5)
98,153
 4,204
 5.73% 4,305
 189
 5.86%
Long-term debt (6)
60,238
 1,481
 3.29% 60,233
 1,251
 2.77%
FHLB borrowings809,879
 6,639
 1.65% 1,257,429
 7,015
 1.13%
Subordinated notes, net of unamortized debt issuance costs98,287
 2,805
 5.76% 98,134
 2,791
 5.74%
Trust preferred subordinated debentures, net of unamortized debt issuance costs60,242
 1,227
 4.11% 60,237
 961
 3.22%
Other borrowings8,696
 44
 1.02% 7,437
 7
 0.19%
Total interest bearing liabilities4,280,688
 31,706
 0.99% 3,927,734
 20,309
 0.69%4,502,049
 26,747
 1.20% 4,313,496
 20,193
 0.94%
Noninterest bearing deposits732,637
     685,982
    1,031,065
     711,745
    
Accrued expenses and other liabilities42,749
     48,120
    47,034
     39,768
    
Total liabilities5,056,074
     4,661,836
    5,580,148
     5,065,009
    
Shareholders’ equity540,962
     464,008
    752,150
     534,069
    
Total liabilities and shareholders’ equity$5,597,036
     $5,125,844
    $6,332,298
     $5,599,078
    
Net interest income (tax-equivalent basis) (7)
  $119,000
     $118,212
  
Net interest margin on average earning assets (tax-equivalent basis) (7)
    3.06%     3.35%
Net interest spread (tax-equivalent basis) (7)
    2.88%     3.23%
Net interest income (FTE)  $91,679
     $79,393
  
Net interest margin (FTE)    3.19%     3.07%
Net interest spread (FTE)    2.92%     2.91%
(1)Interest on loans includes net fees on loans that are not material in amount.
(2)Interest income includes taxable-equivalent adjustments of $3,188 and $3,206 for the nine months ended September 30, 2017 and 2016, respectively. See “Non-GAAP Financial Measures.”
(3)Interest income includes taxable-equivalent adjustments of $10,148 and $10,082 for the nine months ended September 30, 2017 and 2016, respectively. See “Non-GAAP Financial Measures.”
(4)For the purpose of calculating the average yield, the average balance of securities is presented at historical cost.
(5)The unamortized discount and debt issuance costs reflected in the carrying amount of the subordinated notes totaled approximately $1.8 million and $74,000 for the nine months ended September 30, 2017 and 2016, respectively.
(6)Represents issuance of junior subordinated debentures. In connection with the adoption of ASU 2015-03 that requires unamortized debt issuance costs be presented as a direct deduction from the related debt liability, our average long-term debt for the nine months ended September 30, 2017 and 2016 reflect unamortized debt issuance costs of $73,000 and $78,000, respectively.
(7)See “Non-GAAP Financial Measures.”

Note: As of SeptemberJune 30, 20172018 and 2016,2017, loans totaling $3,095$35.4 million and $8,536,$3.0 million, respectively, were on nonaccrual status. Our policy is to reverse previously accrued but unpaid interest on nonaccrual loans; thereafter, interest income is recorded to the extent received when appropriate.


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Year-to-Date Analysis of Changes in Interest Income and Interest Expense
The following table comparespresents on a fully taxable-equivalent basis, a non-GAAP measure, the net change in net interest income and sets forth the dollar amount of increase (decrease) in interest income and interest expense resulting from changes in the average volume of interest earning assets and interest bearing liabilities and from changes in yields/rates for the periods shown (in thousands):
 Nine Months Ended September 30,
2017 Compared to 2016
 Average
Volume
 Average
Yield/Rate
 
Increase
(Decrease)
INTEREST INCOME:     
Loans (1)
$5,277
 $(396) $4,881
Loans held for sale23
 6
 29
Investment securities (taxable)135
 (5) 130
Investment securities (tax-exempt) (1)
3,832
 (1,344) 2,488
Mortgage-backed securities2,085
 1,189
 3,274
FHLB stock, at cost and other investments156
 182
 338
Interest earning deposits642
 354
 996
Federal funds sold49
 
 49
Total interest income12,199
 (14) 12,185
INTEREST EXPENSE:     
Savings deposits14
 112
 126
Time deposits186
 1,919
 2,105
Interest bearing demand deposits(176) 2,409
 2,233
Short-term interest bearing liabilities4,123
 1,080
 5,203
   Long-term interest bearing liabilities – FHLB Dallas(3,940) 1,425
 (2,515)
Subordinated notes4,020
 (5) 4,015
Long-term debt
 230
 230
Total interest expense4,227
 7,170
 11,397
Net interest income$7,972
 $(7,184) $788
(1)Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a taxable equivalent basis. See “Non-GAAP Financial Measures.”

Note:rates. Volume/Yield/Rate variances (change in volume times change in yield/rate) have been allocated to amounts attributable to changes in volumes and to changes in yields/rates in proportion to the amounts directly attributable to those changes.changes (in thousands):

Net interest income for the nine months ended September 30, 2017 increased $740,000, or 0.7%, to $105.7 million, compared to $104.9 million for the same period in 2016.
 Six Months Ended June 30, 2018 Compared to 2017
 Change Attributable to Total
Fully Taxable-Equivalent Basis:Average Volume Average Yield/Rate Change
Interest income on:     
Loans (1)
$17,571
 $4,374
 $21,945
Loans held for sale(86) 8
 (78)
Investment securities (taxable)(541) 175
 (366)
Investment securities (tax-exempt) (1)
955
 (4,266) (3,311)
Mortgage-backed securities(1,145) 1,386
 241
FHLB stock, at cost, and equity investments(56) 284
 228
Interest earning deposits(332) 421
 89
Federal funds sold57
 35
 92
Total earning assets16,423
 2,417
 18,840
Interest expense on:     
Savings deposits97
 82
 179
Time deposits1,164
 2,084
 3,248
Interest bearing demand deposits973
 2,213
 3,186
FHLB borrowings(3,002) 2,626
 (376)
Subordinated notes, net of unamortized debt issuance costs4
 10
 14
Trust preferred subordinated debentures, net of unamortized debt issuance costs
 266
 266
Other borrowings1
 36
 37
Total interest bearing liabilities(763) 7,317
 6,554
Net change$17,186
 $(4,900) $12,286
(1)Interest yields on loans and securities that are nontaxable for federal income tax purposes are presented on a fully taxable-equivalent basis. See “Non-GAAP Financial Measures.”
The increase in nettotal interest income for the nine months ended September 30, 2017, compared to the same period in 2016, was due to the increase in interest income of $12.1 million, or 9.7%, on loans and the securities portfolio, partially offset by the increase in interest expense of $11.4 million, or 56.1%, associated with our deposits and other interest bearing liabilities. Our net interest margin decreased to 3.06% for the nine months ended September 30, 2017, compared to 3.35% for the same period in 2016 and our net interest spread decreased to 2.88%, compared to 3.23% for the same period in 2016, due to higher average rates paid on interest-bearing liabilities along with a decrease in the average yield on earning assets.
Total interest income increased $12.1 million, or 9.7%, to $137.4 million during the nine months ended September 30, 2017, compared to $125.2 million during the same period in 2016. The increase wasprimarily attributable to the increase in average earning assets of $490.7$584.3 million, or 10.4%11.2%, to $5.21$5.80 billion for the ninesix months ended SeptemberJune 30, 20172018 from $4.72$5.21 billion for the same period in 2016, which was partially offset by2017, and to a lesser extent, the decreaseincrease in the average yield on earning assets to 3.87%4.12% for the ninesix months ended SeptemberJune 30, 20172018 from 3.92%3.85% for the ninesix months ended SeptemberJune 30, 2016.2017. The decreaseincrease in the average yield on earning assets during the nine months ended September 30, 2017 was primarily the result of the mix in earning assets, a decreaseacquisition of Diboll in the average yields on investment securities combined with a decrease in purchase accounting accretion on loans and the effect on the average yield on loans in 2016 of the $1.3 million recovery of interest income on the payoff of a long-term nonaccrual loan during the firstfourth quarter of 2016,2017, partially offset by decreases in the securities portfolio and interest earning deposits. The increase in the average yield on mortgage-backed and related securities, FHLB stock, at cost and other investments and interesttotal earning deposits.
Total interest expense increased $11.4 million, or 56.1%, to $31.7 millionassets during the ninesix months ended SeptemberJune 30, 2017, compared to $20.3 million during2018 was the same periodresult of increases in 2016.  the average yields on all of the earning asset categories except the average yield on tax-exempt investment securities.
The increase in total interest expense for the ninesix months ended SeptemberJune 30, 2018 was primarily attributable to the increase in the average rates paid on total interest bearing liabilities to 1.20% for the six months ended June 30, 2018 from 0.94% for the six months ended June 30, 2017, was attributableand to a lesser extent, the increase in average interest bearing liabilities of $353.0$188.6 million, or 9.0%4.4%, to $4.28$4.50 billion during the ninesix months ended SeptemberJune 30, 20172018 from $3.93$4.31 billion during the ninesix months ended SeptemberJune 30, 2016, and an increase

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in the average rates paid on interest bearing liabilities to 0.99% for the nine months ended September 30, 2017, from 0.69% for the nine months ended September 30, 2016.2017.  The increase in average interest-bearing liabilities was primarily thealso a result of increases in short-term interest bearing liabilities and the subordinated notes,acquisition of Diboll during the fourth quarter of 2017, partially offset by a decrease in long-term interest bearing liabilities.FHLB borrowings. The increase in average rates paid on interest bearing liabilities was primarily due to overall higherrising interest rates during 2017 and 2018.
Our net interest margin (FTE) increased to 3.19% for the six months ended June 30, 2018, compared to 3.07% for the same period in 2017 and our net interest spread (FTE) increased slightly to 2.92%, compared to 2.91% for the remaining purchase accretion on the certificate of deposit premium amortizing during the third quarter of 2016.same period in 2017.

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Noninterest Income
Noninterest income consists of revenue generated from a broad range of financial services and activities and other fee generating services that we either provide or in which we participate.
In connection with the adoption of Accounting Standards Update 2014-09 “Revenue from Contracts with Customers (Topic 606)” effective January 1, 2018, for the three and six months ended June 30, 2018, debit card expense and brokerage service expense previously reported in ATM and debit card expense and other noninterest expense are netted with deposit services income and brokerage services income, respectively. Due to the guidance under the modified retrospective method, prior periods have not been adjusted and therefore, are not comparable.
The following table details the categories included in noninterest income (in(dollars in thousands):
Three Months Ended
June 30,
 2018 Six Months Ended
June 30,
 2018
Three Months Ended
September 30,
 Nine Months Ended
September 30,
 Change From Change From
2017 2016 2017 20162018 2017 2017 2018 2017 2017
Deposit services$5,476
 $5,335
 $15,845
 $15,519
$6,261
 $5,255
 $1,006
 19.1 % $12,440
 $10,369
 $2,071
 20.0 %
Net gain on sale of securities available for sale627
 2,343
 874
 5,512
Net (loss) gain on sale of securities available for sale(332) (75) (257) 342.7 % (1,159) 247
 (1,406) (569.2)%
Gain on sale of loans347
 818
 1,553
 2,334
173
 505
 (332) (65.7)% 288
 1,206
 (918) (76.1)%
Trust income873
 867
 2,662
 2,591
1,931
 899
 1,032
 114.8 % 3,691
 1,789
 1,902
 106.3 %
Bank owned life insurance income636
 656
 1,905
 1,977
1,185
 635
 550
 86.6 % 1,817
 1,269
 548
 43.2 %
Brokerage services561
 551
 1,790
 1,661
506
 682
 (176) (25.8)% 956
 1,229
 (273) (22.2)%
Other noninterest income888
 1,162
 3,745
 3,104
1,283
 1,392
 (109) (7.8)% 2,584
 2,857
 (273) (9.6)%
Total noninterest income$9,408
 $11,732
 $28,374
 $32,698
$11,007
 $9,293
 $1,714
 18.4 % $20,617
 $18,966
 $1,651
 8.7 %
NoninterestThe increase in noninterest income was $9.4 million for the three months ended SeptemberJune 30, 2017 compared to $11.7 million for the same period in 2016, a decrease of $2.3 million, or 19.8%.  The decrease for the three months ended September 30, 20172018 when compared to the same period in 2016,2017, was primarily due to a decreaseincreases in net gain on sale of securities available for sale, a decreasetrust income, deposit services income and bank owned life insurance income.
The increase in gain on sale of loans, and a decrease in other noninterest income. We sold U.S. Agency CMOs, U.S. Agency CMBS, and Texas municipal securities that resulted in a net gain on sale of AFS securities of $627,000income for the threesix months ended SeptemberJune 30, 2017. The decrease in gain on sale of loans was primarily due to a decline in the volume of loans sold. The decrease in other noninterest income was primarily attributable to an increase in the net gain on sale of assets during the third quarter of 2016 and a decrease in mortgage servicing fee income due to a decline in the fair value of mortgage servicing rights during the third quarter of 2017.
Noninterest income was $28.4 million for the nine months ended September 30, 2017 compared to $32.7 million for the same period in 2016, a decrease of $4.3 million, or 13.2%.  The decrease for the nine months ended September 30, 20172018 when compared to the same period in 2016,2017, was primarily due to increases in deposit services income, trust income and bank owned life insurance income, partially offset by a decrease in net gain on sale of securities available for sale and a decrease in gain on sale of loans, partially offset by anloans.
The increase in other noninterest income. Wedeposit services income is primarily a result of increased deposit accounts related to the Diboll acquisition on November 30, 2017. The increase consists of income of $2.0 million and $3.9 million prior to netting the debit card expense of $988,000 and $1.8 million for the three and six months ended June 30, 2018, respectively.
During the six months ended June 30, 2018, we sold U.S. Government Agency debentures, U.S. Agency CMOs, U.S. Treasury securities, U.S. Agency CMBS U.S. Agency MBS,and Texas municipal securities and U.S. Treasury securities that resulted in a net gainloss on sale of AFS securities of $874,000$332,000 and $1.2 million for the ninethree and six months ended SeptemberJune 30, 2017. 2018, respectively.
The decrease in gain on sale of loans for the three and six months ended June 30, 2018 was primarily due to a decline in the volume of loans sold.
The increase in other noninteresttrust income for the three and six months ended June 30, 2018 was primarily attributabledue to anthe increase in assets under management, a direct result of the Diboll acquisition.
The increase in bank owned life insurance income from customer derivatives, which were partially offset byfor the three and six months ended June 30, 2018 was primarily due to the death benefits realized in the second quarter of 2018 for a retired covered officer.
Brokerage services income reflects a decrease inprimarily due to the return on other investments.

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brokerage services expense of $151,000 and $302,000 for the three and six months ended June 30, 2018, respectively.
Noninterest Expense
We incur certain types of noninterest expenses associated with the operation of our various business activities. The following table details the categories included in noninterest expense (in(dollars in thousands):
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
 2017 2016 2017 2016
Salaries and employee benefits$14,395
 $15,203
 $45,229
 $47,784
Occupancy expense2,981
 4,569
 8,741
 10,897
Advertising, travel & entertainment487
 588
 1,618
 1,995
ATM and debit card expense1,024
 868
 2,840
 2,316
Professional fees996
 1,148
 2,985
 3,964
Software and data processing expense732
 736
 2,145
 2,224
Telephone and communications459
 407
 1,461
 1,359
FDIC insurance441
 643
 1,327
 1,926
Other noninterest expense3,492
 4,263
 10,056
 11,180
Total noninterest expense$25,007
 $28,425
 $76,402
 $83,645
Noninterest expense was $25.0 million for the three months ended September 30, 2017 compared to $28.4 million for the same period in 2016, representing a decrease of $3.4 million, or 12.0%, for the three months ended September 30, 2017. The decrease for the three months ended September 30, 2017 was primarily the result of decreases in occupancy expense, salary and employee benefits, and other noninterest expense.
Occupancy expense decreased during the three months ended September 30, 2017 due to the early termination of a lease during the third quarter of 2016. We prepaid a lease at approximately 59% of the remaining lease payments on a Fort Worth operations facility that was vacated. The cost of prepaying this lease, combined with writing off the leasehold improvements, was $1.8 million during the third quarter of 2016.
Salary and employee benefits decreased for the three months ended September 30, 2017 compared to the same period in 2016, due to decreases in direct salary expense and retirement expense. Direct salary expense decreased $698,000, or 5.3%, during the three months ended September 30, 2017 compared to the same period in the prior year. Retirement expense decreased $168,000, or 19.5%, during the three months ended September 30, 2017 compared to the same period in 2016, primarily due to an increase in expected return on pension assets.
The decrease in other noninterest expense for the three months ended September 30, 2017 compared to the same period in 2016 was primarily due to decreases in the provision expense for losses on loans sold with recourse and expense related to repossessed assets, partially offset by $405,000 in acquisition expense related to the proposed merger with Diboll.
Noninterest expense was $76.4 million for the nine months ended September 30, 2017 compared to $83.6 million for the same period in 2016, representing a decrease of $7.2 million, or 8.7%, for the nine months ended September 30, 2017. The decrease for the nine months ended September 30, 2017 was primarily the result of decreases in salary and employee benefits, occupancy expense, professional fees, other noninterest expense, FDIC insurance, and advertising, travel and entertainment expense, partially offset by an increase in ATM and debit card expense.
Salary and employee benefits decreased for the nine months ended September 30, 2017 compared to the same period in 2016 due to a decrease in retirement expense and direct salary expense, partially offset by an increase in health insurance expense. Retirement expense decreased $2.3 million, or 52.3%, most of which was related to the acceptance of early retirement packages by 16 employees during the first quarter of 2016. Direct salary expense decreased $1.0 million, or 2.4%, during the nine months ended September 30, 2017 compared to the same period last year. Health insurance expense increased $656,000, or 18.9%, during the nine months ended September 30, 2017 compared to the same period last year. We have a self-insured health plan which is supplemented with stop loss insurance policies.  Health insurance costs are rising nationwide and our health insurance costs may continue to increase during the remainder of 2017.
Occupancy expense decreased during the nine months ended September 30, 2017 due to the early termination of a lease during the third quarter of 2016, as previously disclosed, and lower rent expense due to this termination. Professional fees decreased for the nine months ended September 30, 2017 compared to the same period in 2016 due to lower consulting expense in 2017 associated with the cost containment and process improvement efforts initiated in January 2016.

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FDIC insurance decreased
 Three Months Ended
June 30,
 2018 Six Months Ended
June 30,
 2018
  Change From  Change From
 2018 2017 2017 2018 2017 2017
Salaries and employee benefits$16,633
 $14,984
 $1,649
 11.0 % $35,192
 $30,991
 $4,201
 13.6 %
Occupancy expense3,360
 2,897
 463
 16.0 % 6,943
 5,760
 1,183
 20.5 %
Acquisition expense1,026
 473
 553
 116.9 % 1,858
 473
 1,385
 292.8 %
Advertising, travel & entertainment775
 548
 227
 41.4 % 1,460
 1,131
 329
 29.1 %
ATM and debit card expense243
 889
 (646) (72.7)% 589
 1,816
 (1,227) (67.6)%
Professional fees952
 1,050
 (98) (9.3)% 2,022
 1,989
 33
 1.7 %
Software and data processing expense939
 688
 251
 36.5 % 1,962
 1,413
 549
 38.9 %
Telephone and communications478
 476
 2
 0.4 % 1,016
 1,002
 14
 1.4 %
FDIC insurance484
 445
 39
 8.8 % 981
 886
 95
 10.7 %
Amortization expense on intangibles1,328
 410
 918
 223.9 % 2,706
 841
 1,865
 221.8 %
Other noninterest expense3,056
 2,677
 379
 14.2 % 6,212
 5,093
 1,119
 22.0 %
Total noninterest expense$29,274
 $25,537
 $3,737
 14.6 % $60,941
 $51,395
 $9,546
 18.6 %
The increase in noninterest expense for the ninethree and six months ended SeptemberJune 30, 20172018 compared to the same periodperiods in 20162017, was primarily the result of the acquisition of Diboll on November 30, 2017 and certain other factors as identified below.
Salary and employee benefits increased for the three and six months ended June 30, 2018 compared to the same periods in 2017, due to reduced FDIC assessment rates. increases in direct salary expense, partially offset by decreases in retirement expense. Direct salary expense increased $1.9 million, or 15.0%, and $4.2 million, or 15.6%, during the three and six months ended June 30, 2018, respectively, compared to the same periods in the prior year due to additional employees as a result of the acquisition of Diboll and one-time bonus payments in the first quarter of $744,000 to certain employees in response to the benefits received from the Tax Cuts and Jobs Act, and to a lesser extent, normal salary increases effective in the first quarter of 2018. Retirement expense decreased $560,000, or 70.8%, and $229,000, or 15.0%, for the three and six months ended June 30, 2018, respectively, primarily due to the reversal of a split dollar liability related to the death of a retired covered officer during the second quarter of 2018.
Occupancy expense increased during the three and six months ended June 30, 2018 primarily due to increased depreciation, real estate taxes, janitorial, and various other occupancy related expense associated with the Diboll locations acquired. Also included in occupancy expense is additional rent expense of $164,000 recorded during the first quarter of 2018 in connection with the closure of one of our retail locations located within close proximity to an acquired Diboll location.
For the three months ended June 30, 2018, acquisition expense consisted of $441,000 in change in control payment accruals and severance payments, $541,000 in additional professional fees and $44,000 in travel expenses, both of the latter related to systems integration. For the six months ended June 30, 2018, acquisition expense consisted of $1.1 million in change in control payment accruals and severance payments, $721,000 in additional professional fees and $44,000 in travel expenses, both of the latter related to systems integration. Acquisition expense for the three and six months ended June 30, 2017, was primarily for professional fees.
Advertising, travel and entertainment expensesexpense increased during the three and six months ended June 30, 2018 primarily due to the integration of Diboll along with increased donations throughout our service areas.
ATM and debit card expense decreased for the ninethree and six months ended SeptemberJune 30, 20172018 compared to the same periodperiods in 20162017. In connection with the application of ASU 2014-09 effective January 1, 2018, debit card expense related to interchange revenue of $988,000 and $1.8 million for the three and six months ended June 30, 2018, respectively, is now netted with deposit services income as part of noninterest income. Due to the implementation of the guidance under the modified retrospective method, prior periods have not been adjusted and therefore, are not comparable.
Software and data processing expense increased for the three and six months ended June 30, 2018 compared to the same periods in 2017 primarily due to a decreasethe additional data processing expense and integration costs in advertisingconnection with the acquisition of Diboll.
Amortization expense on intangibles increased for the three and travel expense, partially offset by ansix months ended June 30, 2018 as compared to the same periods in 2017. The increase in media advertising.2018 was due to increased amortization related to both the core deposit intangible and trust relationship intangible recorded with the Diboll acquisition on November 30, 2017.
Other
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The increase in other noninterest expense for the ninethree and six months ended SeptemberJune 30, 2017 decreased2018 compared to the same periodperiods in 20162017, was primarily due to decreasesincreases in the provision expense for losses on loans sold with recourse, expense related to repossessed assets, core deposit intangible amortization expense, losses on other real estate owned, ("OREO"), provision expense for losses on unfunded loan commitments, and equipment maintenance expense, partially offset by $0.9 million of acquisition expense related to repossessed assets, director’s fees and an overall general increase in other noninterest expenses directly related to the proposed merger withacquisition of Diboll.
Income Taxes
During the first quarter of 2017, we adopted a new accounting standard that impacted how the income tax effects associated with stock-based compensation are recognized. See “Note 1 - Summary of Significant Accounting and Reporting Policies” for additional information.
Pre-tax income for the three and ninesix months ended SeptemberJune 30, 20172018 was $18.4$23.6 million and $54.2$41.9 million, respectively, compared to $15.6$17.8 million and $46.3$35.8 million for the same periods in 2016.2017. We recorded income tax expense of $3.9$3.4 million and $10.3$5.5 million for the three and ninesix months ended SeptemberJune 30, 2017,2018, respectively, compared to income tax expense of $2.7$3.4 million and $8.5$6.4 million for the same periods in 2016.2017. The effective tax rate (“ETR”) as a percentage of pre-tax income was 21.1%14.3% and 18.9%13.0% for the three and ninesix months ended SeptemberJune 30, 2017,2018, respectively, compared to an ETR as a percentage of pre-tax income of 17.6%18.8% and 18.3%17.8% for the same periods in 2016.2017.   The higherlower ETR for the three and ninesix months ended SeptemberJune 30, 2018 compared to the same periods in 2017 was mainly due to a decrease in tax-exempt income as a percentage of pre-tax income as comparedthe reduced corporate tax rate from 35% to 21% under the same period in 2016, slightly offset by the effect of the adoption of the accounting standard referenced above, reducing income tax expense by $213,000Tax Cuts and $423,000 and the ETR by 1.2% and 0.8%, respectively. Jobs Act (“Tax Act”) enacted on December 22, 2017.
The ETR differs from the stated rate of 21% and 35% duringfor the comparable periodthree and six months ended June 30, 2018 and 2017, respectively, primarily due to the effect of tax-exempt income from municipal loans and securities, as well as, bank owned life insurance.
Net The net deferred tax assetsasset totaled $21.8$15.4 million at SeptemberJune 30, 2017,2018 as compared to $28.9$12.2 million at December 31, 2016.2017. The $7.0$3.2 million decreaseincrease in the net deferred tax assets was due primarily toasset is the decreaseresult of the increase in the unrealized loss in the AFS securities portfolio. We remeasured certain deferred tax assets and liabilities as of December 22, 2017 based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Tax Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. During the three and six months ended June 30, 2018, there were no material adjustments made to the provisional amounts recorded with the remeasurement. See “Note 12-Income Taxes” to our consolidated financial statements included in this report. No valuation allowance for the net deferred tax assetsasset was recorded at SeptemberJune 30, 20172018 or December 31, 2016,2017, as management believes it is more likely than not that all of the net deferred tax assetsasset will be realized in future years.
Liquidity and Interest Rate Sensitivity
Liquidity management involves our ability to convert assets to cash with a minimum risk of loss to enable us to meet our obligations to our customers at any time.  This means addressing (1) the immediate cash withdrawal requirements of depositors and other fund providers; (2) the funding requirements of all lines and letters of credit; and (3) the short-term credit needs of customers.  Liquidity is provided by short-term investments that can be readily liquidated with a minimum risk of loss.  Cash, interest earning deposits and short-term investments with maturities or repricing characteristics of one year or less continue to be a substantial percentage of our total assets.  At SeptemberJune 30, 2017,2018, these investments were 6.7%5.9% of total assets, as compared with 7.2%6.9% for December 31, 20162017 and 13.5%7.5% for SeptemberJune 30, 2016.2017. The decrease to 6.7%5.9% at SeptemberJune 30, 20172018 is primarily reflective of changes in the investment portfolio. Liquidity is further provided through the matching, by time period, of rate sensitive interest earning assets with rate sensitive interest bearing liabilities.  Southside Bank has three unsecured lines of credit for the purchase of overnight federal funds at prevailing rates with Frost Bank, TIB-The Independent Bankers Bank and Comerica Bank for $30.0$40.0 million, $15.0 million and $7.5 million, respectively.  There were no federal funds purchased at SeptemberJune 30, 2018 or December 31, 2017.  Southside Bank has a $5.0 million line of credit with Frost Bank to be used to issue letters of credit and at SeptemberJune 30, 2017,2018 we had one outstanding letter of credit for $195,000.  At SeptemberJune 30, 2017,2018, the amount of additional funding Southside Bank could obtain from FHLB, securedcollateralized by a portion ofFHLB stock, nonspecified loans and certain securities, was approximately $621.6 million,$1.08 billion, net of FHLB stock purchases required.  Southside Bank currently has no outstanding letters of credit from FHLB held as collateral for a portion of its public fund deposits.
Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of newnet interest income through periods of changing interest rates.  The ALCO closely monitors various liquidity ratios and interest rate spreads and margins.  The ALCO performsutilizes a simulation model to perform interest rate simulation tests that apply various interest rate scenarios including immediate shocks and market value of portfolio equity (“MVPE”) with interest rates immediately shocked plus and minus 200 basis points, among others to assist in determining our overall interest rate risk and the adequacy of our liquidity position.  In addition, the ALCO utilizes athis simulation model to determine the impact on net interest income of several differentvarious interest rate scenarios.  By utilizing this technology, we can determine changes that need to be made to the asset and liability mix to minimize the change in net interest

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income under these various interest rate scenarios. See Part I - “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Quarterly Report on Form 10-Q.

Capital Resources
Our total shareholders’ equity at SeptemberJune 30, 2017 was $556.0 million, representing an increase of 7.3%2018 decreased 0.3%, or $37.7$2.3 million, from December 31, 2016, and representing a 10.1%to $751.8 million, or 12.0% of total assets, at September 30, 2017 compared to 9.3%$754.1 million, or 11.6% of total assets at December 31, 2016.2017.
Increases to our
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The decrease in shareholders’ equity consistedwas primarily the result of net income of $44.0 million, a decreasean increase in accumulated other comprehensive loss of $12.3$21.0 million and cash dividends paid of $20.3 million, partially offset by net income of $36.5 million recorded for the six months ended June 30, 2018, net issuance of common stock under employee stock plans of $2.4 million,$965,000, stock compensation expense of $1.4 million,$965,000 and common stock (33,000 shares) issued pursuant tounder our dividend reinvestment plan of $1.1 million.  These increases were partially offset by cash dividends paid of $23.4 million.$720,000.  
As a result of regulations, which became applicable to the Company and the Bank on January 1, 2015, we are required to comply with higher minimum capital requirements (the “Updated Capital Rules”). The Updated Capital Rules made substantial changes to previous capital standards. Among other things, the regulations (i) introduced a new capital requirement known as “Common Equity Tier 1” (“CET1”), (ii) stated that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain requirements, (iii) defined CET1 to require that most deductions and adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) revised the scope of the deductions and adjustments from capital as compared to regulations that previously applied to the Company and other banking organizations.
The Updated Capital Rules also established the following minimum capital ratios, which started to phase in on January 1, 2015: 4.5 percent CET1 to risk-weighted assets; 6.0 percent Tier 1 capital to risk-weighted assets; 8.0 percent total capital to risk-weighted assets; and 4.0 percent Tier 1 leverage ratio to average consolidated assets. In addition, the Updated Capital Rules also introduced a minimum “capital conservation buffer” equal to 2.5% of an organization’s total risk-weighted assets, which exists in addition to the required minimum CET1, Tier 1, and total capital ratios. The “capital conservation buffer,” which must consist entirely of CET1, is designed to absorb losses during periods of economic stress. The Updated Capital Rules provide for a number of deductions from and adjustments to CET1, which include the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carry-backs and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
Under the previous capital framework, the effects of accumulated other comprehensive income items included in shareholders’ equity under U.S. GAAP were excluded for the purposes of determining capital ratios. Under the Updated Capital Rules, wethe company has elected to permanently exclude capital in accumulated other comprehensive income in Common Equity Tier 1 capital, Tier 1 capital, and Total capital to risk-weighted assets and Tier 1 capital to adjusted quarterly average assets.
Under the Updated Capital Rules, certain hybrid securities, such as trust preferred securities, do not qualify as Tier 1 capital. For bank holding companies that had assets of less than $15 billion as of December 31, 2009, which includes Southside, trust preferred securities issued prior to May 19, 2010 can be treated as Tier 1 capital to the extent that they do not exceed 25% of Tier 1 capital after the application of capital deductions and adjustments.
Failure to meet minimum capital requirements under the Updated Capital Rules could result in certain mandatory and possibly additional discretionary actions by our regulators that, if undertaken, could have a direct material effect on our financial statements. Management believes that, as of SeptemberJune 30, 2017,2018, we met all capital adequacy requirements to which we were subject.
The Federal Deposit Insurance Act requires bank regulatory agencies to take “prompt corrective action” with respect to FDIC-insured depository institutions that do not meet minimum capital requirements.  A depository institution’s treatment for purposes of the prompt corrective action provisions will depend on how its capital levels compare to various capital measures and certain other factors, as established by regulation.  Prompt corrective action and other discretionary actions could have a direct material effect on our financial statements.
It is management’s intention to maintain our capital at a level acceptable to all regulatory authorities and future dividend payments will be determined accordingly.  Regulatory authorities require that any dividend payments made by either us or the Bank not exceed earnings for that year.  Accordingly, shareholders should not anticipate a continuation of ourthe cash dividend payments simply because of the existence of a dividend reinvestment program.  The payment of dividends will depend upon future earnings, our financial condition, and other related factors including the discretion of ourthe board of directors.


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To be categorized as well capitalized we must maintain minimum Common Equity Tier 1 risk-based, Tier 1 risk-based, Total capital risk-based and Tier 1 leverage ratios as set forth in the following table:
Actual 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
Actual 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
Amount Ratio Amount Ratio Amount AmountAmount Ratio Amount Ratio Amount Amount
September 30, 2017(dollars in thousands)
June 30, 2018(dollars in thousands)
Common Equity Tier 1 (to Risk Weighted Assets) 
  
  
  
  
  
 
  
  
  
  
  
Consolidated$486,009
 14.87% $147,040
 4.50% N/A
 N/A
$590,293
 15.49% $171,498
 4.50% N/A
 N/A
Bank Only$619,234
 18.96% $147,006
 4.50% $212,341
 6.50%$730,689
 19.17% $171,493
 4.50% $247,713
 6.50%
                      
Tier 1 Capital (to Risk Weighted Assets)

 

 

 

 

 



 

 

 

 

 

Consolidated$542,939
 16.62% $196,054
 6.00% N/A
 N/A
$648,725
 17.02% $228,664
 6.00% N/A
 N/A
Bank Only$619,234
 18.96% $196,007
 6.00% $261,343
 8.00%$730,689
 19.17% $228,658
 6.00% $304,877
 8.00%
                      
Total Capital (to Risk Weighted Assets)

 

 

 

 

 



 

 

 

 

 

Consolidated$662,783
 20.28% $261,405
 8.00% N/A
 N/A
$774,015
 20.31% $304,885
 8.00% N/A
 N/A
Bank Only$640,869
 19.62% $261,343
 8.00% $326,679
 10.00%$757,653
 19.88% $304,877
 8.00% $381,097
 10.00%
                      
Tier 1 Capital (to Average Assets) (1)


 

 

 

 

 



 

 

 

 

 

Consolidated$542,939
 9.90% $219,431
 4.00% N/A
 N/A
$648,725
 10.76% $241,198
 4.00% N/A
 N/A
Bank Only$619,234
 11.29% $219,337
 4.00% $274,172
 5.00%$730,689
 12.12% $241,107
 4.00% $301,384
 5.00%
Actual 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
Actual 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt
Corrective Actions
Provisions
Amount Ratio Amount Ratio Amount RatioAmount Ratio Amount Ratio Amount Ratio
December 31, 2016(dollars in thousands)
December 31, 2017(dollars in thousands)
Common Equity Tier 1 (to Risk Weighted Assets) 
  
  
  
  
  
 
  
  
  
  
  
Consolidated$461,158
 14.64% $141,759
 4.50% N/A
 N/A
$570,610
 14.65% $175,216
 4.50% N/A
 N/A
Bank Only$566,423
 17.98% $141,734
 4.50% $204,726
 6.50%$711,157
 18.27% $175,145
 4.50% $252,987
 6.50%
                      
Tier 1 Capital (to Risk Weighted Assets)                      
Consolidated$515,831
 16.37% $189,013
 6.00% N/A
 N/A
$627,532
 16.12% $233,621
 6.00% N/A
 N/A
Bank Only$566,423
 17.98% $188,978
 6.00% $251,971
 8.00%$711,157
 18.27% $233,527
 6.00% $311,369
 8.00%
                      
Total Capital (to Risk Weighted Assets) 
  
  
  
  
  
 
  
  
  
  
  
Consolidated$633,289
 20.10% $252,017
 8.00% N/A
 N/A
$748,532
 19.22% $311,495
 8.00% N/A
 N/A
Bank Only$585,781
 18.60% $251,971
 8.00% $314,964
 10.00%$733,909
 18.86% $311,369
 8.00% $389,211
 10.00%
                      
Tier 1 Capital (to Average Assets) (1)


 

 

 

 

 



 

 

 

 

 

Consolidated$515,831
 9.46% $218,029
 4.00% N/A
 N/A
$627,532
 11.16% $224,844
 4.00% N/A
 N/A
Bank Only$566,423
 10.40% $217,892
 4.00% $272,365
 5.00%$711,157
 12.66% $224,741
 4.00% $280,926
 5.00%
(1)Refers to quarterly average assets as calculated in accordance with policies established by bank regulatory agencies.

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Management believes that, as of SeptemberJune 30, 2017,2018, Southside Bancshares and Southside Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if such requirements were currently in effect.

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The table below summarizes our key equity ratios for the three and ninesix months ended SeptemberJune 30, 20172018 and 2016:2017:
 Three Months Ended
September 30,
 2017 2016
Return on Average Assets1.03% 0.98%
Return on Average Shareholders’ Equity10.38
 10.78
Dividend Payout Ratio – Basic57.14
 50.00
Dividend Payout Ratio – Diluted57.14
 50.00
Average Shareholders’ Equity to Average Total Assets9.91
 9.10
 Nine Months Ended
September 30,
 2017 2016
Return on Average Assets1.05% 0.98%
Return on Average Shareholders’ Equity10.87
 10.87
Dividend Payout Ratio – Basic54.00
 50.71
Dividend Payout Ratio – Diluted54.36
 51.08
Average Shareholders’ Equity to Average Total Assets9.67
 9.05

 Three Months Ended
June 30,
 2018 2017
Return on Average Assets1.30% 1.04%
Return on Average Shareholders’ Equity10.79
 10.70
Dividend Payout Ratio – Basic51.72
 57.14
Dividend Payout Ratio – Diluted52.63
 57.14
Average Shareholders’ Equity to Average Total Assets12.06
 9.72
 Six Months Ended
June 30,
 2018 2017
Return on Average Assets1.16% 1.06%
Return on Average Shareholders’ Equity9.77
 11.13
Dividend Payout Ratio – Basic55.77
 52.48
Dividend Payout Ratio – Diluted55.77
 53.00
Average Shareholders’ Equity to Average Total Assets11.88
 9.54


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Composition of Loans

One of our main objectives is to seek attractive lending opportunities in Texas, primarily in the counties in which we operate. Refer to “Part I - Item 1. Business - Market Area” in our Annual Report on Form 10-K for the year ended December 31, 20162017 for a discussion of our primary market area and the geographic concentration of our loan portfolio as of December 31, 2016.2017.  There were no substantial changes in these concentrations during the ninesix months ended SeptemberJune 30, 2017.2018.  Substantially all of our loan originations are made to borrowers who live in and conduct business in the counties in Texas in which we operate or adjoin, with the exception of municipal loans, which are made almost entirely inprimarily throughout the state of Texas.  Municipal loans are made to municipalities, counties, school districts and colleges primarily throughoutcolleges.
The following table sets forth loan totals by class as of the state of Texas.dates presented (dollars in thousands):
Total
       Compared to
       December 31,
2017
 June 30,
2017
 June 30,
2018
 December 31,
2017
 June 30,
2017
 Change (%) Change (%)
Real Estate Loans: 
  
  
    
Construction$487,286
 $475,867
 $386,853
 2.4 % 26.0%
1-4 Family Residential791,359
 805,341
 615,405
 (1.7)% 28.6%
Commercial1,245,936
 1,265,159
 1,033,629
 (1.5)% 20.5%
Commercial Loans282,723
 266,422
 172,311
 6.1 % 64.1%
Municipal Loans345,595
 345,798
 305,023
 (0.1)% 13.3%
Loans to Individuals117,984
 135,769
 96,977
 (13.1)% 21.7%
Total Loans$3,270,883
 $3,294,356
 $2,610,198
 (0.7)% 25.3%
Our loan portfolio decreased $23.5 million at June 30, 2018 compared to December 31, 2017 in the 1-4 family residential, commercial real estate and loans to individual portfolios, with those decreases partially offset by increases in the construction loan and commercial loan portfolios. During the three months ended June 30, 2018, our payoffs outpaced originations in the 1-4 family residential, commercial real estate and loans to individual portfolios.
Our loan portfolio increased $126.2$660.7 million or 4.9%,at June 30, 2018 compared to $2.68 billion at SeptemberJune 30, 2017 from $2.56 billiondue primarily to approximately $621.3 million of loans added on November 30, 2017 in the Diboll acquisition and growth in our Austin and Dallas-Fort Worth markets.
Our loan portfolio decreased at June 30, 2018 compared to December 31, 2016,2017 primarily as a result of roll-off in 1-4 family and increased $199.1 million,commercial real estate out-pacing originations and growth in the construction and commercial loan portfolios.
At June 30, 2018, our real estate loans represented 77.2% of our loan portfolio and are comprised of construction loans of 19.3%, 1-4 family residential loans of 31.3% and commercial real estate loans of 49.4%. Our construction loans are collateralized by property located primarily in or 8.0%,near the market areas we serve. Some of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects typically have cash flows from $2.48 billion at September 30, 2016.  Averageleases with tenants, secondary sources of repayment and in some cases, additional collateral. Our 1-4 family residential loans increased $155.7 million, or 6.4%, for the nine months ended September 30, 2017 when compared to the same period in 2016.consist primarily of loans secured by first mortgages on owner occupied 1-4 family residences. Commercial real estate loans consist primarily of loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches.
The banking industry is affected by general economic conditions such as interest rates, inflation, recession, unemployment and other factors beyond our control.  During the last thirty years the Texas economy has continued to diversify, decreasing the overall impact of fluctuations in oil and gas prices; however, the oil and gas industry is still a significant component of the Texas economy.  Since 2010, economic growth and business activity across a wide range of industries and regions in the U.S. has been slow and uneven. During a majority of that time economic growth and business activity in Texas exceeded the U.S. average. However in 2014, decisions by certain members of the Organization of Petroleum Exporting Countries (“OPEC”) to maintain higher crude oil production levels, combined with increased production levels in the United States, led to increased global oil supplies which has resulted in significant declines in market oil prices. Decreased market oil prices have compressed margins for many U.S. and Texas-based oil producers, particularly those that utilize higher-cost production technologies such as hydraulic fracking and horizontal drilling, as well as oilfield service providers, energy equipment manufacturers and transportation suppliers, among others. As of October 20, 2017, the price per barrel of crude oil was approximately $51 compared to approximately $98 as of December 31, 2013. Due to our limited loans in the energy segment, we have not experienced a significant impact from this prolonged decline in oil prices. However if this period of low oil prices continues for a significant amount time, the residual effects could have a negative impact on the U.S. economy and, in particular, the economies of energy-dominant states such as Texas. Energy loans comprised approximately 1.10% and 1.09% of our loan portfolio at September 30, 2017 and December 31, 2016, respectively.
In August of 2017, parts of the Texas coast and Houston metropolitan area experienced widespread damage and flooding from Hurricane Harvey. Surveys of the bank’s borrowers and collateral located within the hurricane zone indicated that most customers experienced little to no business interruption or minor damage which, to date, has been fully covered by insurance. The bank is continuing to communicate with borrowers in the affected areas and is evaluating any financial impact.
We cannot predict whether current economic conditions will improve, remain the same or decline.  A decline in credit markets generally could adversely affect our financial condition and results of operation if we are unable to extend credit or sell loans into the secondary market. During the last 30 years the Texas economy has continued to diversify, decreasing the overall impact of fluctuations in oil and gas prices; however, the oil and gas industry is still a significant component of the Texas economy. Despite a significant reduction in oil prices during 2015 and 2016 when the price per barrel of crude oil traded below $30 at one point, the Texas economy as a whole has continued to perform very well, reflective of the economic diversity Texas has achieved. Energy loans comprised approximately 1.55% and 1.50% of our loan portfolio at June 30, 2018 and December 31, 2017, respectively.

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The following table sets forth loan totals by class for the periods presented:
 At
September 30,
2017
 At
December 31,
2016
 At
September 30,
2016
 (in thousands)
Real Estate Loans: 
  
  
Construction$420,497
 $380,175
 $466,323
1-4 Family Residential609,159
 637,239
 644,746
Commercial1,073,646
 945,978
 759,795
Commercial Loans166,919
 177,265
 191,154
Municipal Loans322,286
 298,583
 293,949
Loans to Individuals90,259
 117,297
 127,674
Total Loans$2,682,766
 $2,556,537
 $2,483,641
Construction loans increased $40.3 million, or 10.6%, to $420.5 million at September 30, 2017 from $380.2 million at December 31, 2016, and decreased $45.8 million, or 9.8%, from $466.3 million at September 30, 2016. Our construction loans increased during the nine months ended September 30, 2017 due to continued growth in our Dallas-Fort Worth market. The decrease compared to September 30, 2016 was due to payoffs and transfers to permanent financing, more than offsetting new loans and advances on existing construction projects during that time.
1-4 family residential loans decreased $28.1 million, or 4.4%, to $609.2 million at September 30, 2017 from $637.2 million at December 31, 2016, and decreased $35.6 million, or 5.5%, from $644.7 million at September 30, 2016 due primarily to payoffs in excess of originations.
Commercial real estate loans increased $127.7 million, or 13.5%, to $1.07 billion at September 30, 2017 from $946.0 million at December 31, 2016, and increased $313.9 million, or 41.3%, from $759.8 million at September 30, 2016. Our commercial real estate loans continued to increase during the nine months ended September 30, 2017 primarily as a result of providing permanent financing on completed construction projects and continued growth in our Austin and Dallas-Fort Worth markets.
Commercial loans decreased $10.3 million, or 5.8%, to $166.9 million at September 30, 2017 from $177.3 million at December 31, 2016, and decreased $24.2 million, or 12.7%, from $191.2 million at September 30, 2016 due primarily to payoffs in excess of originations.
Municipal loans increased $23.7 million, or 7.9%, to $322.3 million at September 30, 2017 from $298.6 million at December 31, 2016, and increased $28.3 million, or 9.6%, from $293.9 million at September 30, 2016.
Loans to individuals decreased $27.0 million, or 23.1%, to $90.3 million at September 30, 2017, from $117.3 million at December 31, 2016, and decreased $37.4 million, or 29.3%, from $127.7 million at September 30, 2016, which primarily reflects the continued roll-off of the indirect automobile loan portfolio acquired from Omni.
Loan Loss Experience and Allowance for Loan Losses
The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes.  First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral.  These recommendations are reviewed by senior loan administration, the special assets department and the loan review department on a monthly basis.  Third, the loan review department independently reviews the portfolio on an annual basis. The loan review department follows a board-approved annual loan review scope.  The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan.  The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater.  The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process.
At each review, a subjective analysis methodology is used to grade the respective loan.  Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that

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the entire balance of the loan will be uncollectible.  If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowances.  The internal loan review department maintains a list (“Watch List”) of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loan.
We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated quarterly based on actual charge-off experience and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans.
Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of our loans will require partial or full charge-off.  Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the loan.  Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions, and geographic and industry loan concentration.
After all of the data in the loan portfolio is accumulated, the reserve allocations are separated into various loan classes.
As of SeptemberJune 30, 2017,2018, our review of the loan portfolio indicated that a loan loss allowance of $19.9$25.1 million was appropriate to cover probable losses in the portfolio.  Changes in economic and other conditions may require future adjustments to the allowance for loan losses.
During the ninesix months ended SeptemberJune 30, 2017,2018, the allowance for loan losses increased $2.0$4.3 million, or 10.9%20.6%, to $19.9$25.1 million, or 0.77% of total loans, when compared to $20.8 million, or 0.63% of total loans at December 31, 2017, and increased $5.8 million, or 30.3%, from $19.2 million, or 0.74% of total loans when compared to $17.9 million, or 0.70% of total loans at December 31, 2016, and increased $3.9 million, or 24.2%, from $16.0 million, or 0.64% of total loans at SeptemberJune 30, 2016,2017, due primarily to an increase in nonaccruals during the first quarter of 2018 as well as growth in the loan growth and changes in qualitative factors in accordance with our methodology for determining the estimate of the allowance for loan loss.portfolio since June 30, 2017.
For the three and ninesix months ended SeptemberJune 30, 2017,2018, loan charge-offs were $677,000$917,000 and $2.8$1.7 million, respectively, and recoveries were $347,000$488,000 and $1.4$1.0 million, respectively. For the three and ninesix months ended SeptemberJune 30, 2016,2017, loan charge-offs were $1.3$1.1 million and $13.7$2.1 million, respectively, and recoveries were $711,000$498,000 and $2.2$1.0 million, respectively. The necessary provision expense was estimated at $1.0$1.3 million and $3.4$5.0 million for the three and ninesix months ended SeptemberJune 30, 2017,2018, respectively, a decrease of $671,000,$65,000, or 41.1%4.8%, and $4.3an increase of $2.6 million, or 55.9%105.2%, from $1.6$1.3 million and $7.7$2.4 million, respectively, for the comparable periods in 2016.2017. The significant decreaseincrease in provision expense for the ninesix months ended June 30, 2018 was primarily due to the partial charge-offs applied to two large commercial borrowingreal estate loan relationships during the second quarter of 2016.placed on nonaccrual status.
Nonperforming Assets

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Nonperforming assets consist of delinquent loans 90 days or more past due, nonaccrual loans, OREO, repossessed assets and restructured loans.  Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected.  Additionally, some loans that are not delinquent or that are delinquent less than 90 days may be placed on nonaccrual status if it is probable that we will not receive contractualdue to doubts about full collection of principal and interest payments in accordance with the terms of the respective loan agreement.or interest. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes. OREO represents real estate taken in full or partial satisfaction of debts previously contracted.  The dollar amount of OREO is based on a current evaluation of the OREO at the time it is recorded on our books, net of estimated selling costs.  Updated valuations are obtained as needed and any additional impairments are recognized.  Restructured loans represent loans that have been renegotiated to provide a below market or deferral of interest or principal because of deterioration in the financial position of the borrowers.  The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.  Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.  Categorization of a loan as nonperforming is not in itself a reliable indicator of potential loan loss.  Other factors, such as the value of collateral securing the loan and the financial condition of the borrower must be considered in judgments as to potential loan loss.  

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The following tables set forth nonperforming assets for the periods presented (in thousands):
At
September 30,
2017
 At
December 31,
2016
 At
September 30,
2016
At
June 30,
2018
 At
December 31,
2017
 At
June 30,
2017
Nonaccrual loans (1)
$3,095
 $8,280
 $8,536
$35,351
 $2,937
 $3,034
Accruing loans past due more than 90 days (1)

 6
 1
7
 1
 
Restructured loans (2)
5,725
 6,431
 7,193
5,860
 5,767
 5,884
Other real estate owned298
 339
 237
1,137
 1,613
 233
Repossessed assets1
 49
 41
68
 154
 14
Total Nonperforming Assets$9,119
 $15,105
 $16,008
$42,423
 $10,472
 $9,165

(1) Excludes PCI loans measured at fair value at acquisition.acquisition if the timing and amount of cash flows expected to be collected from those sales can be reasonably estimated.
(2) Includes $3.0$2.9 million, $3.1$2.9 million, and $3.2$3.0 million in PCI loans restructured as of SeptemberJune 30, 2017,2018, December 31, 2016,2017, and SeptemberJune 30, 2016,2017, respectively.
At
September 30,
2017
 At
December 31,
2016
 At
September 30,
2016
At
June 30,
2018
 At
December 31,
2017
 At
June 30,
2017
Asset Quality Ratios:          
Nonaccruing loans to total loans0.12% 0.32% 0.34%1.08% 0.09% 0.12%
Allowance for loan losses to nonaccruing loans642.04
 216.32
 187.36
70.92
 707.56
 634.18
Allowance for loan losses to nonperforming assets217.91
 118.58
 99.91
59.10
 198.44
 209.94
Allowance for loan losses to total loans0.74
 0.70
 0.64
0.77
 0.63
 0.74
Nonperforming assets to total assets0.17
 0.27
 0.29
0.68
 0.16
 0.16
Net charge-offs to average loans0.07
 0.47
 0.63
0.04
 0.07
 0.09
Total nonperforming assets at SeptemberJune 30, 20172018 were $9.1$42.4 million, a decreasean increase of $6.0$32.0 million, or 39.6%305.1%, from $15.1$10.5 million at December 31, 20162017 and a decreasean increase of $6.9$33.3 million, or 43.0%362.9%, from $16.0$9.2 million at SeptemberJune 30, 2016.2017.  
From December 31, 20162017 to SeptemberJune 30, 2018, nonaccrual loans increased $32.4 million, or 1,103.6%, to $35.4 million and increased $32.3 million, or 1,065.2%, from June 30, 2017, nonaccrualprimarily due to the addition of two large commercial real estate relationships consisting of three loans decreased $5.2 million, or 62.6%, to $3.1 million, and decreased $5.4 million, or 63.7%, from September 30, 2016.during the first quarter of 2018.  Of the total nonaccrual loans at SeptemberJune 30, 2017, $1.12018, $32.1 million are commercial real estate loans, $1.8 million are 1-4 family residential real estate loans, $765,000 are commercial real estate loans, $641,000$1.0 million are commercial loans, $472,000$340,000 are loans to individuals, and $90,000$119,000 are construction loans. Restructured loans totaled $5.7$5.9 million at SeptemberJune 30, 2017, a decrease2018, an increase of $706,000,$93,000, or 11.0%1.6%, compared to December 31, 20162017 and decreased $1.5 million,$24,000, or 20.4%0.4%, when compared to $7.2$5.9 million at SeptemberJune 30, 2016.2017. OREO decreased $41,000,$476,000, or 12.1%29.5%, to $298,000$1.1 million at SeptemberJune 30, 20172018 from $339,000$1.6 million at December 31, 20162017 and increased $61,000,$904,000, or 25.7%388.0%, from $237,000$233,000 at SeptemberJune 30, 2016.2017.  The OREO at SeptemberJune 30, 20172018 consisted of construction, and 1-4 family residential and commercial real estate properties.  We are actively marketing all OREO properties and none are being held for investment

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purposes. Repossessed assets decreased $48,000,$86,000, or 98.0%55.8%, to $1,000$68,000 at SeptemberJune 30, 2017,2018, from $49,000$154,000 at December 31, 20162017 and decreased $40,000,increased $54,000, or 97.6%385.7%, from $41,000$14,000 at SeptemberJune 30, 2016.2017.
Pending Acquisition
See “Note 2 - Pending Acquisition” in our consolidated financial statements included in this Quarterly Report on Form 10-Q.
Branch Closures
Due to the close proximity of an acquired Diboll location to one of our branch locations in Tyler, Texas, we closed a retail branch located within the Fresh Grocery Store effective June 29, 2018. As part of the re-engineering of one of our branches during the rebranding efforts, we made the decision to relocate our Tyler South Broadway branch and drive-thru to one location which is scheduled to open during the fourth quarter of 2018 at which time our current Tyler South Broadway branch and drive-thru are scheduled to permanently close.
Recent Accounting Pronouncements
See “Note 1 – Summary of Significant Accounting and Reporting Policies” in our consolidated financial statements included in this Quarterly Report on Form 10-Q.

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements” included in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report and other cautionary statements set forth elsewhere in this Quarterly Report on Form 10-Q.
Refer to the discussion of market risks included in “Item 7A.  Quantitative and Qualitative Disclosures About Market Risks” in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.  There have been no significant changes in the types of market risks we face since December 31, 2016.2017.
In the banking industry, a major risk exposure is changing interest rates.  The primary objective of monitoring our interest rate sensitivity, or risk, is to provide management the tools necessary to manage the balance sheet to minimize adverse changes in net interest income as a result of changes in the direction and level of interest rates.  Federal Reserve Board monetary control efforts, the effects of deregulation, the economic uncertainty and legislative changes have been significant factors affecting the task of managing interest rate sensitivity positions in recent years.
In an attempt to manage our exposure to changes in interest rates, management closely monitors our exposure to interest rate risk through our ALCO.  Our ALCO meets regularly and reviews our interest rate risk position and makes recommendations to our board for adjusting this position.  In addition, our board reviews our asset/liability position on a monthly basis.  We primarily use two methods for measuring and analyzing interest rate risk: net income simulation analysis and MVPE modeling.  We utilize the net income simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates.  This model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months.  The model is used to measure the impact on net interest income relative to a base case scenario of rates immediately increasing 100 and 200 basis points or decreasing 100 and 200 basis points over the next 12 months.  These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet.  The impact of interest rate-related risks such as prepayment, basis and option risk are also considered.  Due to the low level of interest rates, many of the current interest rates cannot decline 100 or 200 basis points. The model has floors for each of those interest rates, and none are assumed to go negative. As of SeptemberJune 30, 2017,2018, the model simulations projected that immediate increases in interest rates of 100 and 200 basis points would result in positive variances in net interest income of 6.94%of 2.48% and 5.66%1.53%, respectively, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 and 200 basis points would result in negative variances in net interest income of 0.88%0.94% and 4.87%5.64%, respectively, relative to the base case over the next 12 months. As of December 31, 2016,2017, the model simulations projected that an immediate increase in interest rates of 100 basis points would result in a positive variance on net interest income of 0.88% and an immediate increase in interest rates of 200 basis points would result in a negative variance on net interest income of 0.21%1.13%, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 basis points would result in a positive variance in net interest income of 1.25% and an immediate decrease in interest rates of 200 basis points would result in positive variances ina negative variance on net interest income of 2.25% and 1.67%2.50%, respectively, relative to the base case over the next 12 months.  As of SeptemberJune 30, 2016,2017, the model simulations projected that 100 and 200 basis point immediate increases in interest rates would result in positive variances on net interest income of 2.21%2.55% and 2.18%3.08%, respectively, relative to the base case over the next 12 months, while an immediate decrease in interest rates of 100 and 200 basis points would result in positive variances in net interest income of 0.10%6.63% and 1.16%5.42%, respectively, relative to the base case over the next 12 months. As part of the overall assumptions, certain assets and liabilities are given reasonable floors.  This type of simulation analysis requires numerous assumptions including but not limited to changes in balance sheet mix, prepayment rates on mortgage-related assets and fixed rate loans, cash flows and repricing of all financial instruments, changes in volumes and pricing, future shapes of the yield curve, relationship of market interest rates to each other (basis risk), credit spread and deposit sensitivity.  Assumptions are based on management’s best estimates but may not accurately reflect actual results under certain changes in interest rates.
The ALCO monitors various liquidity ratios to ensure a satisfactory liquidity position for us. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates. Regulatory authorities also monitor our gap position along with other liquidity ratios. In addition, as described above, we utilize a simulation model to determine the impact of net interest income under several different interest rate scenarios. By utilizing this technology, we can determine changes that need to be made to the asset and liability mixes to mitigate the change in net interest income under these various interest rate scenarios.

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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), undertook an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report, and, based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, in recording, processing, summarizing and reporting in a timely manner the information that the Company is required to disclose in its reports under the Exchange Act and in accumulating and communicating to the Company’s management, including the Company’s CEO and CFO, such information as appropriate to allow timely decisions regarding required disclosure.  
Changes in Internal Control Over Financial Reporting
No changes were made to our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended SeptemberJune 30, 20172018 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS 

We are a party to various litigation in the normal course of business. Management, after consulting with our legal counsel, believes that any liability resulting from litigation will not have a material effect on our financial position, results of operations or liquidity.

ITEM 1A.    RISK FACTORS

Additional information regarding risk factors appears in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Statements” of this Form 10-Q and in Part I - “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.  There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.2017. The risks and uncertainties described in our Annual Report on Form 10-K for the year ended December 31, 20162017 are not the only ones we face. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES
None.

ITEM 4.    MINE SAFETY DISCLOSURES
None.

ITEM 5.    OTHER INFORMATION
None.


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ITEM 6.    EXHIBITS

Exhibit Index

      Incorporated by Reference
Exhibit Number Exhibit Description Filed Herewith Exhibit Form Filing Date File No.
             
(3) Articles of Incorporation and Bylaws          
3.1    3 (a) 10-Q 5/9/2014 0-12247
             
3.2    3.1 8-K 11/24/2014 0-12247
             
(10) Material Contracts          
10.1  X        
             
10.2  X        
             
10.3  X        
             
             
(31) Rule 13a-14(a)/15d-14(a) Certifications          
31.1  X        
             
31.2  X        
             
(32) Section 1350 Certification          
†32  X        
             
(101) Interactive Date File          
101.INS XBRL Instance Document. X        
             
101.SCH XBRL Taxonomy Extension Schema Document. X        
             
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document. X        
             
101.LAB XBRL Taxonomy Extension Label Linkbase Document. X        
             
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document. X        
             
101.DEF XBRL Taxonomy Extension Definition Linkbase Document. X        
             
† The certification attached as Exhibit 32 accompanies this Quarterly Report on Form 10-Q and is “furnished” to the Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by us for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
      Incorporated by Reference
Exhibit Number Exhibit Description Filed Herewith Exhibit Form Filing Date File No.
             
(3) Articles of Incorporation and Bylaws          
3.1    3.1 8-K 05/14/2018 0-12247
             
3.2    3.1 8-K 02/22/2018 0-12247
             
(31) Rule 13a-14(a)/15d-14(a) Certifications          
31.1  X        
             
31.2  X        
             
(32) Section 1350 Certification          
†32  X        
             
(101) Interactive Date File          
101.INS XBRL Instance Document. X        
             
101.SCH XBRL Taxonomy Extension Schema Document. X        
             
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document. X        
             
101.LAB XBRL Taxonomy Extension Label Linkbase Document. X        
             
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document. X        
             
101.DEF XBRL Taxonomy Extension Definition Linkbase Document. X        
             
† The certification attached as Exhibit 32 accompanies this Quarterly Report on Form 10-Q and is “furnished” to the Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by us for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
  SOUTHSIDE BANCSHARES, INC.
   
DATE:OctoberJuly 27, 20172018BY:/s/ Lee R. Gibson
   Lee R. Gibson, CPA
   President and Chief Executive Officer
   (Principal Executive Officer)
    
    
    
    
DATE:OctoberJuly 27, 20172018BY: /s//s/ Julie N. Shamburger
   Julie N. Shamburger, CPA
   Senior Executive Vice President and Chief Financial Officer
   (Principal Financial and Accounting Officer)
 


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