TCBK 10-Q Quarter ended Sept. 30, 2018

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended: September 30, 2018

☐	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from to .

Commission File Number: 000-10661

TriCo Bancshares

(Exact Name of Registrant as Specified in Its Charter)

CALIFORNIA		94-2792841
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

63 Constitution Drive

Chico, California 95973

(Address of Principal Executive Offices) (Zip Code)

(530) 898-0300

(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    ☐  No

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    ☐  No

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

Large accelerated filer		☒		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☐
				Emerging growth company		☐

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.  ☐

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

Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:

Common stock, no par value: 30,417,818 shares outstanding as of November 6, 2018

TriCo Bancshares

FORM 10-Q

TABLE OF CONTENTS

		Page
PART I – FINANCIAL INFORMATION			2
Item 1 – Financial Statements (Unaudited)			2
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations			38
Item 3 – Quantitative and Qualitative Disclosures about Market Risk			55
Item 4 – Controls and Procedures			55
PART II – OTHER INFORMATION			56
Item 1 – Legal Proceedings			56
Item 1A – Risk Factors			56
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds			56
Item 6 – Exhibits			57
Signatures			58
Exhibits

1

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

TRICO BANCSHARES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data; unaudited)

		At September 30, 2018				At December 31, 2017
Assets:
Cash and due from banks		$	109,363			$	105,968
Cash at Federal Reserve and other banks			117,180				99,460
Cash and cash equivalents			226,543				205,428
Investment securities:
Marketable equity securities			2,846				2,938
Available for sale debt securities			1,055,960				727,945
Held to maturity debt securities			459,897				514,844
Restricted equity securities			17,250				16,956
Loans held for sale			3,824				4,616
Loans			4,027,436				3,015,165
Allowance for loan losses			(31,603	)			(30,323	)
Total loans, net			3,995,833				2,984,842
Foreclosed assets, net			1,832				3,226
Premises and equipment, net			89,290				57,742
Cash value of life insurance			116,596				97,783
Accrued interest receivable			19,592				13,772
Goodwill			220,972				64,311
Other intangible assets, net			30,711				5,174
Mortgage servicing rights			7,122				6,687
Other assets			70,597				55,051
Total assets		$	6,318,865			$	4,761,315
Liabilities and Shareholders’ Equity:
Liabilities:
Deposits:
Noninterest-bearing demand		$	1,710,505			$	1,368,218
Interest-bearing			3,382,612				2,640,913
Total deposits			5,093,117				4,009,131
Accrued interest payable			1,729				930
Other liabilities			82,077				66,422
Other borrowings			282,831				122,166
Junior subordinated debt			56,996				56,858
Total liabilities			5,516,750				4,255,507
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock, no par value: 1,000,000 shares authorized, zero issued and outstanding at September 30, 2018 and December 31, 2017			—				—
Common stock, no par value: 50,000,000 shares authorized; issued and outstanding:
30,417,818 at September 30, 2018
22,955,963 at December 31, 2017			541,519				255,836
Retained earnings			287,555				255,200
Accumulated other comprehensive loss, net of tax			(26,959	)			(5,228	)
Total shareholders’ equity			802,115				505,808
Total liabilities and shareholders’ equity		$	6,318,865			$	4,761,315

See accompanying notes to unaudited condensed consolidated financial statements.

2

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data; unaudited)

		Three months ended September 30,								Nine months ended September 30,
		2018				2017				2018				2017
Interest and dividend income:
Loans, including fees		$	53,102			$	37,268			$	130,455			$	108,600
Investments:
Taxable securities			9,189				7,011				23,949				20,617
Tax exempt securities			1,189				1,041				3,272				3,124
Dividends			459				301				1,093				1,020
Interest bearing cash at Federal Reserve and other banks			615				292				1,384				1,080
Total interest and dividend income			64,554				45,913				160,153				134,441
Interest expense:
Deposits			2,072				1,028				4,402				2,896
Other borrowings			1,178				149				2,106				164
Junior subordinated debt			815				652				2,301				1,870
Total interest expense			4,065				1,829				8,809				4,930
Net interest income			60,489				44,084				151,344				129,511
Provision for (benefit from) loan losses			2,651				765				1,777				(1,588	)
Net interest income after provision for (benefit from) loan losses			57,838				43,319				149,567				131,099
Noninterest income:
Service charges and fees			9,743				9,475				28,327				27,861
Commissions on sale of non-deposit investment products			728				672				2,414				1,984
Increase in cash value of life insurance			732				732				1,996				2,043
Gain on sale of loans			539				606				1,831				2,293
Gain on sale of investment securities			207				961				207				961
Other			237				484				1,875				2,401
Total noninterest income			12,186				12,930				36,650				37,543
Noninterest expense:
Salaries and related benefits			25,823				20,933				68,928				62,320
Other			21,555				16,289				54,482				46,628
Total noninterest expense			47,378				37,222				123,410				108,948
Income before income taxes			22,646				19,027				62,807				59,694
Provision for income taxes			6,476				7,130				17,698				22,129
Net income		$	16,170			$	11,897			$	45,109			$	37,565
Earnings per share:
Basic		$	0.54			$	0.52			$	1.78			$	1.64
Diluted		$	0.53			$	0.51			$	1.76			$	1.62

See accompanying notes to unaudited condensed consolidated financial statements.

3

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands; unaudited)

		Three months ended September 30,								Nine months ended September 30,
		2018				2017				2018				2017
Net income		$	16,170			$	11,897			$	45,109			$	37,565
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on available for sale securities arising during the period, after reclassifications			(5,917	)			(166	)			(20,941	)			3,137
Change in minimum pension liability, after reclassifications			81				55				241				164
Other comprehensive income (loss)			(5,836	)			(111	)			(20,700	)			3,301
Comprehensive income		$	10,334			$	11,786			$	24,409			$	40,866

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands, except share and per share data; unaudited)

														Accumulated
		Shares of												Other
		Common				Common				Retained				Comprehensive
		Stock				Stock				Earnings				Income (loss)				Total
Balance at December 31, 2016			22,867,802			$	252,820			$	232,440			$	(7,913	)		$	477,347
Net income											37,565								37,565
Other comprehensive income															3,301				3,301
Stock option vesting							211												211
Service condition RSU vesting							657												657
Market plus service condition RSU vesting							316												316
Stock options exercised			133,850				2,418												2,418
Service condition RSUs released			28,397																—
Market plus service condition RSUs released			18,805																—
Repurchase of common stock			(107,390	)			(1,191	)			(2,663	)							(3,854	)
Dividends paid ($ 0.49 per share)											(11,228	)							(11,228	)
Balance at September 30, 2017			22,941,464			$	255,231			$	256,114			$	(4,612	)		$	506,733
Balance at December 31, 2017			22,955,963			$	255,836			$	255,200			$	(5,228	)		$	505,808
Net income											45,109								45,109
Adoption ASU 2016-01											(62	)			62				—
Adoption ASU 2018-02											1,093				(1,093	)			—
Other comprehensive loss															(20,700	)			(20,700	)
Stock option vesting							75												75
Service condition RSU vesting							745												745
Market plus service condition RSU vesting							274												274
Service condition RSUs released			32,516																—
Market plus service condition RSUs released			25,512																—
Stock options exercised			27,400				475												475
Issuance of common stock			7,405,277				284,437												284,437
Repurchase of common stock			(28,850	)			(323	)			(801	)							(1,124	)
Dividends paid ($ 0.51 per share)											(12,984	)							(12,984	)
Balance at September 30, 2018			30,417,818			$	541,519			$	287,555			$	(26,959	)		$	802,115

See accompanying notes to unaudited condensed consolidated financial statements.

4

TRICO BANCSHARES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands; unaudited)

		For the nine months ended September 30,
		2018				2017
Operating activities:
Net income		$	45,109			$	37,565
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment, and amortization			4,914				5,089
Amortization of intangible assets			2,068				1,050
Provision for (benefit from) loan losses			1,777				(1,588	)
Amortization of investment securities premium, net			1,953				2,431
Gain on sale of investment securities			(207	)			(961	)
Originations of loans for resale			(63,912	)			(83,907	)
Proceeds from sale of loans originated for resale			66,138				85,846
Gain on sale of loans			(1,831	)			(2,293	)
Change in market value of mortgage servicing rights			(38)				795
Provision for losses on foreclosed assets			89				162
Gain on sale of foreclosed assets			(390)				(308	)
Loss on disposal of fixed assets			206				61
Gain on sale of premises held for sale			—				(3	)
Increase in cash value of life insurance			(1,996)				(2,043	)
Life insurance proceeds in excess of cash value			—				(108	)
Loss on marketable equity securities			92				—
Equity compensation vesting expense			1,094				1,184
Change in:
Reserve for unfunded commitments			(864)				270
Interest receivable			(5,820)				(629	)
Interest payable			799				49
Other assets and liabilities, net			10,724				3,155
Net cash from operating activities			59,905				45,817
Investing activities:
Cash acquired in acquisition, net of consideration paid			30,613				—
Proceeds from maturities of securities available for sale			54,510				20,889
Proceeds from maturities of securities held to maturity			54,203				64,969
Proceeds from sale of available for sale securities			293,279				25,757
Purchases of securities available for sale			(370,843)				(195,465	)
Net redemption of restricted equity securities			7,429				—
Loan origination and principal collections, net			(178,596	)			(174,914	)
Proceeds from sale of foreclosed assets			2,206				1,787
Proceeds from sale of premises held for sale			—				3,338
Proceeds from sale of premises and equipment			62				—
Purchases of premises and equipment			(5,736	)			(10,874	)
Life insurance proceeds			—				649
Net cash from investing activities			(112,873	)			(263,864	)
Financing activities:
Net change in deposits			92,051				31,896
Net change in other borrowings			(4,335)				81,237
Repurchase of common stock			(834)				(1,629	)
Dividends paid			(12,984)				(11,228	)
Exercise of stock options			185				193
Net cash from financing activities			74,083				100,469
Net change in cash and cash equivalents			21,115				(117,578	)
Cash and cash equivalents at beginning of year			205,428				305,612
Cash and cash equivalents at end of year		$	226,543			$	188,034
Supplemental disclosure of noncash activities:
Unrealized (loss) gain on securities available for sale		$	(29,704	)		$	5,411
Loans transferred to foreclosed assets		$	511			$	726
Market value of shares tendered in-lieu of cash to pay for exercise of options and/or related taxes		$	1,124			$	3,854
Supplemental disclosure of cash flow activity:
Cash paid for interest expense		$	8,010			$	4,881
Cash paid for income taxes		$	11,625			$	15,450
Assets acquired in acquisition plus goodwill recognized, net		$	1,456,505			$	—
Liabilities assumed in acquisition		$	1,172,068			$	—

See accompanying notes to unaudited condensed consolidated financial statements.

5

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Description of Business and Basis of Presentation

TriCo Bancshares (the “Company” or “we”) is a California corporation organized to act as a bank holding company for Tri Counties Bank (the “Bank”). The Company and the Bank are headquartered in Chico, California. The Bank is a California-chartered bank that is engaged in the general commercial banking business in 29 California counties. The Bank operates from 69 traditional branches, 9 in-store branches and 2 loan production offices. The Company has five capital subsidiary business trusts (collectively, the “Capital Trusts”) that issued trust preferred securities, including two organized by the Company and three acquired with the acquisition of North Valley Bancorp.

The consolidated financial statements are prepared in accordance with accounting policies generally accepted in the United States of America and general practices in the banking industry. All adjustments necessary for a fair presentation of these consolidated financial statements have been included and are of a normal and recurring nature. The financial statements include the accounts of the Company. All inter-company accounts and transactions have been eliminated in consolidation. For financial reporting purposes, the Company’s investments in the Capital Trusts of $1,741,000 are accounted for under the equity method and, accordingly, are not consolidated and are included in other assets on the consolidated balance sheet. The subordinated debentures issued and guaranteed by the Company and held by the Capital Trusts are reflected as debt on the Company’s consolidated balance sheet.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulatinos of the Securities and Exchange Commission. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidtated financial statements and notes thereto included in the Company’s Annua Report on Form 10-K for the year ended December 31, 2017 (the “2017 Annual Report”).

Significant Group Concentration of Credit Risk

The Company grants agribusiness, commercial, consumer, and residential loans to customers located throughout northern and central California. The Company has a diversified loan portfolio within the business segments located in this geographical area. The Company currently classifies all its operation into one business segment that it denotes as community banking.

Geographical Descriptions

For the purpose of describing the geographical location of the Company’s loans, the Company has defined northern California as that area of California north of, and including, Stockton; central California as that area of the state south of Stockton, to and including, Bakersfield; and southern California as that area of the state south of Bakersfield.

Business Combinations

The Company accounts for acquisitions of businesses using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of acquisition. Management utilizes various valuation techniques including discounted cash flow analyses to determine these fair values. Any excess of the purchase price over amounts allocated to the acquired assets, including identifiable intangible assets, and liabilities assumed is recorded as goodwill.

Cash and Cash Equivalents

Net cash flows are reported for loan and deposit transactions and other borrowings. For purposes of the consolidated statement of cash flows, cash, due from banks with maturities less than 90 days, interest-earning deposits in other banks, and Federal funds sold are considered to be cash equivalents.

Revenue Recognition

The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation.

Most of our revenue-generating transactions are not subject to Topic 606, including revenue generated from financial instruments, such as our loans and investment securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances. The Company has evaluated the nature of its revenue streams and determined that further disaggregation of revenue into more granular categories beyond what is presented in the Note 15 was not necessary.

6

Accounting Standards Adopted in 2018

FASB Accounting Standards Update (ASU) No. 2014- 09, Revenue from Contracts with Customers (Topic 606): ASU 2014-09 is intended to clarify the principles for recognizing revenue, and to develop common revenue standards and disclosure requirements that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosures; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle 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. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods therein, with early adoption permitted for reporting periods beginning after December 15, 2016. ASU 2014-09 does not apply to revenue associated with financial instruments such as loans and investments, which are accounted for under other provisions of GAAP. The Company adopted ASU 2014-09 on January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The adoption of ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial Statements. In accordance with (1) above, the Company recorded a reclassification of cumulative unrealized losses of its marketable equity securities from accumulated other comprehensive income (loss) to retained earnings as of January 1, 2018. Additionally, the Company recognized changes in the fair value of its marketable equity securities in the condensed consolidated statements of net income for the three and nine months ended September 30, 2018. In accordance with (5) above, the Company measured the fair value of its loan portfolio as of September 30, 2018 using an exit price notion (see Note 18 Fair Value Measurement ).

FASB issued ASU No. 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 was effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2017-01, Business Combinations - Clarifying the Definition of a Business (Topic 805). ASU 2017-01 clarifies the definition and provides a more robust framework to use in determining when a set of assets and activities constitutes a business. ASU 2017-01 is intended to provide guidance when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 was effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715). ASU 2017-07 requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component. ASU 2017-07 was effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718). ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under ASU 2017-09, 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 award’s fair value, (ii) the award’s vesting conditions and (iii) the award’s classification as an equity or liability instrument. ASU 2017-09 was effective for the Company on January 1, 2018 and did not have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). ASU 2018-02 allows, but does not require, entities to reclassify certain income tax effects in accumulated other comprehensive income (AOCI) to retained earnings that resulted from the Tax Cuts and Jobs Act (Tax Act) that was enacted on December 22, 2017. The Tax Act included a reduction to the Federal corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. The amount of the reclassification would be the difference between the income tax effects in

7

AOCI calculated using the historical Federal corporate income tax rate of 35 percent and the income tax effects in AOCI calculated using the newly enacted 21 percent Federal corporate income tax rate. The amendments in ASU 2018-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company adopted ASU 2018-02 on January 1, 2018, and elected to reclassify certain income tax effects in AOCI to retained earnings. This change in accounting principle was accounted for as a cumulative-effect adjustment to the balance sheet resulting in a $1,093,000 increase to retained earnings and a corresponding decrease to AOCI on January 1, 2018.

Accounting Standards Pending Adoption

FASB issued ASU No. 2016-02, Leases (Topic 842) . ASU 2016-2, among other things, requires lessees to recognize most leases on-balance sheet, increasing reported assets and liabilities. Lessor accounting remains substantially similar to current U.S. GAAP. ASU 2016-02 will be effective for the Company on January 1, 2019, utilizing the modified retrospective transition approach. FASB has issued incremental guidance to the new leasing standard through ASU No. 2018-10 and 2018-11. Based on current leases, subject to change, the Company estimates that the adoption of this standard will result in an increase in assets of approximately $30 million to recognize the present value of the lease obligations with a corresponding increase in liabilities of approximately $30 million. This amount is subject to change as the Company continues to evaluate the provisions of ASU No. 2016-02, 2018-10 and 2018-11. The Company does not expect this to have a material impact on the Company’s results of operations or cash flows.

FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) . ASU 2016-13 is the final guidance on the new current expected credit loss (‘‘CECL’’) model. ASU 2016-13, among other things, requires the incurred loss impairment methodology in current GAAP be replaced with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to estimate future credit loss estimates. As CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held to maturity (‘‘HTM’’) debt securities. ASU 2016-13 amends the accounting for credit losses on available-for-sale securities (‘‘AFS’’), whereby credit losses will be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for purchased loans with credit deterioration since origination, so that reserves are established at the date of acquisition for purchased loans. Lastly, ASU 2016-13 requires enhanced disclosures on the significant estimates and judgments used to estimate credit losses, as well as on the credit quality and underwriting standards of an organization’s portfolio. These disclosures require organizations to present the currently required credit quality disclosures disaggregated by the year of origination or vintage. ASU 2016-13 allows for a modified retrospective approach with a cumulative effect adjustment to the balance sheet upon adoption (charge to retained earnings instead of the income statement). ASU 2016-13 will be effective for the Company on January 1, 2020, and early adoption is permitted. While the Company is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, and evaluating its current IT systems. Management expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the first reporting period in which the new standard is effective, but cannot yet estimate the magnitude of the one-time adjustment or the overall impact of the new guidance on the Company’s financial position, results of operations or cash flows.

FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350): ASU 2017-04 eliminates step two of the goodwill impairment test (the hypothetical purchase price allocation used to determine the implied fair value of goodwill) when step one (determining if the carrying value of a reporting unit exceeds its fair value) is failed. Instead, entities simply will compare the fair value of a reporting unit to its carrying amount and record goodwill impairment for the amount by which the reporting unit’s carrying amount exceeds its fair value. ASU 2017-04 will be effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s consolidated financial statements.

FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Topic 310). ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to require such premiums to be amortized to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount. ASU 2017-08 will be effective for the Company on January 1, 2019, and is not expected to have a significant impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. As ASU No. 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-14, “Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans.” This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted. As ASU 2018-14 only revises disclosure requirements, it will not have a material impact on the Company’s consolidated financial statements.

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Note 2 - Business Combinations

Merger with FNB Bancorp

On July 6, 2018, the Company completed the acquisition of FNB Bancorp (“FNBB”) for an aggregate transaction value of $291,132,000. FNBB was merged into the Company, and the Company issued 7,405,277 shares of common stock to the former shareholders of FNBB. FNBB’s subsidiary, First National Bank of Northern California, merged into the Bank on the same day. The Company also paid $6.7 million to settle and retire all FNBB stock options outstanding as of the acquisition date. Upon the consummation of the merger, the Company added 12 branches within San Mateo, San Francisco, and Santa Clara counties.

In accordance with accounting for business combinations, the Company recorded $156,661,000 of goodwill and $27,605,000 of core deposit intangibles on the acquisition date. The core deposit intangibles will be amortized over the weighted average remaining life of 6.2 years with no significant residual value. For tax purposes, purchase prices accounting adjustments including goodwill are all non-taxable and /or non-deductible. Acquisition related costs of $4,150,000 and $5,227,000 are included in the income statement for the three and nine months ended September 30, 2018. During the nine months ended September 30, 2017, there were no acquisition costs incurred.

The acquisition was consistent with the Company’s strategy to expand into the Bay Area market. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region. Goodwill arising from the acquisition consisted largely of the estimated cost savings resulting from the combined operations.

The following table summarizes the consideration paid for FNBB and the amounts of assets acquired and liabilities assumed that were recorded at the acquisition date (in thousands).

		FNB Bancorp July 6, 2018
Fair value of consideration transferred:
Fair value of shares issued		$	284,437
Cash consideration			6,695
Total fair value of consideration transferred			291,132
Assets acquired:
Cash and cash equivalents			37,308
Securities available for sale			335,667
Restricted equity securities			7,723
Loans			834,683
Premises and equipment			30,522
Cash value of life insurance			16,817
Core deposit intangible			27,605
Other assets			16,214
Total assets acquired			1,306,539
Liabilities assumed:
Deposits			991,935
Other liabilities			15,133
Short-term borrowings - Federal Home Loan Bank			165,000
Total liabilities assumed			1,172,068
Total net assets acquired			134,471
Goodwill recognized		$	156,661

The fair value of net assets acquired includes fair value adjustments to certain loans that were not considered impaired (PNCI loans) as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. As such, these loans were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans (PCI loans), which have shown evidence of credit deterioration since origination. The gross contractual amounts receivable and fair value for PNCI loans as of the acquisition date was $866,189,000 and $833,381,000, respectively. The gross contractual amounts receivable and fair value for PCI loans as of the acquisition date was $1,683,000 and $1,302,000, respectively.

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The accompanying condensed consolidated financial statements include the accounts of FNB Bancorp since July 6, 2018. The table below presents the unaudited pro forma information as if the acquisition of FNB Bancorp had occurred on January 1, 2017 after giving effect to certain acquisition accounting adjustments. The pro forma information for the three and nine months ended September 30, 2018 and 2017 includes acquisition adjustments for the amortization/accretion on loans, core deposit intangibles, and related income tax effects. The pro forma financial information also includes one-time costs associated with the acquisition but does not include expected costs savings synergies that we expect to achieve. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.

		Three months ended								Nine months ended
		September 30, 2018				September 30, 2017				September 30, 2018				September 30, 2017
		( in thousands, except per share data)
Summarized proforma income statement data:
Net interest income		$	61,259			$	57,329			$	178,434			$	168,363
Provision for (benefit from) loan losses			2,651				765				1,374				(1,728	)
Noninterest income			12,288				13,902				38,517				40,537
Noninterest expense			(40,850	)			(45,983	)			(135,048	)			(135,218	)
Income before taxes			30,046				24,483				80,529				75,410
Income taxes			8,384				9,055				22,996				27,436
Net income		$	21,662			$	15,428			$	57,533			$	47,974
Basic earnings per share		$	0.72			$	0.51			$	1.76			$	1.58
Diluted earnings per share		$	0.71			$	0.50			$	1.74			$	1.56

It is impracticable to separately provide information regarding the revenue and earnings of FNB Bancorp included in the Company’s consolidated income statement from the July 6, 2018 acquisition date to September 30, 2018 because the operations of FNB Bancorp were substantially comingled with the operations of the Company as of the system conversion date of July 22, 2018.

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Note 3 - Investment Securities

The amortized cost and estimated fair values of investments in debt securities are summarized in the following tables:

		September 30, 2018
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
		(in thousands)
Debt Securities Available for Sale
Obligations of U.S. government agencies		$	666,021				163				(27,308	)		$	638,876
Obligations of states and political subdivisions			129,072				107				(5,759	)			123,420
Corporate bonds			4,368				65				(2	)			4,431
Asset backed securities			289,550				181				(498	)			289,233
Total debt securities available for sale		$	1,089,011			$	516			$	(33,567	)		$	1,055,960
Debt Securities Held to Maturity
Obligations of U.S. government agencies		$	445,309			$	88			$	(13,361	)		$	432,036
Obligations of states and political subdivisions			14,588				58				(395	)			14,251
Total debt securities held to maturity		$	459,897			$	146			$	(13,756	)		$	446,287
		December 31, 2017
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
		(in thousands)
Debt Securities Available for Sale
Obligations of U.S. government agencies		$	609,695			$	695			$	(5,601	)		$	604,789
Obligations of states and political subdivisions			121,597				1,888				(329	)			123,156
Total debt securities available for sale		$	731,292			$	2,583			$	(5,930	)		$	727,945
Debt Securities Held to Maturity
Obligations of U.S. government agencies		$	500,271			$	5,101			$	(1,889	)		$	503,483
Obligations of states and political subdivisions			14,573				146				(37	)			14,682
Total debt securities held to maturity		$	514,844			$	5,247			$	(1,926	)		$	518,165

Proceeds from sales of available for sale debt securities of $293,279,000 and $25,757,000 were received during the three months ended September 30, 2018 and 2017, respectively. Gross realized gains during the three months ended September 30, 2018 and 2017 were $207,000 and $961,000, respectively. There were no sales of investment securities during the first six months of 2018 or 2017. Investment securities with an aggregate carrying value of $548,123,000 and $285,596,000 at September 30, 2018 and December 31, 2017, respectively, were pledged as collateral for specific borrowings, lines of credit and local agency deposits.

The amortized cost and estimated fair value of debt securities at September 30, 2018 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At September 30, 2018, obligations of U.S. government corporations and agencies with a cost basis totaling $1,111,330,000 consist almost entirely of residential real estate mortgage-backed securities whose contractual maturity, or principal repayment, will follow the repayment of the underlying mortgages. For purposes of the following table, the entire outstanding balance of these mortgage-backed securities issued by U.S. government corporations and agencies is categorized based on final maturity date. At September 30, 2018, the Company estimates the average remaining life of these mortgage-backed securities issued by U.S. government corporations and agencies to be approximately 6.1 years. Average remaining life is defined as the time span after which the principal balance has been reduced by half.

Debt Securities		Available for Sale								Held to Maturity
(In thousands)		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
Due in one year		$	2,435			$	2,434			$	—			$	—
Due after one year through five years			12,486				12,501				1,231				1,240
Due after five years through ten years			17,764				17,740				25,955				25,210
Due after ten years			1,056,326				1,023,285				432,711				419,837
Totals		$	1,089,011			$	1,055,960			$	459,897			$	446,287

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Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
September 30, 2018										(in thousands)
Debt Securities Available for Sale
Obligations of U.S. government agencies		$	323,972			$	(10,839	)		$	311,035			$	(16,469	)		$	635,007			$	(27,308	)
Obligations of states and political subdivisions			85,668				(3,659	)			18,323				(2,100	)			103,991				(5,759	)
Corporate bonds			1,969				(2	)			—				—				1,969				(2	)
Asset backed securities			79,943				(498	)			—				—				79,943				(498	)
Total debt securities available for sale		$	491,552			$	(14,998	)		$	329,358			$	(18,569	)		$	820,910			$	(33,567	)
Debt Securities Held to Maturity
Obligations of U.S. government agencies		$	307,432			$	(7,693	)		$	109,312			$	(5,668	)		$	416,744			$	(13,361	)
Obligations of states and political subdivisions			8,971				(230	)			3,076				(165	)			12,047				(395	)
Total debt securities held to maturity		$	316,403			$	(7,923	)		$	112,388			$	(5,833	)		$	428,791			$	(13,756	)
		Less than 12 months								12 months or more								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
December 31, 2017										(in thousands)
Debt Securities Available for Sale
Obligations of U.S. government agencies		$	284,367			$	(2,176	)		$	166,338			$	(3,425	)		$	450,705			$	(5,601	)
Obligations of states and political subdivisions			4,904				(35	)			17,085				(294	)			21,989				(329	)
Total securities available for sale		$	289,271			$	(2,211	)		$	183,423			$	(3,719	)		$	472,694			$	(5,930	)
Debt Securities Held to Maturity
Obligations of U.S. government agencies		$	93,017			$	(567	)		$	95,367			$	(1,322	)		$	188,384			$	(1,889	)
Obligations of states and political subdivisions			1,488				(7	)			2,637				(30	)			4,125				(37	)
Total debt securities held to maturity		$	94,505			$	(574	)		$	98,004			$	(1,352	)		$	192,509			$	(1,926	)

Obligations of U.S. government agencies: Unrealized losses on investments in obligations of U.S. government agencies are caused by interest rate increases. The contractual cash flows of these securities are guaranteed by U.S. Government Sponsored Entities (principally Fannie Mae and Freddie Mac). It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At September, 2018, 171 debt securities representing obligations of U.S. government agencies had unrealized losses with aggregate depreciation of (3.7%) from the Company’s amortized cost basis.

Obligations of states and political subdivisions: The unrealized losses on investments in obligations of states and political subdivisions were caused by increases in required yields by investors in these types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At September 30, 2018, 132 debt securities representing obligations of states and political subdivisions had unrealized losses with aggregate depreciation of (5.0%) from the Company’s amortized cost basis.

Corporate bonds: The unrealized losses on investments in corporate bonds were caused by increases in required yields by investors in these types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because management believes the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At September 30, 2018, one corporate bond had unrealized losses with aggregate depreciation of (0.1%) from the Company’s amortized cost basis.

Asset backed securities: The unrealized losses on investments in asset backed securities were caused by increases in required yields by investors in these types of securities. At the time of purchase, each of these securities were rated AA or AAA and through September 30, 2018 have not experienced any deterioration in credit rating. The Company continues to monitor these securities for changes in credit rating or other indications of credit deterioration. Because management believes the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At September 30, 2018, 6asset backed securities had unrealized losses with aggregate depreciation of (0.6%) from the Company’s amortized cost basis.

Marketable equity securities: All unrealized losses recognized during the reporting period were for equity securities still held at September 30, 2018.

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Note 4 – Loans

A summary of loan balances follows (in thousands):

		September 30, 2018
		Originated				PNCI				PCI				Total
Mortgage loans on real estate:
Residential 1-4 family		$	340,515			$	182,201			$	1,698			$	524,414
Commercial			1,863,604				736,299				7,885				2,607,788
Total mortgage loans on real estate			2,204,119				918,500				9,583				3,132,202
Consumer:
Home equity lines of credit			284,956				44,881				1,299				331,136
Home equity loans			35,556				4,690				447				40,693
Other			26,294				23,120				42				49,456
Total consumer loans			346,806				72,691				1,788				421,285
Commercial			234,741				52,479				2,427				289,647
Construction:
Residential			81,533				33,041				—				114,574
Commercial			63,508				6,220				—				69,728
Total construction			145,041				39,261				—				184,302
Total loans, net of deferred loan fees and discounts		$	2,930,707			$	1,082,931			$	13,798			$	4,027,436
Total principal balance of loans owed, net of charge-offs		$	2,940,897			$	1,120,654			$	21,007			$	4,082,558
Unamortized net deferred loan fees			(10,190	)			—				—				(10,190	)
Discounts to principal balance of loans owed, net of charge-offs			—				(37,723	)			(7,209	)			(44,932	)
Total loans, net of unamortized deferred loan fees and discounts		$	2,930,707			$	1,082,931			$	13,798			$	4,027,436
Allowance for loan losses		$	(30,927	)		$	(566	)		$	(110	)		$	(31,603	)
		December 31, 2017
		Originated				PNCI				PCI				Total
Mortgage loans on real estate:
Residential 1-4 family		$	320,522			$	63,519			$	1,385			$	385,426
Commercial			1,690,510				215,823				8,563				1,914,896
Total mortgage loan on real estate			2,011,032				279,342				9,948				2,300,322
Consumer:
Home equity lines of credit			269,942				16,248				2,498				288,688
Home equity loans			39,848				2,698				485				43,031
Other			22,859				2,251				45				25,155
Total consumer loans			332,649				21,197				3,028				356,874
Commercial			209,437				8,391				2,584				220,412
Construction:
Residential			67,920				10				—				67,930
Commercial			69,364				263				—				69,627
Total construction			137,284				273				—				137,557
Total loans, net of deferred loan fees and discounts		$	2,690,402			$	309,203			$	15,560			$	3,015,165
Total principal balance of loans owed, net of charge-offs		$	2,699,053			$	316,238			$	23,181			$	3,038,472
Unamortized net deferred loan fees			(8,651	)			—				—				(8,651	)
Discounts to principal balance of loans owed, net of charge-offs			—				(7,035	)			(7,621	)			(14,656	)
Total loans, net of unamortized deferred loan fees and discounts		$	2,690,402			$	309,203			$	15,560			$	3,015,165
Allowance for loan losses		$	(29,122	)		$	(929	)		$	(272	)		$	(30,323	)

The following is a summary of the change in accretable yield for PCI loans during the periods indicated (in thousands):

		Three months ended September 30,								Nine months ended September 30,
		2018				2017				2018				2017
Change in accretable yield:
Balance at beginning of period		$	3,996			$	7,956			$	4,262			$	10,348
Accretion to interest income			(253	)			(594	)			(769	)			(2,554	)
Reclassification (to) from nonaccretable difference			(47	)			(2,893	)			203				(3,325	)
Balance at end of period		$	3,696			$	4,469			$	3,696			$	4,469

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