Note 2 – Business Combinations

Proposed Merger with FNB Bancorp

On December 11, 2017, the Company and FNB Bancorp, a California corporation (“FNBB”), entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) pursuant to which FNBB will be merged with and into the Company, with the Company as the surviving corporation (the “Merger”). Management expects the acquisition to close in the second quarter of 2018, subject to the satisfaction of customary closing conditions, including regulatory and shareholder approvals. The Merger Agreement provides that immediately after the Merger, FNBB’s bank subsidiary, First National Bank of Northern California (“First National Bank”), will merge with and into the Company’s bank subsidiary, Tri Counties Bank, with Tri Counties Bank as the surviving bank (the “Bank Merger”). The Merger and Bank Merger are collectively referred to as the “Proposed Transaction.”

The Merger Agreement provides that each share of FNBB common stock issued and outstanding immediately prior to the effective time of the Merger will be canceled and converted into the right to receive 0.98 shares of the Company’s common stock (the “Exchange Ratio”), with cash paid in lieu of fractional shares of the Company’s common stock.

Based on the closing price of the Company’s common stock of $41.64 on December 8, 2017, the consideration value was $40.81 per share of FNBB common stock or approximately $315.3 million in aggregate. The value of the merger consideration will fluctuate until closing based on the value of the Company’s stock and subject to a trading collar in certain circumstances. Upon consummation of the Merger, the shareholders of FNBB will own approximately 24% of the combined company.

The Merger Agreement includes a trading collar that could result in termination of the Merger Agreement or a change to the Exchange Ratio. First, The Company can elect to terminate the Merger Agreement if both (i) the average share price of the Company’s common stock for the 20 day period up to and including the fifth day prior to the closing date (the “Average Closing Share Price”) is greater than $49.78, which equals 120% of the average share price of the Company’s Stock for the 20 trading-day period up to and including December 8, 2017, which was $41.48 (the “Initial Price”) and (ii) the Company’s common stock outperforms the KBW Regional Banking Index by more than 20%, unless FNBB agrees that the Exchange Ratio will be reduced and fewer shares of the Company’s common stock will be issued to FNBB shareholders on a per share basis. Conversely, FNBB can terminate the Merger Agreement if both (i) the Average Closing Share Price is less than $33.18, which is equivalent to 80% of the Initial Price, and (ii) the Company’s common stock underperforms the KBW Regional Banking Index by more than 20%, unless the Company agrees that the Exchange Ratio will be increased and more shares of the Company common stock will be issued to FNBB shareholders on a per share basis.

Upon consummation of the Merger, each outstanding and unexercised option to acquire shares of FNBB common stock held by FNBB’s employees and directors will be canceled and, in exchange, the holder of the option will be entitled to receive, whether or not the option is fully vested, a lump sum cash payment equal to the product of (1) the number of shares of FNBB common stock remaining under the option multiplied by (2) the Exchange Ratio multiplied by (3) the amount, if any, by which the Average Closing Share Price exceeds the exercise price of the option.

The consummation of the Merger is subject to a number of conditions, which include: (i) the approval of the Merger Agreement by FNBB’s shareholders and the approval of the Merger Agreement and the issuance of shares of the Company common stock by the Company’s shareholders; (ii) as of the closing of the Merger, FNBB shall have tangible common equity of not less than $119.0 million, subject to credit for certain merger-related expenses and certain assumptions and adjustments that are set forth in the Merger Agreement; (iii) the receipt of all necessary regulatory approvals for the Proposed Transaction, without the imposition of conditions or requirements that the Company’s Board of Directors reasonably determines in good faith would, individually or in the aggregate, materially reduce the economic benefits of the Proposed Transaction; (iv) the absence of any regulation, judgment, decree, injunction or other order of a governmental authority which prohibits the consummation of the Proposed Transaction or which prohibits or makes illegal the consummation of the Proposed Transaction; (v) the effective registration of the shares of the Company’s Common Stock to be issued to FNBB’s shareholders with the Securities and Exchange Commission (the “SEC”) and the approval of such shares for listing on the Nasdaq Global Select Market; (vi) all representations and warranties made by the Company and FNBB in the Merger Agreement must remain true and correct, except for certain inaccuracies that would not have, or would not reasonably be expected to have, a material adverse effect; and (vii) the Company and FNBB must have performed their respective obligations under the Merger Agreement in all material respects.

Acquisition of Three Bank Branches and Associated Deposits

On March 18, 2016, the Bank completed its acquisition of three branch banking offices from Bank of America originally announced October 28, 2015. The acquired branches are located in Arcata, Eureka and Fortuna in Humboldt County on the North Coast of California, and have significant overlap compared to the Company’s then-existing Northern California customer base and branch locations. As a result, these branch acquisitions create potential cost savings and future growth potential. With the levels of capital at the time, the acquisitions fit well into the Company’s growth strategy. Also on March 18, 2016, the electronic customer service and other data processing systems of the acquired branches were converted into the Bank’s systems, and the effect of revenue and expenses from the operations of the acquired branches are included in the results of the Company. The Bank paid a premium of $3,204,000 for deposit relationships with balances of $161,231,000 and loans with balances of $289,000, and received cash of $159,520,000 from Bank of America.

The assets acquired and liabilities assumed in the acquisition of these branches were accounted for in accordance with ASC 805 “Business Combinations,” using the acquisition method of accounting and were recorded at their estimated fair values on the March 18, 2016 acquisition date, and the results of operations of the acquired branches are included in the Company’s consolidated statements of income since that date. The excess of the fair value of consideration transferred over total identifiable net assets was recorded as goodwill. The goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company and the acquired branches. $849,000 of the goodwill is deductible for income tax purposes because the acquisition was accounted for as a purchase of assets and assumption of liabilities for tax purposes.

The following table discloses the calculation of the fair value of consideration transferred, the total identifiable net assets acquired and the resulting goodwill relating to the acquisition of three branch banking offices and certain deposits from Bank of America on March 18, 2016:


(in thousands)	March 18, 2016
Fair value of consideration transferred:
Cash consideration	$	3,204

Total fair value of consideration transferred		3,204

Asset acquired:
Cash and cash equivalents		159,520
Loans		289
Premises and equipment		1,590
Core deposit intangible		2,046
Other assets		141

Total assets acquired		163,586

Liabilities assumed:
Deposits		161,231

Total liabilities assumed		161,231

Total net assets acquired		2,355

Goodwill recognized	$	849

A summary of the cash paid and estimated fair value adjustments resulting in the goodwill recorded in the acquisition of three branch banking offices and certain deposits from Bank of America on March 18, 2016 are presented below:


(in thousands)	March 18, 2016
Cash paid	$	3,204
Cost basis net assets acquired		—
Fair value adjustments:
Loans		—
Premises and Equipment		(309	)
Core deposit intangible		(2,046	)

Goodwill	$	849

As part of the acquisition of three branch banking offices from Bank of America, the Company performed a valuation of premises and equipment acquired. This valuation resulted in a $309,000 increase in the net book value of the land and buildings acquired, and was based on current appraisals of such land and buildings.

The Company recognized a core deposit intangible of $2,046,000 related to the acquisition of the core deposits. The recorded core deposit intangibles represented approximately 1.50% of the core deposits acquired and will be amortized over their estimated useful lives of 7 years.

A valuation of the time deposits acquired was also performed as of the acquisition date. Time deposits were split into similar pools based on size, type of time deposits, and maturity. A discounted cash flow analysis was performed on the pools based on current market rates currently paid on similar time deposits. The valuation resulted in no material fair value discount or premium, and none was recorded.