Note 2 - Sales/Mergers/Acquisitions

12 Months Ended

Dec. 31, 2020

Notes to Financial Statements

Sales/Mergers/Acquisitions

Note 2. Sales/Mergers/Acquisitions

Sale of the Bates Companies

On August 12, 2020, the Company sold all the issued and outstanding capital stock of the Bates Companies.  The aggregate consideration paid to the Company was a $500 thousand note receivable, less imputed interest of $52 thousand, plus cancellation of all future amounts otherwise to become payable to the purchaser by the Company under an earn-out agreement entered into between the same parties in 2018 with a non-discounted value of approximately $880 thousand at the sale date.

Assets and liabilities of the Bates Companies sold are summarized as follows as of the date of closing:

	As of
	August 12, 2020
	(dollars in thousands)
ASSETS
Cash and due from banks	$	349
Premises and equipment, net		19
Other assets		2,259
Total assets sold	$	2,627
LIABILITIES
Other liabilities	$	946
Total liabilities sold	$	946
Net assets sold	$	1,681
Cash consideration	$	195
Forgiveness of earn-out consideration		880
Note receivable consideration		448
Loss on sale of subsidiary	$	158

Disposition costs in 2020 related to the sale totaled $227 thousand and were comprised primarily of legal, accounting and personnel costs.

Sale of Assets and Liabilities of Rockford Bank & Trust

On November 30, 2019, the Company sold substantially all of the assets and transferred substantially all of the deposits and certain other liabilities of the Company’s wholly-owned subsidiary, RB&T, to IB&T, a wholly-owned subsidiary of Heartland Financial USA, Inc., for a cash payment.  The cash payment amount was determined substantially by the following formula: (i) the “Purchase Price Premium”, plus (ii) the aggregate net book value of the acquired assets,

Note 2. Sales/Mergers/Acquisitions (continued)

minus (iii) the aggregate book value of the assumed liabilities.  The Purchase Price Premium was equal to: (a) 8% of RB&T’s tangible assets, multiplied by (b) 0.345.  The Purchase Price Premium totaled $12.5 million and the total payment by IB&T to the Company at closing was $46.6 million.

Assets and liabilities of RB&T sold are summarized as follows as of the date of closing:

	As of
	11/30/2019
	(dollars in thousands)
ASSETS
Cash and due from banks	$	3,973
Interest-bearing deposits at financial institutions		55,291
Securities held to maturity, at amortized cost		3,243
Securities available for sale, at fair value		21,874
Loans/leases receivable held for investment, net		357,931
Premises and equipment, net		5,612
Restricted investment securities		675
Other real estate owned, net		2,134
Other assets		3,228
Total assets acquired	$	453,961
LIABILITIES
Noninterest-bearing deposits	$	69,802
Interest-bearing deposits		331,486
Short-term borrowings		1,158
FHLB advances		15,000
Other liabilities		2,241
Total liabilities assumed	$	419,687
Net assets sold	$	34,274
Cash consideration received	$	46,560
Gain on sale of assets and liabilities	$	12,286

The Company retained certain assets, mainly comprised of BOLI, and certain liabilities, mainly comprised of deferred compensation and income tax accruals. These assets and liabilities totaling $12.0 million and $5.0 million, respectively, as of December 31, 2019, were liquidated in 2020 and are included within assets and liabilities held for sale on the consolidated balance sheets.

Disposition costs in 2019 related to the sale totaled $3.3 million and were comprised primarily of legal and accounting costs, costs in connection with the disposal of fixed assets and prepaids, personnel costs and IT deconversion costs related to the sale of RB&T.

General – Mergers/Acquisitions

The narrative in this subsection applies to all mergers and acquisitions detailed throughout this footnote.

Loans acquired in a business combination are recorded and initially measured at their estimated fair value as of the acquisition date. Credit discounts are included in the determination of fair value. A third party valuation consultant assisted with the determination of fair value.

Purchased loans are segregated into two categories: PCI loans and non-PCI (performing) loans. PCI loans are accounted for in accordance with ASC 310-30, as they display significant credit deterioration since origination and it is probable, as of the acquisition date, that the Company will be unable to collect all contractually required payments from the borrower. Performing loans are accounted for in accordance with ASC 310-20, as these loans do not have evidence of significant credit deterioration since origination and it is probable that the contractually required payments will be received from the borrower.

For PCI loans, the difference between the contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable discount. Further, any excess cash flows expected at acquisition

Note 2. Sales/Mergers/Acquisitions (continued)

over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the expected remaining life of the loan. Subsequent to the purchase date, increases in cash flows over those expected at the purchase date are recognized as interest income prospectively. The present value of any decreases in expected cash flows after the purchase date is recognized by recording an allowance for loan and lease losses and provision for loan losses.

For performing loans, the difference between the estimated fair value of the loans and the principal balance outstanding is accreted over the remaining life of the loans.

Acquisition of the Bates Companies

On October 1, 2018, the Company acquired the Bates Companies, headquartered in Rockford, Illinois. The acquisition added approximately $704 million of assets under management at acquisition. In the acquisition, the Company acquired 100% of the Bates Companies’ outstanding common stock for aggregate consideration of $3.0 million cash and up to $3.0 million of the Company’s common stock.  Of the total cash consideration, $1.5 million in cash was paid at closing funded through operating cash.  The additional $1.5 million was recorded as a promissory note to be repaid in five equal, annual installments of $300,000 each on the first through fifth anniversaries of the closing date.  Interest was to be paid at a rate of 2.18% per annum, based on the applicable federal rate as of the closing date.  This $1.5 million promissory note is included in Other Liabilities on the Consolidated Balance Sheet.  Additionally, in a private placement exempt from registration with the SEC, the Company issued 23,501 shares of Company stock in December 2018.  Assuming all future performance based targets were to be met, total stock consideration could have reached $3.0 million, which would result in the Company issuing approximately 47,003 additional common shares based on the 10-day volume weighted average of the closing stock price of the Company ending five days prior to closing.  The contingent consideration for the additional common shares, totaling $2.0 million, as of December 31, 2018, is included in Other Liabilities on the Consolidated Balance Sheet. Required performance targets were met during 2019 and the Company issued 9,400 shares of common stock in December 2019 as described above.

During 2018, the Company incurred $394 thousand of expenses related to the acquisition, comprised primarily of legal and accounting costs.

The Company recorded a customer list intangible totaling $1.6 million, which is the portion of the acquisition purchase price that represents the value assigned to the existing customer base. The customer list intangible has a finite life and is amortized over the estimated useful life of the customer base. The Company recorded goodwill totaling $3.7 million, which is the excess of the consideration paid over the fair value of the net assets acquired. This goodwill is not deductible for tax purposes.  See Note 6 to the Consolidated Financial Statements for additional information.

The Company accounted for the business combination under the acquisition method of accounting in accordance with ASC 805. The Company recognized the full fair value of the assets acquired and liabilities assumed at the acquisition date, net of applicable income tax effects. The Company considers all purchase accounting adjustments as provisional and fair values are subject to refinement for up to one year after the closing date.

Note 2. Sales/Mergers/Acquisitions (continued)

Unaudited pro forma combined operating results for the year ended December 31, 2018, giving effect to the Bates Companies acquisition as if it had occurred as of January 1, 2017, are as follows:

	For the Year Ended
	December 31, 2018
	(dollars in thousands, except per share data)
Net interest income	$	142,368
Noninterest income	$	44,455
Net income	$	44,032
Earnings per common share:
Basic	$	2.98
Diluted	$	2.92

The pro forma results do not purport to be indicative of the results of operations that actually would have resulted had the merger occurred on January 1, 2017 or of future results of operations of the consolidated entities.

Springfield Bancshares, Inc.

On July 1, 2018, the Company merged with Springfield Bancshares, the holding company of SFCB, headquartered in Springfield, Missouri.  The Company acquired 100% of Springfield Bancshares common stock in the merger.  SFCB is a Missouri-chartered bank that operates one location in the Springfield, Missouri market. As a result of the transaction, SFCB became an independent charter of the Company.

The merger with Springfield Bancshares allowed the Company to enter the Springfield, Missouri market which is consistent with the Company’s strategic plan to selectively acquire other high-performing financial institutions in vibrant mid-sized metropolitan markets with a high concentration of commercial clients.  Financial metrics related to the transaction were favorable, as measured by EPS and ROAA accretion.

Stockholders of Springfield Bancshares received 0.3060 shares of the Company’s common stock and $1.50 in cash in exchange for each common share of Springfield Bancshares held.  On June 29, 2018, the last trading date before the closing, the Company’s common stock closed at $47.45, resulting in stock consideration valued at $80.6 million and total consideration paid by the Company of $89.0 million.  To help fund the cash portion of the purchase price, on June 29, 2018, the Company borrowed $4.1 million on its existing $10.0 million revolving line of credit.  The Company also borrowed $4.9 million on this same revolving line of credit to fund the repayment of certain debt assumed in the merger shortly after closing.  This note is included within Other Borrowings on the Consolidated Balance Sheets. The remaining cash consideration paid to the shareholders of Springfield Bancshares came from operating cash.

The Company accounted for the business combination under the acquisition method of accounting in accordance with ASC 805. The Company recognized the full fair value of the assets acquired and liabilities assumed at the merger date, net of applicable income tax effects.  The Company considers all purchase accounting adjustments as provisional and fair values are subject to refinement for up to one year after the closing date.

Note 2. Sales/Mergers/Acquisitions (continued)

The excess of the consideration paid over the fair value of the net assets acquired is recorded as goodwill. This goodwill is not deductible for tax purposes. During the fourth quarter of 2018, various measurement period adjustments were made.  The result of these adjustments was an increase to goodwill of $447 thousand.

The fair values of the assets acquired and liabilities assumed, after measurement period adjustments to date, including the consideration paid and resulting goodwill is as follows.

	As of
	July 1, 2018
	(dollars in thousands)
ASSETS
Cash and due from banks	$	4,586
Interest-bearing deposits at financial institutions		62,924
Securities		4,845
Loans/leases receivable, net		477,337
Bank-owned life insurance		7,092
Premises and equipment		6,092
Restricted investment securities		3,654
Intangibles		8,209
Other assets		1,471
Total assets acquired	$	576,210
LIABILITIES
Deposits	$	439,579
Short-term borrowings		1,143
FHLB advances		74,539
Other borrowings		9,544
Other liabilities		8,409
Total liabilities assumed	$	533,214
Net assets acquired	$	42,996
CONSIDERATION PAID:
Cash	$	8,334
Common stock		80,637
Total consideration paid	$	88,971
Goodwill	$	45,975

The following table presents the purchased loans as of the merger date:

	PCI		Performing
	Loans		Loans		Total
	(dollars in thousands)
Contractually required principal payments	$	7,553	$	479,440	$	486,993
Nonaccretable discount		(1,563)		—		(1,563)
Principal cash flows expected to be collected	$	5,990	$	479,440	$	485,430
Accretable discount		(293)		(7,800)		(8,093)
Fair Value of acquired loans	$	5,697	$	471,640	$	477,337

Note 2. Sales/Mergers/Acquisitions (continued)

Changes in accretable yield for the loans acquired are as follows:

	Year ended December 31, 2020
	PCI		Performing
	Loans		Loans		Total
	(dollars in thousands)
Balance at the beginning of the period	$	(51)	$	(3,524)	$	(3,575)
Reclassification of nonaccretable discount to accretable		(512)		—		(512)
Accretion recognized		563		2,048		2,611
Balance at the end of the period	$	—	$	(1,476)	$	(1,476)

	For the year ended December 31, 2019
	PCI		Performing
	Loans		Loans		Total
Balance at the beginning of the period	$	(659)	$	(5,849)	$	(6,508)
Reclassification of nonaccretable discount to accretable		(159)		—		(159)
Accretion recognized		767		2,325		3,092
Balance at the end of the period	$	(51)	$	(3,524)	$	(3,575)
		For the year ended December 31, 2018
	PCI		Performing
	Loans		Loans		Total
Balance at the beginning of the period	$	—	$	—	$	—
Discount added at acquisition		(293)		(7,800)		(8,093)
Reclassification of nonaccretable discount to accretable		(892)		—		(892)
Accretion recognized		526		1,951		2,477
Balance at the end of the period	$	(659)	$	(5,849)	$	(6,508)

During 2020, there was no nonaccretable discount that was recognized due to the repayment of PCI loans. However, $512 thousand of nonaccretable discount was reclassified to accretable due to significant improvement on specific credits subsequent to the merger date and all of this amount was accreted to income in 2020.

During 2019, there was no nonaccretable discount that was recognized due to the repayment of PCI loans. However, $159 thousand of nonaccretable discount was reclassified to accretable due to significant improvement on one specific credit subsequent to the merger date.  Of this amount, $153 thousand was accreted to income in 2019, while the remainder will be accreted over the next 8 months, which is the remaining contractual life of the loan.

During 2018, there was no nonaccretable discount that was recognized due to the repayment of PCI loans. However, $892 thousand of nonaccretable discount was reclassified to accretable during the third quarter of 2018 due to significant improvement on one specific credit subsequent to the merger date.  Of this amount, $396 thousand was accreted to income in 2018, while the remainder will be accreted over the next 8 months, which is the remaining contractual life of the loan.

Premises and equipment acquired with a fair value of $6.1 million includes one branch location. The fair value was determined with the assistance of a third party appraiser. The buildings and building write-ups will be recognized in depreciation expense over 39 years.

The Company recorded a core deposit intangible totaling $8.2 million which is the portion of the merger purchase price which represents the value assigned to the existing deposit base. The core deposit intangible has a finite life and

Note 2. Sales/Mergers/Acquisitions (continued)

is amortized using an accelerated method over the estimated useful life of the deposits (estimated to be ten years). See Note 6 to the Consolidated Financial Statements for additional information.

FHLB advances and other borrowings assumed with a fair value of $84.1 million included $40.0 million in overnight FHLB advances, $34.5 million of FHLB term advances, $4.7 million in subordinated debentures and a $4.8 million bank stock loan.  The $4.8 million bank stock loan was paid off immediately after the merger date on July 2, 2018, at its book value.  See Note 10 and 11 to the Consolidated Financial Statements for additional information.

During 2018, the Company incurred $1.4 million of expenses related to the merger comprised primarily of legal, accounting, and investment banking costs. These costs are presented on their own line within the consolidated statements of income. SFCB results are included in the consolidated statements of income effective on the merger date. For the period July 1, 2018 to December 31, 2018, SFCB reported revenues of $15.2 million and net income of $4.8 million, which included $391 thousand of after tax post-acquisition, compensation, transition and integration costs.

Unaudited pro forma combined operating results for the year ended December 31, 2018, giving effect to the merger with Springfield Bancshares as if it had occurred as of January 1, 2017, are as follows:

	For the Year Ended
	December 31, 2018
	(dollars in thousands, except per share data)
Net interest income	$	153,229
Noninterest income	$	42,538
Net income	$	49,542
Earnings per common share:
Basic	$	3.17
Diluted	$	3.11

The pro forma results do not purport to be indicative of the results of operations that actually would have resulted had the merger occurred on January 1, 2017 or of future results of operations of the consolidated entities.