NOTE

–

BUSINESS ACQUISITION

In the

second

quarter of

2016,

the Company announced the signing of a definitive merger agreement to acquire

100%

of the outstanding equity interest of Liberty Bank for cash and stock. Liberty was an Ohio bank that conducted its business from a main office in Beachwood, Ohio with branches in Twinsburg and Solon, Ohio.

The transaction closed on

January

12,

2017,

with Liberty having been merged into Middlefield Bank, with Middlefield Bank as the surviving entity. The acquisition established the Company’s presence in Cuyahoga and Summit Counties.

Under the terms of the merger agreement, the Company acquired all of the outstanding shares of Liberty for a total purchase price of

$42.2

million.

As a result of the acquisition, the Company issued

544,610

common shares and

$21.2

million in cash to the former shareholders of Liberty Bank. The shares were issued with a value of

$38.55

per share, which was the closing price of the Company’s stock on

January 12, 2017.

Prior to the acquisition the Company had a previously held equity interest in Liberty Bank which was re-measured at fair value on the acquisition date and resulted in a gain of

$488,000,

which was recorded in the Investment Securities Gains – Taxable Interest line on the consolidated Income Statement for the

nine

months ended

September 30, 2017.

The acquired assets and assumed liabilities were measured at estimated fair values. The Company relied on the income approach to estimate the value of the loans. The loans

’ underlying characteristics (account types, remaining terms (in months), annual interest rates or coupons, interest types, past delinquencies, timing of principal and interest payments, current market rates, loan-to-value ratios, loss exposures and remaining balance) were considered. Various assumptions were applied regarding credit, interest, and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications.

The Company also recorded an identifiable intangible asset representing the core deposit base of Liberty Bank. The discounted cash flow method was used in valuing this intangible. This method is based upon the principle of future benefits; economic value is based on anticipated future benefits as measured by cash flows expected to occur in the future. The estimated future cash flows are converted to a value indicator by determining the present value of the cash flows using a discount rate. The discount rate is based upon the nature of the business, the level of risk, and the expected stability of the estimated future cash flows. The higher the risk, the higher the discount rate, and the lower the value indicator.

Time deposit fair values were estimated using an income approach. The methodology entailed discounting the contractual cash flows of the instruments over their remaining contractual lives at prevailing market rates. Interest and principal payments were projected for each category of CDs over the period from the valuation date to the maturity dates. These payments represent future cash flows to be paid to depositors until maturity. Using appropriate market interest rates for each category of CDs

, the future cash flows were discounted to their present value equivalents. The market interest rates were selected based on peer rates in Ohio from Bankrate as of the valuation date.

The following table summarizes the purchase of Liberty Bank as of

January 12, 2017:

(In Thousands, Except Per Share Data)
Purchase Price Consideration in Common Stock
Middlefield Banc Corp. shares issued		544,610
Value assigned to Middlefield Banc Corp. common share	$	38.55
Purchase price assigned to Liberty Bank common shares exchanged for					20,995
Middlefield Banc Corp. shares
Purchase Price Consideration in Cash
Purchase price assigned to Liberty Bank common shares exchanged for cash					21,173
Total Purchase Price					42,168
Previously held equity interest in Liberty Bank					1,068
Net Assets Acquired:
Liberty Bank shareholders equity	$	30,474
Adjustments to reflect assets acquired at fair value:
Loans
Allowance for loan loss		3,257
Core deposit intangible		3,087
Loans - interest rate		578
Loans - general credit		(2,161	)
Other		254
Adjustments to reflect liabilities acquired at fair value:
Time deposits		(141	)
Deferred taxes		(1,134	)
Change in control		(1,718	)
					32,496
Goodwill resulting from merger				$	10,740

The following condensed statement reflects the amounts recognized as of the acquisition date for each major class of asset acquired and liability assumed, at fair value:

(In Thousands)
Total purchase price			$	42,168
Previously held equity interest in Liberty Bank				1,068
Assets (liabilities) acquired:
Net assets acquired:
Cash	26,604
Loans and loans held for sale	201,341
Premises and equipment, net	325
Accrued interest receivable	440
Bank-owned life insurance	1,681
Core deposit intangible	3,087
Other assets	997
Time deposits	(30,744	)
Non-time deposits	(167,300	)
Accrued interest payable	(47	)
Deferred taxes	(1,134	)
Other liabilities	(2,754	)
				32,496
Goodwill resulting from the Liberty Bank merger			$	10,740

Middlefield recorded goodwill and intangibles associated with the purchase of Liberty Bank totaling $

10,740,000.

Goodwill is

not

amortized, but is periodically evaluated for impairment. Middlefield Bank did

not

recognize any impairment during the

nine

months ended

September 30, 2017.

Management made adjustments to goodwill subsequent to the acquisition of

$347,000

due to refinements in a purchase accounting adjustment.

Identifiable intangibles are amortized to their estimated residual values over the expected useful lives. Such lives are also periodically reassessed to determine if any amortization period adjustments are required. During the

nine

months ended

September 30, 2017,

such adjustments were recorded. The identifiable intangible assets consist of a core deposit intangible which is being amortized over the estimated useful life. The gross carrying amount of the core deposit intangible at

September 30, 2017

was

$2,838,000

with

$249,000

accumulated amortization as of that date.

As of

September 30, 2017,

the current year and estimated future amortization expense for the core deposit intangible is as follows:

Remaining	2017	93
	2018	348
	2019	341
	2020	332
	2021	321
	2022	309
	2023	296
	2024	281
	2025	264
	2026	253
		2,838

Results of operations for Liberty prior to the acquisition date are

not

included in the Consolidated Statement of Income for the

three

-month period and

nine

-month period ended

September 30, 2017.

The results of activities from the former Liberty Bank operations that are included in the Consolidated Statement of Income from the date of acquisition through

September 30, 2017

are broken out in the following table:

	Actual from Acquisition Date Through September 30, 2017		Actual Third Quarter 2017
	(in thousands)		(in thousands)

Net interest income	$	7,810	$	2,566
Noninterest income		744		219
Net income	$	2,625	$	1,323

The table below presents unaudited pro forma information as if the acquisition of Liberty Bank had occurred on

January 1, 2016

. This has been prepared for comparative purposes only and is

not

necessarily indicative of the actual results that would have been attained had the acquisition occurred as of the beginning of the periods presented, nor is it indicative of future results. Furthermore, the unaudited pro forma information does

not

reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings as a result of the integration and consolidation of the acquisition. Merger and acquisition integration costs and amortization of fair value adjustments are included in the amounts below.

	Pro Formas				Pro Formas
	Nine-month period ended September 30,				Three-month period ended September 30,
	2017		2016		2017		2016
	(in thousands, except per share data)				(in thousands, except per share data)

Net interest income	$	27,844	$	25,790	$	9,214	$	8,868
Noninterest income		4,002		4,141		1,380		1,538
Net income	$	6,052	$	6,416	$	3,479	$	2,691
Pro forma earnings per share:
Basic	$	2.04	$	3.12	$	1.17	$	1.31
Diluted	$	2.03	$	3.10	$	1.17	$	1.30

Included in the above net income amount

for the

three

and

nine

months ended

September 30, 2017

are

$338,000

and

$1,032,000

of nonrecurring merger expenses, respectively.