Franklin Financial Network Inc. - FORM 10-Q

Franklin Financial Network Inc. - FORM 10-Q - August 9, 2016

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EX-32 - EX-32 - Franklin Financial Network Inc.	d225719dex32.htm
EX-31.2 - EX-31.2 - Franklin Financial Network Inc.	d225719dex312.htm
EX-31.1 - EX-31.1 - Franklin Financial Network Inc.	d225719dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

¨	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 001-36895

FRANKLIN FINANCIAL NETWORK, INC.

(Exact name of registrant as specified in its charter)


Tennessee		20-8839445
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

722 Columbia Avenue Franklin, Tennessee		37064
(Address of principal executive offices)		(Zip Code)

615-236-2265

(Registrant’s telephone number, including area code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 ¨

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 ¨

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

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

The number of shares outstanding of the registrant’s common stock, no par value per share, as of July 29, 2016, was 10,702,314.

TABLE OF CONTENTS


PART I FINANCIAL INFORMATION

Cautionary Note Regarding Forward-Looking Statements			1
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets			2
Consolidated Statements of Income			3
Consolidated Statements of Comprehensive Income (Loss)			4
Consolidated Statement of Changes in Shareholders’ Equity			5
Consolidated Statements of Cash Flows			6
Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
Item 3. Quantitative and Qualitative Disclosures About Market Risk			50
Item 4. Controls and Procedures			51

PART II OTHER INFORMATION

Item 1. Legal Proceedings			51
Item 1A. Risk Factors			51
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			52
Item 3. Defaults Upon Senior Securities			53
Item 4. Mine Safety Disclosures			53
Item 5. Other Information			53
Item 6. Exhibits			54

SIGNATURES

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements” as defined under U.S. federal securities laws. These statements reflect management’s current knowledge, assumptions, beliefs, estimates, and expectations and express management’s current views of future performance, results, and trends and may be identified by their use of terms such as “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “contemplate,” “seek,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” and other similar terms. Forward-looking statements are subject to a number of risks and uncertainties that could cause our actual results to differ materially from those described in the forward-looking statements. Readers should not place undue reliance on forward-looking statements. Such statements are made as of the date of this Quarterly Report on Form 10-Q, and we undertake no obligation to update such statements after this date.

Risks and uncertainties that could cause our actual results to differ materially from those described in forward-looking statements include those discussed in our filings with the Securities and Exchange Commission (“SEC”), including those described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2015 and those described in Item 1A of Part II of this Quarterly Report on Form 10-Q.

PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands, except share and per share data)


	June 30, 2016			December 31, 2015
	*(Unaudited)*
ASSETS
Cash and due from financial institutions	$	72,050		$	52,394
Certificates of deposit at other financial institutions		1,065			250
Securities available for sale		676,875			575,838
Securities held to maturity (fair value 2016—$243,594 and 2015—$161,969)		232,656			158,200
Loans held for sale, at fair value		16,808			14,079
Loans		1,550,729			1,303,826
Allowance for loan losses		(14,253	)		(11,587	)

Net loans		1,536,476			1,292,239

Restricted equity securities, at cost		9,889			7,998
Premises and equipment, net		8,449			7,640
Accrued interest receivable		8,448			7,299
Bank owned life insurance		22,942			22,619
Deferred tax asset		3,174			9,430
Assets held for sale		—			1,640
Foreclosed assets		200			200
Servicing rights, net		3,491			3,455
Goodwill		9,124			9,124
Core deposit intangible, net		1,750			2,043
Other assets		3,704			3,344

Total assets	$	2,607,101		$	2,167,792

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	229,035		$	176,742
Interest bearing		2,020,700			1,637,297

Total deposits		2,249,735			1,814,039
Federal funds purchased and repurchase agreements		36,672			101,086
Federal Home Loan Bank advances		52,000			57,000
Subordinated notes, net of issuance costs		58,312			—
Accrued interest payable		1,800			644
Other liabilities		4,306			6,207

Total liabilities		2,402,825			1,978,976
Shareholders’ equity
Preferred stock, no par value: 1,000,000 shares authorized; Senior non-cumulative preferred stock, Series A, no par value, $1,000 liquidation value per share, 10,000 shares authorized; no shares outstanding at June 30, 2016 and 10,000 shares issued and outstanding at December 31, 2015		—			10,000
Common stock, no par value; 20,000,000 shares authorized; 10,689,481 and 10,571,377 shares issued and outstanding at June 30, 2016 and December 31 2015, respectively		150,026			147,784
Retained earnings		44,561			31,352
Accumulated other comprehensive income (loss)		9,689			(320	)

Total shareholders’ equity		204,276			188,816

Total liabilities and shareholders’ equity	$	2,607,101		$	2,167,792

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Dollar amounts in thousands, except share and per share data)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Interest income and dividends
Loans, including fees	$	18,930		$	12,173		$	36,672		$	23,327
Securities:
Taxable		3,985			2,957			7,513			5,622
Tax-Exempt		1,197			169			2,319			189
Dividends on restricted equity securities		118			83			221			150
Federal funds sold and other		56			31			122			51

Total interest income		24,286			15,413			46,847			29,339

Interest expense
Deposits		3,358			1,913			6,435			3,546
Federal funds purchased and repurchase agreements		82			92			168			163
Federal Home Loan Bank advances		187			81			296			146
Subordinated notes and other borrowings		725			—			738			—

Total interest expense		4,352			2,086			7,637			3,855

Net interest income		19,934			13,327			39,210			25,484
Provision for loan losses		1,567			805			2,703			1,430

Net interest income after provision for loan losses		18,367			12,522			36,507			24,054

Noninterest income
Service charges on deposit accounts		46			18			95			34
Other service charges and fees		767			690			1,400			1,308
Net gains on sale of loans		2,309			1,463			3,917			3,110
Wealth management		529			301			897			587
Loan servicing fees, net		(4	)		60			38			103
Gain on sale or call of securities		795			109			1,105			524
Net gain on sale of foreclosed assets		3			21			6			27
Other		181			189			253			373

Total noninterest income		4,626			2,851			7,711			6,066

Noninterest expense
Salaries and employee benefits		7,603			6,071			14,120			11,752
Occupancy and equipment		1,755			1,699			3,562			3,278
FDIC assessment expense		405			216			818			430
Marketing		188			198			405			418
Professional fees		977			507			2,071			866
Amortization of core deposit intangible		144			167			293			339
Indirect expenses related to public offering		—			309			—			326
Other		1,841			1,405			3,475			2,784

Total noninterest expense		12,913			10,572			24,744			20,193

Income before income tax expense		10,080			4,801			19,474			9,927
Income tax expense		3,081			1,667			6,242			3,661

Net income		6,999			3,134			13,232			6,266
Dividends paid on Series A preferred stock		—			(25	)		(23	)		(50	)

Net income available to common shareholders	$	6,999		$	3,109		$	13,209		$	6,216

Earnings per share:
Basic	$	0.66		$	0.30		$	1.24		$	0.67
Diluted		0.62			0.28			1.18			0.64

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and Six Months Ended June 30, 2016 and 2015

(Dollar amounts in thousands, except share and per share data)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Net income	$	6,999		$	3,134		$	13,232		$	6,266
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gain (loss) arising during the period		6,514			(6,900	)		17,574			(3,865	)
Reclassification adjustment for gains included in net income		(795	)		(109	)		(1,105	)		(524	)

Net unrealized gains (losses)		5,719			(7,009	)		16,469			(4,389	)
Tax effect		(2,243	)		2,754			(6,460	)		1,689

Total other comprehensive income (loss)		3,476			(4,255	)		10,009			(2,700	)

Comprehensive income (loss)	$	10,475		$	(1,121	)	$	23,241		$	3,566

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Six Months Ended June 30, 2016 and 2015

(Dollar amounts in thousands, except share and per share data)

(Unaudited)


	Preferred Stock			Common Stock						Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders Equity
	Preferred Stock			Shares			Amount			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders Equity
Balance at December 31, 2014	$	10,000			7,756,411		$	94,251		$	15,372		$	2,176		$	121,799
Exercise of common stock options		—			71,965			780			—			—			780
Exercise of common stock warrants		—			3,600			43			—			—			43
Dividends paid on Series A preferred stock		—			—			—			(50	)		—			(50	)
Stock based compensation expense, net of restricted share forfeitures		—			30,695			371			—			—			371
Stock issued related to initial public offering, net of stock issuance costs		—			2,640,000			50,425			—			—			50,425
Excess tax benefit from exercise of stock options		—			—			147			—			—			147
Net income		—			—			—			6,266			—			6,266
Other comprehensive income		—			—			—			—			(2,700	)		(2,700	)

Balance at June 30, 2015	$	10,000			10,502,671		$	146,017		$	21,588		$	(524	)	$	177,081

Balance at December 31, 2015	$	10,000			10,571,377		$	147,784		$	31,352		$	(320	)	$	188,816
Exercise of common stock options, net		—			87,710			975									975
Exercise of common stock warrants		—			3,775			45									45
Redemption of Series A preferred stock		(10,000	)		—			—			—			—			(10,000	)
Dividends paid on Series A preferred stock		—			—			—			(23	)		—			(23	)
Stock based compensation expense, net of restricted share forfeitures		—			30,564			795			—			—			795
Stock issued (divestment) in conjunction with 401(k) employer match, net of distributions		—			(3,945	)		(82	)		—			—			(82	)
Excess tax benefit from restricted stock vesting		—			—			90			—			—			90
Excess tax benefit from exercise of stock options		—			—			419			—			—			419
Net income		—			—			—			13,232			—			13,232
Other comprehensive income		—			—			—			—			10,009			10,009

Balance at June 30, 2016	$	—			10,689,481		$	150,026		$	44,561		$	9,689		$	204,276

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands, except share and per share data)

(Unaudited)


	Six Months Ended June 30,
	2016			2015
Cash flows from operating activities
Net income	$	13,232		$	6,266
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization on premises and equipment		652			659
Accretion of purchase accounting adjustments		(635	)		(1,245	)
Net amortization of securities		3,364			1,837
Amortization of loan servicing right asset		556			441
Amortization of core deposit intangible		293			339
Amortization of debt issuance costs		34			—
Provision for loan losses		2,703			1,430
Deferred income tax (benefit) expense		(204	)		74
Origination of loans held for sale		(148,829	)		(161,442	)
Proceeds from sale of loans held for sale		149,425			165,486
Net gain on sale of loans		(3,917	)		(3,110	)
Gain on sale of available for sale securities		(1,105	)		(375	)
Gain on call of held to maturity securities		—			(149	)
Income from bank owned life insurance		(323	)		(274	)
Net gain on foreclosed assets		(6	)		(27	)
Loss on sale of assets held for sale		98			—
Stock-based compensation		795			371
Compensation expense related to common stock issued to 401(k) plan		269			240
Deferred gain on sale of loans		(38	)		(18	)
Net change in:
Accrued interest receivable and other assets		(1,509	)		(2,639	)
Accrued interest payable and other liabilities		(970	)		184

Net cash from operating activities		13,885			8,048
Cash flows from investing activities
Securities available for sale :
Sales		62,263			32,288
Purchases		(185,270	)		(446,795	)
Maturities, prepayments and calls		37,234			169,306
Securities held to maturity :
Purchases		(82,405	)		—
Maturities, prepayments and calls		6,895			6,538
Net change in loans		(246,305	)		(173,912	)
Purchase of bank owned life insurance		—			(10,000	)
Proceeds from sale of assets held for sale		1,542			4,080
Purchase of restricted equity securities		(1,891	)		(2,336	)
Proceeds from sale of foreclosed assets		—			531
Purchases of premises and equipment, net		(1,461	)		(579	)
Increase in certificates of deposits at other financial institutions		(815	)		—

Net cash from investing activities		(410,213	)		(420,879	)
Cash flows from financing activities
Increase in deposits		435,696			319,813
Decrease in federal funds purchased and repurchase agreements		(64,414	)		(2,511	)
Proceeds from Federal Home Loan Bank advances		75,000			157,000
Repayment of Federal Home Loan Bank advances		(80,000	)		(119,000	)
Proceeds from other borrowings		10,000			—
Repayment of other borrowings		(10,000	)		—
Proceeds from issuance of subordinated notes, net of issuance costs		58,278			—
Proceeds from exercise of common stock warrants		45			43
Proceeds from exercise of common stock options, including excess tax benefit		1,394			927
Excess tax benefit from restricted stock vesting		90			—
Proceeds from issuance of common stock, net of offering costs		—			50,425
Divestment of common stock issued to 401(k) plan		(82	)		—
Redemption of Series A preferred stock		(10,000	)		—
Dividends paid on preferred stock		(23	)		(50	)

Net cash from financing activities		415,984			406,647

Net change in cash and cash equivalents		19,656			(6,184	)
Cash and cash equivalents at beginning of period		52,394			49,347

Cash and cash equivalents at end of period	$	72,050		$	43,163

Supplemental information:
Interest paid	$	6,481		$	3,698
Income taxes paid		7,291			5,150

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands, except share and per share data)

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles (U.S. GAAP). All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included as required by Regulation S-X, Rule 10-01. All such adjustments are of a normal recurring nature. It is suggested that these interim consolidated financial statements and notes be read in conjunction with the financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2016.

These consolidated financial statements include the accounts of Franklin Financial Network, Inc. (“FFN”), and its wholly-owned subsidiaries, Franklin Synergy Bank (“Franklin Synergy” or the “Bank”) and Franklin Synergy Risk Management, Inc. (collectively, the “Company”). Franklin Synergy Investments of Tennessee, Inc., Franklin Synergy Investments of Nevada, Inc., and Franklin Synergy Preferred Capital, Inc. are direct or indirect subsidiaries of the Bank and are included in these consolidated financial statements. Significant intercompany transactions and accounts are eliminated in consolidation.

NOTE 2—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available for sale portfolio at June 30, 2016 and December 31, 2015 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income.


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2016
U.S. government sponsored entities and agencies	$	5,750	$	160	$	—		$	5,910
Mortgage-backed securities: residential		583,974		12,599		(109	)		596,464
Mortgage-backed securities: commercial		19,671		335		—			20,006
State and political subdivisions		51,538		2,957		—			54,495

Total	$	660,933	$	16,051	$	(109	)	$	676,875


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2015
U.S. government sponsored entities and agencies	$	6,792	$	72	$	(47	)	$	6,817
Mortgage-backed securities: residential		502,916		2,386		(4,347	)		500,955
Mortgage-backed securities: commercial		19,993		22		(180	)		19,835
State and political subdivisions		46,664		1,570		(3	)		48,231

Total	$	576,365	$	4,050	$	(4,577	)	$	575,838

The amortized cost and fair value of the securities held to maturity portfolio at June 30, 2016 and December 31, 2015 and the corresponding amounts of gross unrecognized gains and losses were as follows:


	Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses			Fair Value
June 30, 2016
U.S. government sponsored entities and agencies	$	222	$	9	$	—		$	231
Mortgage backed securities: residential		108,839		1,084		(93	)		109,830
State and political subdivisions		123,595		9,938		—			133,533

Total	$	232,656	$	11,031	$	(93	)	$	243,594


	Gross Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses			Fair Value
December 31, 2015
U.S. government sponsored entities and agencies	$	3,300	$	11	$	(72	)	$	3,239
Mortgage backed securities: residential		30,398		410		(408	)		30,400
State and political subdivisions		124,502		3,841		(13	)		128,330

Total	$	158,200	$	4,262	$	(493	)	$	161,969

The proceeds from sales and calls of securities available for sale and the associated gains and losses were as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Proceeds	$	13,491		$	22,999		$	62,263		$	32,288
Gross gains		797			—			1,490			390
Gross losses		(2	)		(1	)		(385	)		(15	)

Call proceeds of $2,000 with an associated gain of $143 for securities that were called at a price in excess of par value are included in the balances for the six months ended June 30, 2015.

The proceeds from calls of securities held to maturity that were called at a price in excess of par value and the associated gains were as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Proceeds	$	—	$	1,500	$	—	$	2,300
Gross gains		—		110		—		149
Gross losses		—		—		—		—

The amortized cost and fair value of the investment securities portfolio are shown by contractual maturity. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.


	June 30, 2016
	Amortized Cost		Fair Value
Available for sale
Over one year through five years	$	3,000	$	3,157
Over ten years		54,288		57,248
Mortgage-backed securities: residential		583,974		596,464
Mortgage-backed securities: commercial		19,671		20,006

Total	$	660,933	$	676,875

Held to maturity
Over one year through five years	$	1,225	$	1,278
Over five years through ten years		5,092		5,416
Over ten years		117,500		127,070
Mortgage-backed securities: residential		108,839		109,830

Total	$	232,656	$	243,594

Securities pledged at June 30, 2016 and December 31, 2015 had a carrying amount of $818,330 and $595,524, respectively, and were pledged to secure public deposits and repurchase agreements.

At June 30, 2016 and December 31, 2015, there were no holdings of securities of any one issuer, other than the U.S. government-sponsored entities and agencies, in an amount greater than 10% of shareholders’ equity.

The following table summarizes the securities with unrealized and unrecognized losses at June 30, 2016 and December 31, 2015, aggregated by major security type and length of time in a continuous unrealized loss position:


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2016
Available for sale
Mortgage-backed securities: residential	$	8,391	$	(58	)	$	11,713	$	(51	)	$	20,104	$	(109	)

Total available for sale	$	8,391	$	(58	)	$	11,713	$	(51	)	$	20,104	$	(109	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses
Held to maturity
Mortgage-backed securities: residential	$	12,482	$	(10	)	$	5,171	$	(83	)	$	17,653	$	(93	)

Total held to maturity	$	12,482	$	(10	)	$	5,171	$	(83	)	$	17,653	$	(93	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2015
Available for sale
U.S. government sponsored entities and agencies	$	2,703	$	(47	)	$	—	$	—		$	2,703	$	(47	)
Mortgage-backed securities: residential		313,570		(3,691	)		23,319		(656	)		336,889		(4,347	)
Mortgage-backed securities: commercial		15,980		(180	)		—		—			15,980		(180	)
State and political subdivisions		716		(3	)		—		—			716		(3	)

Total available for sale	$	332,969	$	(3,921	)	$	23,319	$	(656	)	$	356,288	$	(4,577	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses
Held to maturity
U.S. government sponsored entities and agencies	$	1,957	$	(43	)	$	971	$	(29	)	$	2,928	$	(72	)
Mortgage-backed securities: residential		9,788		(97	)		5,481		(311	)		15,269		(408	)
State and political subdivisions		3,351		(13	)		—		—			3,351		(13	)

Total held to maturity	$	15,096	$	(153	)	$	6,452	$	(340	)	$	21,548	$	(493	)

Unrealized losses on debt securities have not been recognized into income because the issuers’ bonds are of high credit quality (rated AA or higher), management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The fair value is expected to recover as the bonds approach maturity.

NOTE 3—LOANS

Loans at June 30, 2016 and December 31, 2015 were as follows:


	June 30, 2016			December 31, 2015
Loans that are not PCI loans
Construction and land development	$	438,850		$	372,767
Commercial real estate:
Nonfarm, nonresidential		415,790			353,268
Other		24,987			10,955
Residential real estate:
Closed-end 1-4 family		184,823			162,933
Other		132,948			112,001
Commercial and industrial		345,556			283,888
Consumer and other		5,718			6,577

Loans before net deferred loan fees		1,548,672			1,302,389
Deferred loan fees, net		(1,019	)		(2,476	)

Total loans that are not PCI loans		1,547,653			1,299,913

PCI loans
Construction and land development	$	80		$	78
Commercial real estate:
Nonfarm, nonresidential		582			1,460
Other		—			—
Residential real estate:
Closed-end 1-4 family		564			562
Other		7			1
Commercial and industrial		1,843			1,812
Consumer and other		—			—

Total PCI loans		3,076			3,913

Allowance for loan losses		(14,253	)		(11,587	)

Total loans, net of allowance for loan losses	$	1,536,476		$	1,292,239

The following table presents the activity in the allowance for loan losses by portfolio segment for the three month periods ended June 30, 2016 and 2015:


	Construction and Land Development		Commercial Real Estate		Residential Real Estate			Commercial and Industrial		Consumer and Other			Total
Three Months Ended June 30, 2016
Allowance for loan losses:
Beginning balance	$	3,378	$	3,564	$	1,800		$	3,875	$	59		$	12,676
Provision for loan losses		246		301		248			780		(8	)		1,567
Loans charged-off		—		—		—			—		(4	)		(4	)
Recoveries		—		—		12			—		2			14

Total ending allowance balance	$	3,624	$	3,865	$	2,060		$	4,655	$	49		$	14,253

Three Months Ended June 30, 2015
Allowance for loan losses:
Beginning balance	$	2,549	$	2,124	$	1,727		$	850	$	58		$	7,308
Provision for loan losses		18		197		24			474		92			805
Loans charged-off		—		—		(17	)		—		(88	)		(105	)
Recoveries		—		—		5			—		3			8

Total ending allowance balance	$	2,567	$	2,321	$	1,739		$	1,324	$	65		$	8,016

The following table presents the activity in the allowance for loan losses by portfolio segment for the six-month periods ended June 30, 2016 and 2015:


	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Six Months Ended June 30, 2016
Allowance for loan losses:
Beginning balance	$	3,186		$	3,146	$	1,861		$	3,358		$	36		$	11,587
Provision for loan losses		438			719		159			1,362			25			2,703
Loans charged-off		—			—		—			(65	)		(15	)		(80	)
Recoveries		—			—		40			—			3			43

Total ending allowance balance	$	3,624		$	3,865	$	2,060		$	4,655		$	49		$	14,253

Six Months Ended June 30, 2015
Allowance for loan losses:
Beginning balance	$	2,690		$	1,494	$	1,791		$	650		$	55		$	6,680
Provision for loan losses		(123	)		827		(43	)		674			95			1,430
Loans charged-off		—			—		(17	)		—			(88	)		(105	)
Recoveries		—			—		8			—			3			11

Total ending allowance balance	$	2,567		$	2,321	$	1,739		$	1,324		$	65		$	8,016

As of June 30, 2016 and December 31, 2015, there was $0 and $9 allowance for loan losses for PCI loans.

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2016 and December 31, 2015. For purposes of this disclosure, recorded investment in loans excludes accrued interest receivable and deferred loan fees, net due to immateriality.


	Construction and Land Development		Commercial Real Estate		Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
June 30, 2016
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	95	$	—	$	95
Collectively evaluated for impairment		3,624		3,865		2,060		4,560		49		14,158
Purchased credit-impaired loans		—		—		—		—		—		—

Total ending allowance balance	$	3,624	$	3,865	$	2,060	$	4,655	$	49	$	14,253

Loans:
Individually evaluated for impairment	$	119	$	1,073	$	955	$	510	$	10	$	2,667
Collectively evaluated for impairment		438,731		439,704		316,816		345,046		5,708		1,546,005
Purchased credit-impaired loans		80		582		571		1,843		—		3,076

Total ending loans balance	$	438,930	$	441,359	$	318,342	$	347,399	$	5,718	$	1,551,748

December 31, 2015
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	113	$	—	$	113


	Construction and Land Development		Commercial Real Estate		Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
Collectively evaluated for impairment		3,186		3,137		1,861		3,245		36		11,465
Purchased credit-impaired loans		—		9		—		—		—		9

Total ending allowance balance	$	3,186	$	3,146	$	1,861	$	3,358	$	36	$	11,587

Loans:
Individually evaluated for impairment	$	1,943	$	908	$	1,185	$	134	$	—	$	4,170
Collectively evaluated for impairment		370,824		363,315		273,749		283,754		6,577		1,298,219
Purchased credit-impaired loans		78		1,460		563		1,812		—		3,913

Total ending loans balance	$	372,845	$	365,683	$	275,497	$	285,700	$	6,577	$	1,306,302

Loans collectively evaluated for impairment reported at June 30, 2016 include certain acquired loans. At June 30, 2016, these non-PCI loans had a carrying value of $88,793, comprised of contractually unpaid principal totaling $86,976 and discounts totaling $1,817. Management evaluated these loans for credit deterioration since acquisition and determined that $30 in allowance for loan losses was necessary at June 30, 2016.

The following table presents information related to impaired loans by class of loans as of June 30, 2016 and December 31, 2015:


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
June 30, 2016
With no allowance recorded:
Construction and land development	$	119	$	119	$	—
Commercial real estate:
Nonfarm, nonresidential		2,754		1,073		—
Residential real estate:
Closed-end 1-4 family		121		120		—
Other		835		835		—
Commercial and industrial		19		20		—
Consumer and other		10		10		—

Subtotal		3,858		2,177		—
With an allowance recorded:
Commercial and industrial		490		490		95

Subtotal		490		490		95

Total	$	4,348	$	2,667	$	95

December 31, 2015
With no allowance recorded:
Construction and land development	$	1,943	$	1,943	$	—
Commercial real estate:
Nonfarm, nonresidential		2,495		908		—
Residential real estate:
Closed-end 1-4 family		476		476		—
Other		709		709		—
Commercial and industrial		21		21		—

Subtotal		5,644		4,057		—

With an allowance recorded:
Commercial and industrial		113		113		113

Subtotal		113		113		113

Total	$	5,757	$	4,170	$	113

The following table presents the average recorded investment of impaired loans by class of loans for the three months ended June 30, 2016 and 2015:


	Three Months Ended June 30,				Six Months Ended June 30,
Average Recorded Investment	2016		2015		2016		2015
With no allowance recorded:
Construction and land development	$	121	$	—	$	510	$	—
Commercial real estate:
Nonfarm, nonresidential		1,094		865		1,248		850
Residential real estate:
Closed-end 1-4 family		413		313		574		265
Other		754		238		733		119
Commercial and industrial		263		110		142		104
Consumer and other		30		—		15		—

Subtotal		2,675		1,526		3,222		1,338

With an allowance recorded:
Commercial and industrial	$	163	$	43	$	125	$	30
Consumer and other		—		16		—		8

Subtotal		163		59		125		38

Total	$	2,838	$	1,585	$	3,347	$	1,376

The impact on net interest income for these loans was not material to the Company’s results of operations for the three and six months ended June 30, 2016 and 2015.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2016 and December 31, 2015:


	Nonaccrual		Loans Past Due Over 90 Days
June 30, 2016
Construction and land development	$	—	$	119
Commercial real estate:
Nonfarm, nonresidential		835		—
Residential real estate:
Closed-end 1-4 family		41		—
Other		126		—
Commercial and industrial		491		—

Total	$	1,493	$	119

December 31, 2015
Construction and land development	$	—	$	1,943
Commercial real estate:
Nonfarm, nonresidential		835		—
Residential real estate:
Closed-end 1-4 family		41		435
Commercial and industrial		32		—

Total	$	908	$	2,378

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following table presents the aging of the recorded investment in past due loans as of June 30, 2016 and December 31, 2015 by class of loans:


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Loans Not Past Due		PCI Loans		Total
June 30, 2016
Construction and land development	$	1,039	$	—	$	119	$	1,158	$	437,692	$	80	$	438,930
Commercial real estate:
Nonfarm, nonresidential		115		—		835		950		414,840		582		416,372
Other		—		—		—		—		24,987		—		24,987
Residential real estate:
Closed-end 1-4 family		78		—		41		119		184,704		564		185,387
Other		68		—		126		194		132,754		7		132,955
Commercial and industrial		73		11		491		575		344,981		1,843		347,399
Consumer and other		—		10		—		10		5,708		—		5,718

	$	1,373	$	21	$	1,612	$	3,006	$	1,545,666	$	3,076	$	1,551,748


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Loans Not Past Due		PCI Loans		Total
December 31, 2015
Construction and land development	$	—	$	149	$	1,943	$	2,092	$	370,675	$	78	$	372,845
Commercial real estate:
Nonfarm, nonresidential		258		—		835		1,093		352,175		1,460		354,728
Other		—		—		—		—		10,955		—		10,955
Residential real estate:
Closed-end 1-4 family		213		—		476		689		162,244		562		163,495
Other		30		—		—		30		111,971		1		112,002
Commercial and industrial		86		32		—		118		283,770		1,812		285,700
Consumer and other		2		—		—		2		6,575		—		6,577

	$	589	$	181	$	3,254	$	4,024	$	1,298,365	$	3,913	$	1,306,302

Credit Quality Indicators: The Company categorizes loans into risk categories 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. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans as well as non-homogeneous residential real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. The following table includes PCI loans, which are included in the “Substandard” column. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of June 30, 2016 and December 31, 2015:


	Pass		Special Mention		Substandard		Total
June 30, 2016
Construction and land development	$	438,731	$	—	$	199	$	438,930
Commercial real estate:
Nonfarm, nonresidential		414,769		—		1,603		416,372
Other		24,987		—		—		24,987
Residential real estate:
Closed-end 1-4 family		184,409		—		978		185,387
Other		132,955		—		—		132,955
Commercial and industrial		345,397		—		2,002		347,399
Consumer and other		5,708		—		10		5,718

	$	1,546,956	$	—	$	4,792	$	1,551,748


	Pass		Special Mention		Substandard		Total
December 31, 2015
Construction and land development	$	370,824	$	—	$	2,021	$	372,845
Commercial real estate:
Nonfarm, nonresidential		352,451		—		2,277		354,728
Other		10,955		—		—		10,955
Residential real estate:
1-4 family		162,160		—		1,335		163,495
Other		111,292		—		710		112,002
Commercial and industrial		284,144		—		1,556		285,700
Consumer and other		6,577		—		—		6,577

	$	1,298,403	$	—	$	7,899	$	1,306,302

Purchased Credit-impaired (“PCI”) loans

Income is recognized on PCI loans pursuant to ASC Topic 310-30. A portion of the fair value discount is recognized as an accretable yield that is accreted into interest income over the estimated remaining life of the loans. The remaining non-accretable difference represents cash flows not expected to be collected.

The table below summarizes the total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the loans as of June 30, 2016 and December 31, 2015.


	Jun 30, 2016			Dec 31, 2015
Contractually required principal and interest	$	4,462		$	5,618
Non-accretable difference		(319	)		(352	)

Cash flows expected to be collected		4,143			5,266
Accretable yield		(1,067	)		(1,353	)

Carrying value of acquired loans		3,076			3,913
Allowance for loan losses		—			(9	)

Carrying value less allowance for loan losses	$	3,076		$	3,904

Management adjusted estimates of future expected losses, cash flows and renewal assumptions during the quarter ended June 30, 2016. These adjustments resulted in changes in expected cash flows, accretable yield, and the non-accretable difference for the three and six months ended June 30, 2016.

The table below summarizes the changes in total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the loans during the three-month periods ended June 30, 2016 and 2015.


Activity during the three month period ended June 30, 2016	Mar 31, 2016			Effect of Acquisitions		Income Accretion		All other Adjustments			Jun 30, 2016
Contractually required principal and interest	$	4,563		$	—	$	—	$	(101	)	$	4,462
Non-accretable difference		(305	)		—		—		(14	)		(319	)

Cash flows expected to be collected		4,258			—		—		(115	)		4,143
Accretable yield		(1,129	)		—		115		(53	)		(1,067	)

Carry value of acquired loans	$	3,129		$	—	$	115	$	(168	)	$	3,076


Activity during the three month period ended June 30, 2015	Mar 31, 2015			Effect of Acquisitions		Income Accretion		All other Adjustments			Jun 30, 2015
Contractually required principal and interest	$	6,135		$	—	$	—	$	(135	)	$	6,000
Non-accretable difference		(989	)		—		—		16			(973	)

Cash flows expected to be collected		5,146			—		—		(119	)		5,027
Accretable yield		(840	)		—		133		(42	)		(749	)

Carry value of acquired loans	$	4,306		$	—	$	133	$	(161	)	$	4,278


Activity during the six month period ended June 30, 2016	Dec 31, 2015			Effect of Acquisitions		Income Accretion		All other Adjustments			Jun 30, 2016
Contractually required principal and interest	$	5,618		$	—	$	—	$	(1,156	)	$	4,462
Non-accretable difference		(352	)		—		—		33			(319	)

Cash flows expected to be collected		5,266			—		—		(1,123	)		4,143
Accretable yield		(1,353	)		—		309		(23	)		(1,067	)

Carry value of acquired loans	$	3,913		$	—	$	309	$	(1,146	)	$	3,076


Activity during the six month period ended June 30, 2015	Dec 31, 2014			Effect of Acquisitions		Income Accretion		All other Adjustments			Jun 30, 2015
Contractually required principal and interest	$	6,532		$	—	$	—	$	(532	)	$	6,000
Non-accretable difference		(1,270	)		—		—		297			(973	)

Cash flows expected to be collected		5,262			—		—		(235	)		5,027
Accretable yield		(947	)		—		190		8			(749	)

Carry value of acquired loans	$	4,315		$	—	$	190	$	(227	)	$	4,278

Troubled Debt Restructurings

The Company’s loan portfolio contains no loans that have been modified in a troubled debt restructuring.

NOTE 4—LOAN SERVICING

Loans serviced for others are not reported as assets. The principal balances of these loans at June 30, 2016 and December 31, 2015 are as follows:


	June 30, 2016		December 31, 2015
Loan portfolios serviced for:
Federal Home Loan Mortgage Corporation	$	479,393	$	463,952
Other		3,315		4,037

The components of net loan servicing fees for the three and six months ended June 30, 2016 and 2015 were as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Loan servicing fees, net:
Loan servicing fees	$	301		$	278		$	594		$	544
Amortization of loan servicing fees		(305	)		(218	)		(556	)		(441	)
Change in impairment		—			—			—			—

Total	$	(4	)	$	60		$	38		$	103

The fair value of servicing rights was estimated by management to be approximately $3,673 at June 30, 2016. Fair value for June 30, 2016 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 15.7%. At December 31, 2015, the fair value of servicing rights was estimated by management to be approximately $4,635. Fair value for December 31, 2015 was determined using weighted average discount rate of 10.5% and a weighted average prepayment speed of 10.2%.

NOTE 5—SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

Our subsidiary bank enters into borrowing arrangements with our retail business customers and correspondent banks through agreements to repurchase (“securities sold under agreements to repurchase”) under which the bank pledges investment securities owned and under its control as collateral against these short-term borrowing arrangements. At maturity the securities underlying the agreements are returned to the Company. At June 30, 2016 and December 31, 2015, these short-term borrowings totaled $36,664 and $61,261, respectively, and were secured by securities with carrying amounts of $38,881 and $73,478, respectively. At June 30, 2016, all of the Company’s repurchase agreements had one-day maturities.

The following table provides additional details as of June 30, 2016:


As of June 30, 2016	U.S. Government Sponsored Entities and Agencies Securities			Mortgage- Backed Securities: Residential			State and Political Subdivisions			Total
Market value of securities pledged	$	230		$	63		$	41,791		$	42,084
Borrowings related to pledged amounts	$	—		$	—		$	36,664		$	36,664
Market value pledged as a % of borrowings		—	%		—	%		114	%		115	%

NOTE 6—SHARE-BASED PAYMENTS

In connection with the Company’s 2010 private offering, 32,425 warrants were issued to shareholders, one warrant for every twenty shares of common stock purchased. Each warrant allows the shareholders to purchase an additional share of common stock at $12.00 per share. The warrants were issued with an effective date of March 30, 2010 and will be exercisable in whole or in part up to seven years following the date of issuance. The warrants are detachable from the common stock. There were 3,775 and 3,600 warrants exercised during the six months ended June 30, 2016 and 2015, respectively. A summary of the stock warrant activity for the six months ended June 30, 2016 and 2015 follows:


	June 30, 2016		June 30, 2015
Stock warrants exercised:
Intrinsic value of warrants exercised	$	73	$	31
Cash received from warrants exercised		45		43

At June 30, 2016, there were 21,532 outstanding warrants associated with the 2010 offering.

Since the common stock of the Company is registered under the Securities Act and has been traded on a national securities exchange at $15.00 or more for forty-five (45) consecutive days, the Company may redeem the 2010 warrants at any time with not less than thirty (30) days’ written notice to the holders of such 2010 warrants, in whole or in part, at a redemption price of $1.00 per warrant; provided, however, that the holder of the 2010 warrant may exercise the 2010 warrant, in whole or in part, during such thirty (30) day period.

The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $537 and $225 and $795 and $371 for the three and six months ended June 30, 2016 and 2015, respectively. The total income tax benefit related to vesting of restricted stock and exercises of stock options was $509 and $147 for the six months ended June 30, 2016 and 2015. The total income tax benefit for the three months ended June 30, 2016 was $509. There was no excess tax benefit from the exercise of stock options for the three months ended June 30, 2015.

Stock Option Plan: The Company’s 2007 Stock Option Plan (“stock option plan” or the “Plan”), which was shareholder-approved, permitted the grant of share options to its employees, organizers and directors for up to 551,250 shares of common stock. The Plan was amended during April 2010 to increase the number of shares available for issuance to 1,000,000. In April 2013, the Plan was amended to offer additional forms of equity compensation, to change the Plan’s name to the Franklin Financial Network, Inc. 2007 Omnibus Equity Incentive Plan, and to increase the number of authorized shares to 1,500,000. The Company believes that such awards better align the interests of its employees with those of its shareholders. Shareholders approved amendments to the Plan to increase the number of authorized shares to 2,000,000 in June 2014 and to 4,000,000 in February 2015. At June 30, 2016, there were 2,074,089 authorized shares available for issuance.

Employee, organizer and director awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant; those option awards have a vesting period of three to five years and have a ten-year contractual term. The Company assigns discretion to its Board of Directors to make grants either as qualified incentive stock options or as non-qualified stock options. All employee grants are intended to be treated as qualified incentive stock options, if allowable. All other grants are expected to be treated as non-qualified.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected stock price volatility is based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior.

The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of options granted was determined using the following weighted-average assumptions as of grant date.


	June 30, 2016			June 30, 2015
Risk-free interest rate		1.63	%		1.81	%
Expected term		7.5 years			7.5 years
Expected stock price volatility		29.46	%		25.00	%
Dividend yield		0.24	%		0.22	%

The weighted average fair value of options granted for the six months ended June 30, 2016 and 2015 were $9.47 and $6.35, respectively.

A summary of the activity in the stock option plans for the six months ended June 30, 2016 follows:


	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		1,312,791		$	13.04		6.23	$	24,070
Granted		243,587			27.54
Exercised		(90,477	)		11.69
Forfeited, expired, or cancelled		(2,415	)		19.43

Outstanding at period end		1,463,486		$	15.53		6.51	$	23,166

Vested or expected to vest		1,386,512		$	15.53		6.51	$	22,008
Exercisable at period end		842,494		$	11.38		4.87	$	16,831


	For the six months ended June 30,
	2016		2015
Stock options exercised:
Intrinsic value of options exercised	$	1,648	$	639
Cash received from options exercised		975		780
Tax benefit realized from option exercises		419		147

As of June 30, 2016, there was $3,490 of total unrecognized compensation cost related to non-vested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.0 years.

Restricted Share Award Plan: Additionally, the Company’s 2007 Omnibus Equity Incentive Plan provides for the granting of restricted share awards and other performance related incentives. When the restricted shares are awarded, a participant receives voting and dividend rights with respect to the shares, but is not able to transfer the shares until the restrictions have lapsed. These awards have a vesting period of three to five years and vest in equal annual installments on the anniversary date of the grant.

A summary of activity for non-vested restricted share awards for the six months ended June 30, 2016 is as follows:


Non-vested Shares	Shares			Weighted-Average Grant-Date Fair Value
Non-vested at December 31, 2015		105,864		$	15.89
Granted		32,480			27.60
Vested		(20,829	)		17.95
Forfeited		(1,916	)		16.00

Non-vested at June 30, 2016		115,599		$	18.80

Compensation expense associated with the restricted share awards is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of June 30, 2016, there was $1,975 of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 3.2 years. The total fair value of shares vested during the six months ended June 30, 2016 and 2015 was $603 and $252, respectively.

NOTE 7—REGULATORY CAPITAL MATTERS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019.

The Basel III rules additionally provide for countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Under the Basel III rules, banks must maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital equal to 2.5% of risk-weighted assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying certain discretionary bonuses. This new capital conservation buffer requirement was phased in beginning January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented at 2.5% in January 2019.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At June 30, 2016, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Management believes, as of June 30, 2016, that the Company and Bank met all capital adequacy requirements to which they are subject. There are no conditions or events since that notification that management believes have changed the institution’s category.

Actual and required capital amounts and ratios are presented below as of June 30, 2016 and December 31, 2015 for the Company and Bank:


	Actual					Required For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2016
Company common equity Tier 1 capital to risk-weighted assets	$	180,200		9.22	%	$	87,937		4.50	%		N/A		N/A
Company Total Capital to risk weighted assets	$	252,765		12.93	%	$	156,333		8.00	%		N/A		N/A
Company Tier 1 (Core) Capital to risk weighted assets	$	180,200		9.22	%	$	117,250		6.00	%		N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	180,200		7.33	%	$	98,349		4.00	%		N/A		N/A
Bank common equity Tier 1 capital to risk-weighted assets	$	236,538		12.10	%	$	87,935		4.50	%	$	127,017		6.50	%
Bank Total Capital to risk weighted assets	$	250,791		12.83	%	$	156,329		8.00	%	$	195,411		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	236,538		12.10	%	$	117,247		6.00	%	$	156,329		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	236,538		9.62	%	$	98,337		4.00	%	$	122,921		5.00	%

December 31, 2015
Company common equity Tier 1 capital to risk-weighted assets	$	167,562		10.08	%	$	74,768		4.50	%		N/A		N/A
Company Total Capital to risk weighted assets	$	186,243		11.21	%	$	132,922		8.00	%		N/A		N/A
Company Tier 1 (Core) Capital to risk weighted assets	$	174,656		10.51	%	$	99,691		6.00	%		N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	174,656		8.48	%	$	82,362		4.00	%		N/A		N/A
Bank common equity Tier 1 capital to risk-weighted assets	$	172,205		10.36	%	$	74,772		4.50	%	$	108,004		6.50	%
Bank Total Capital to risk weighted assets	$	183,792		11.06	%	$	132,928		8.00	%	$	166,160		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	172,205		10.36	%	$	99,696		6.00	%	$	132,928		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	172,205		8.36	%	$	82,357		4.00	%	$	102,946		5.00	%

Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. During 2016 the Bank can declare, without prior approval, dividends of approximately $25,887 plus any 2016 net profits retained to the date of declaration.

NOTE 8—FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. Appraisals for impaired loans are generally obtained annually but may be obtained more frequently based on changing circumstances as part of the aforementioned quarterly evaluation.

Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Foreclosed assets are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the credit administration department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.

Loans Held For Sale: The Company has elected the fair value option for loans held for sale to align with other accounting policies related to mortgage banking, such as mortgage banking derivatives. These loans are typically sold to an investor following loan origination and the fair value of such accounts are readily available based on direct quotes from investors or similar transactions experienced in the secondary loan market. Fair value adjustments, as well as realized gains and losses are recorded in current earnings. Fair value is determined by market prices for similar transactions adjusted for specific attributes of that loan (Level 2).

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:


	Fair Value Measurements at June 30, 2016 Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Securities available for sale
U.S. government sponsored entities and agencies	$	—	$	5,910	$	—
Mortgage-backed securities-residential		—		596,464		—
Mortgage-backed securities-commercial		—		20,006		—
State and political subdivisions		—		54,495		—

Total securities available for sale	$	—	$	676,875	$	—

Loans held for sale	$	—	$	16,808	$	—

Mortgage banking derivatives	$	—	$	729	$	—

Financial Liabilities
Mortgage banking derivatives	$	—	$	180	$	—


	Fair Value Measurements at December 31, 2015 Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Securities available for sale
U.S. government sponsored entities and agencies	$	—	$	6,817	$	—
Mortgage-backed securities-residential		—		500,955		—
Mortgage-backed securities-commercial		—		19,835		—
State and political subdivisions		—		48,231		—

Total securities available for sale	$	—	$	575,838	$	—

Loans held for sale	$	—	$	14,079	$	—

Mortgage banking derivatives	$	—	$	411	$	—

Financial Liabilities
Mortgage banking derivatives	$	—	$	29	$	—

As of June 30, 2016, the unpaid principal balance of loans held for sale was $16,252 resulting in an unrealized gain of $556 included in gains on sale of loans. As of December 31, 2015, the unpaid principal balance of loans held for sale was $13,754, resulting in an unrealized gain of $325 included in gains on sale of loans. For the three months ended June 30, 2016 and 2015, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $194 and ($293), respectively. For the six months ended June 30, 2016 and 2015, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $231 and ($270), respectively. None of these loans were 90 days or more past due or on nonaccrual as of June 30, 2016 and December 31, 2015.

There were no transfers between level 1 and 2 during 2016 or 2015.

Assets measured at fair value on a non-recurring basis are summarized below:

There were no collateral dependent impaired loans carried at fair value as of June 30, 2016 or December 31, 2015. For the three and six months ended June 30, 2016 and 2015, no additional provision for loan losses was recorded related to impaired loans recorded at fair value of collateral.

Foreclosed assets measured at fair value less costs to sell, had a net carrying amount of $200 as of both June 30, 2016 and December 31, 2015. There were no properties at June 30, 2016 or 2015 that had required write-downs to fair value resulting in no write downs for the three and six months ended June 30, 2016 and 2015, respectively.

The carrying amounts and estimated fair values of financial instruments, at June 30, 2016 and December 31, 2015 are as follows:


	Carrying Amount		Fair Value Measurements at June 30, 2016 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	72,050	$	72,050	$	—	$	—	$	72,050
Certificates of deposit held at other financial institutions		1,065		—		1,065		—		1,065
Securities available for sale		676,875		—		676,875		—		676,875
Securities held to maturity		232,656		—		243,594		—		243,594
Loans held for sale		16,808		—		16,808		—		16,808
Net loans		1,536,476		—		—		1,519,781		1,519,781
Restricted equity securities		9,889		n/a		n/a		n/a		n/a
Servicing rights, net		3,491		—		3,673		—		3,673
Accrued interest receivable		8,448		—		4,535		3,913		8,448
Financial liabilities
Deposits	$	2,249,735	$	1,156,860	$	1,095,418	$	—	$	2,252,278
Federal funds purchased and repurchase agreements		36,672		—		36,672		—		36,672
Federal Home Loan Bank advances		52,000		—		52,079		—		52,079
Subordinated notes, net		58,312		—		—		58,107		58,107
Accrued interest payable		1,800		112		989		699		1,800


	Carrying Amount		Fair Value Measurements at December 31, 2015 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	52,394	$	52,394	$	—	$	—	$	52,394
Certificates of deposit held at other financial institutions		250		—		250		—		250
Securities available for sale		575,838		—		575,838		—		575,838
Securities held to maturity		158,200		—		161,969		—		161,969
Loans held for sale		14,079		—		14,079		—		14,079
Net loans		1,292,239		—		—		1,279,849		1,279,849
Restricted equity securities		7,998		n/a		n/a		n/a		n/a
Servicing rights, net		3,455		—		4,635		—		4,635
Accrued interest receivable		7,299		3		3,780		3,516		7,299
Financial liabilities
Deposits	$	1,814,039	$	1,062,587	$	748,961	$	—	$	1,811,548
Federal funds purchased and repurchase agreements		101,086		—		101,086		—		101,086
Federal Home Loan Bank advances		57,000		—		56,931		—		56,931
Accrued interest payable		644		100		544		—		644

The methods and assumptions not previously described used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

(b) Loans: Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(c) Restricted Equity Securities: It is not practical to determine the fair value of Federal Home Loan Bank or Federal Reserve Bank stock due to restrictions placed on its transferability.

(d) Mortgage Servicing Rights: Fair value of mortgage servicing rights is based on valuation models that calculate the present value of estimated net cash flows based on industry market data. The valuation model incorporates assumptions that market participants would use in estimating future net cash flows resulting in a Level 2 classification.

(e) Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of fixed-term money market accounts approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Federal Funds Purchased and Repurchase Agreements: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(g) Federal Home Loan Bank Advances: The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

(h) Subordinated Notes: The fair values of the Company’s subordinated notes are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(i) Accrued Interest Receivable/Payable: The carrying amounts of accrued interest approximate fair value resulting in a Level 1, Level 2 or Level 3 classification based on the asset/liability with which they are associated.

(j) Off-balance Sheet Instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

NOTE 9—EARNINGS PER SHARE

The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. The factors used in the earnings per share computation follow:


	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Basic
Net income available to common shareholders	$	6,999		$	3,109		$	13,209		$	6,216
Less: earnings allocated to participating securities		(80	)		(34	)		(143	)		(73	)

Net income allocated to common shareholders	$	6,919		$	3,075		$	13,066		$	6,143

Weighted average common shares outstanding including participating securities		10,654,351			10,490,972			10,617,328			9,237,574
Less: Participating securities		(121,475	)		(116,103	)		(115,270	)		(109,183	)

Average shares		10,532,876			10,374,869			10,502,058			9,128,391

Basic earnings per common share	$	0.66		$	0.30		$	1.24		$	0.67


	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Diluted
Net income allocated to common shareholders	$	6,919	$	3,075	$	13,066	$	6,143
Weighted average common shares outstanding for basic earnings per common share		10,532,876		10,374,869		10,502,058		9,128,391
Add: Dilutive effects of assumed exercises of stock options		584,005		457,613		571,511		445,611
Add: Dilutive effects of assumed exercises of stock warrants		13,015		12,785		12,721		12,882

Average shares and dilutive potential common shares		11,129,896		10,845,267		11,086,290		9,586,884

Dilutive earnings per common share	$	0.62	$	0.28	$	1.18	$	0.64

For the three months ended June 30, 2016 and 2015, stock options for 243,587 and 147,782 shares of common stock were not considered in computing diluted earnings per common share because they were antidilutive. Stock options for 152,877 and 210,782 shares of common stock were not considered in computing diluted earnings per common share for the six months ended June 30, 2016 and 2015 because they were antidilutive.

NOTE 10—SUBORDINATED DEBT ISSUANCE

On June 30, 2016, Company entered in a Subordinated Note Purchase Agreement (the “Purchase Agreement”) with certain institutional accredited investors (the “Purchasers”) pursuant to which the Company sold and issued $20,000 in aggregate principal amount of 7.00% fixed-to-floating rate subordinated notes due 2026 (the “June 2016 Notes”). The June 2016 Notes have a stated maturity of July 1, 2026, and bear interest at a fixed rate of 7.00% per year, from and including June 30, 2016 through June 30, 2021, computed on the basis of a 360-day year consisting of twelve 30-day months, payable semi-annually in arrears on January 1 and July 1 of each year beginning on January 1, 2017. Beginning July 1, 2021 through the maturity date or an early redemption date, the interest rate shall reset quarterly to an interest rate per year equal to the then current three-month LIBOR rate plus 604 basis points, computed on the basis of a 360-day year and the actual number of days elapsed, payable quarterly in arrears. The June 2016 Notes are redeemable, in whole or in part, on or after July 1, 2021 and at any time upon the occurrence of certain events set forth in the June 2016 Notes. Any early redemption of the March 2016 Notes will be subject to the receipt of the approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to the extent then required under applicable laws or regulations, including capital regulations. There is no sinking fund for the June 2016 Notes.

The June 2016 Notes were offered and sold by the Company to eligible purchasers in a private offering in reliance on the exemption from the registration requirements of Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), and the provisions of Rule 506 of Regulation D thereunder.

The June 2016 Notes are not convertible into, or exchangeable for, any other securities or assets of the Company or any of its subsidiaries and are not subject to redemption at the option of the holder. Prior to July 1, 2021, the Company may redeem the June 2016 Notes, in whole at any time, or in part from time to time, only under certain limited circumstances set forth in the June 2016 Notes. On or after July 1, 2021, the Company may redeem the June 2016 Notes at its option, in whole at any time, or in part on any interest payment date. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding principal amount of the June 2016 Notes being redeemed, together with any accrued and unpaid interest on the June 2016 Notes being redeemed up to the date of redemption.

Principal and interest on the June 2016 Notes are subject to acceleration only in limited circumstances. The June 2016 Notes are unsecured, subordinated obligations of the Company and rank junior in right to payment to the Company’s current and future senior indebtedness and equal with the Company’s previously issued and outstanding Fixed-to-Floating Rate Subordinated Notes due 2026, initially issued in the aggregate principal amount of $40,000 pursuant to that certain Indenture and that certain Supplemental Indenture, each by and between the Company and U.S. Bank National Association, as Trustee, and each dated March 31, 2016.

The June 2016 Notes are unsecured and will rank at least equally with all of the Company’s other unsecured subordinated indebtedness and will be effectively subordinated to all of our secured debt to the extent of the value of the collateral securing such debt. The June 2016 Notes will be subordinated in right of payment to all of our existing and future senior indebtedness, and will rank structurally junior to all existing and future liabilities of our subsidiaries including, in the case of the Bank, its depositors, and any preferred equity holders of our subsidiaries. The holders of the June 2016 Notes may be fully subordinated to interests held by the U.S. government in the event that we enter into a receivership, insolvency, liquidation, or similar proceeding.

The issuance costs related to the June 2016 Notes have not yet been fully determined but have been estimated to be $340 and will be amortized as interest expense over the ten-year term of the June 2016 Notes.

On March 31, 2016, the Company issued $40,000 in aggregate principal amount of fixed-to-floating rate Subordinated Notes due 2026 (the “March 2016 Notes”) in a public offering to accredited institutional investors. The March 2016 Notes will mature on March 30, 2026, unless redeemed prior to that date. The Company may redeem the March 2016 Notes in whole or in part on or after March 30, 2021, and in whole, but not in part, at any time within 90 days following a “Regulatory Capital Treatment Event”, as defined in the First Supplemental Indenture, dated as of March 31, 2016, between the Company and U.S. Bank National Association, as trustee (the “Supplemental Indenture”) governing the March 2016 Notes. The redemption price for any redemption will be 100% of the principal amount of the March 2016 Notes, plus unpaid interest, if any, accrued to but excluding the date of redemption. Any early redemption of the March 2016 Notes will be subject to the receipt of the approval of the Federal Reserve to the extent then required under applicable laws or regulations, including capital regulations. There is no sinking fund for the March 2016 Notes.

The March 2016 Notes initially bear interest at 6.875% per year, payable semi-annually in arrears on March 30 and September 30 of each year, beginning on September 30, 2016, and going through March 29, 2021. Thereafter, the March 2016 Notes will bear interest at an annual floating rate equal to three-month LIBOR as determined for the applicable quarterly period, plus a spread of 5.636%, with interest payable quarterly in arrears on March 30, June 30, September 30 and December 30 of each year, beginning on June 30, 2021.

The March 2016 Notes are unsecured and will rank at least equally with all of the Company’s other unsecured subordinated indebtedness and will be effectively subordinated to all of our secured debt to the extent of the value of the collateral securing such debt. The March 2016 Notes will be subordinated in right of payment to all of our existing and future senior indebtedness, and will rank structurally junior to all existing and future liabilities of our subsidiaries including, in the case of the Bank, its depositors, and any preferred equity holders of our subsidiaries. The holders of the March 2016 Notes may be fully subordinated to interests held by the U.S. government in the event that we enter into a receivership, insolvency, liquidation, or similar proceeding.

The sale of the March 2016 Notes yielded net proceeds of approximately $38,843 after deducting the placement agents’ fees and estimated expenses payable by the Company. The Company used the net proceeds from the offering to pay off a $10 million borrowing that had been used to redeem the shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) issued to the United States Department of the Treasury (“Treasury”) in connection with the Company’s participation in the Small Business Lending Fund and to fund future growth of the Bank.

The issuance costs related to the March 2016 Notes amounted to $1,382 and are being amortized as interest expense over the ten-year term of the March 2016 Notes.

For regulatory capital purposes, the June 2016 Notes and the March 2016 Notes are treated as Tier 2 capital, subject to certain limitations, and are included in total regulatory capital when calculating the Company’s total capital to risk weighted assets ratio as indicated in Note 7 of these consolidated financial statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in the understanding and assessment of significant changes and trends related to the Company’s results of operations and financial condition. This discussion and analysis should be read in conjunction with the accompanying unaudited financial statements, the audited financial statements and accompanying notes included in the Company’s Form 10-K filed with the SEC on March 15, 2016, which includes additional information about critical accounting policies and practices and risk factors, and Item 1A of Part II of this report, which updates those risk factors. Historical results and trends that might appear in the consolidated financial statements should not be interpreted as being indicative of future operations. All amounts are in thousands, except per share data or unless otherwise indicated.

Company Overview

We are a financial holding company headquartered in Franklin, Tennessee. Through our wholly-owned bank subsidiary, Franklin Synergy Bank, a Tennessee-chartered commercial bank and a member of the Federal Reserve System, we provide a full range of banking and related financial services with a focus on service to small businesses, corporate entities, local governments and individuals. We operate through 12 branches and one loan production office in the demographically attractive and growing Williamson, Rutherford and Davidson Counties within the Nashville metropolitan statistical area. As used in this report, unless the context otherwise indicates, any reference to “Franklin Financial,” “our Company,” “the Company,” “us,” “we” and “our” refers to Franklin Financial Network, Inc. together with its consolidated subsidiaries (including Franklin Synergy Bank), any reference to “FFN” refers to Franklin Financial Network, Inc. only and any reference to “Franklin Synergy” or the “Bank” refers to our banking subsidiary, Franklin Synergy Bank.

Critical Accounting Policies

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

The Company’s accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the notes to the consolidated financial statements in Form 10-K that was filed on March 15, 2016. The critical accounting policies require judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. Management has established policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief summary of the more significant policies.

Purchased Loans

The Company maintains an allowance for loan losses on purchased loans based on credit deterioration subsequent to the acquisition date. In accordance with the accounting guidance for business combinations, because we recorded all acquired loans at fair value as of the date of the acquisition. For purchased credit-impaired loans accounted for under ASC 310-30, management establishes an allowance for loan losses subsequent to the date of acquisition by re-estimating expected cash flows on these loans on a quarterly basis, with any decline in expected cash flows due to credit triggering impairment recorded as provision for loan losses. The allowance established is the excess of the loan’s carrying value over the present value of projected future cash flows, discounted at the current accounting yield of the loan. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. While the determination of specific cash flows involves estimates, each estimate is unique to the individual loan, and none is individually significant. For non-purchased credit-impaired loans acquired and that are accounted for under ASC 310-20, the historical loss estimates are based on the historical losses experienced by the Company for loans with similar characteristics as those acquired other than purchased credit-impaired loans.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.

Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

All loans classified by management as substandard or worse are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank’s loss history and loss history from the Bank’s peer group over the past three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

Mortgage Servicing Rights

When loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gain on sale of loans. Fair value is based on market prices for comparable servicing contracts. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported with loan servicing fees on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Servicing fee income, which is reported on the income statement as loan servicing fees, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against mortgage loan servicing fee income.

Recent Accounting Pronouncements

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” 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 impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods 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, (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 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, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to securities available-for-sale. ASU 2016-01 will be effective for the Company on January 1, 2018 and is not expected to have a significant impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective for us on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Management is currently evaluating the potential impact of ASU 2016-02 on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 will be effective on January 1, 2017, and early adoption is allowed. The Company has not yet elected to adopt this ASU early, but management has considered early adoption. Had the Company adopted ASU 2016-09 during the quarter ended June 30, 2016, the impact to earnings would have been a decrease in income tax expense of approximately $509 for both the three and six months ended June 30, 2016, and the impact to diluted earnings per share would have been increases of $0.04 per share and $0.05 per share for the three and six months ended June 30, 2016, respectively.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326). The amendments in this update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses within this update is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net carrying value at the amount expected to be collected on the financial assets. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount of financial assets. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Off-balance-sheet arrangements such as commitments to extend credit, guarantees, and standby letters of credit that are not considered derivatives under ASC 815 and are not unconditionally cancellable are also within the scope of this amendment. Credit losses relating to available-for-sale debt securities should be recorded

through an allowance for credit losses. For public companies, the update is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in this update earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in this update on a modified retrospective basis, through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED

JUNE 30, 2016 AND 2015

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $6,999 and $13,232 for the three and six months ended June 30, 2016, respectively, compared to $3,134 and $6,266 for the three and six months ended June 30, 2015. After the payment of preferred dividends on the shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) issued to the United States Department of the Treasury (“Treasury”) pursuant to the Small Business Lending Fund (“SBLF”), the Company’s net earnings available to common shareholders for the three and six months ended June 30, 2016 was $6,999 and $13,209, respectively, compared to $3,109 and $6,216 for the three and six months ended June 30, 2015. The primary reason for the increase in net earnings available to common shareholders for the three and six months ended June 30, 2016 was increased interest income on loans and investment securities compared with the same periods in 2015. The increase in loans was due to significant organic growth. The growth in the securities portfolio is primarily attributable to the capital leverage programs implemented during the second quarter of 2016 to utilize proceeds received from the issuance of subordinated notes at the end of the March 2016.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets less interest expense paid on interest-bearing liabilities and is the most significant component of our revenues. Net interest income for the three and six months ended June 30, 2016, totaled $19,934 and $39,210, respectively, compared to $13,327 and $25,484 for the same periods in 2015, an increase of $6,607 and $13,726, or 49.6% and 53.9%, between the respective periods. For the three and six months ended June 30, 2016, interest income increased $8,873 and $17,508, or 57.6% and 59.7%, respectively, due to growth in both the loan and investment securities portfolios. For the three and six months ended June 30, 2016, interest expense increased $2,266 and $3,782, or 108.6% and 98.1%, respectively, as a result of increases in interest-bearing deposits, FHLB advances and subordinated notes.

Interest-earning assets averaged $2,404,060 and $1,524,082 during the three months ended June 30, 2016 and 2015, respectively, an increase of $879,978, or 57.7%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 64.6%, and investment securities increased 52.2%, when comparing the three months ended June 30, 2016 with the same period in 2015. When comparing the three months ended June 30, 2016 and 2015, the yield on average interest earning assets, adjusted for tax equivalent yield increased 14 basis points to 4.20% compared to 4.06% for the same period during 2015. For the three months ended June 30, 2016, the tax equivalent yield on available for sale securities was 2.48%, and for the three months ended June 30, 2015, the yield on available for sale securities was 2.19%. For the three months ended June 30, 2016, the tax equivalent yield on held to maturity securities was 3.94%, and for the three months ended June 30, 2015, the yield on held to maturity securities was 2.77%. The primary driver for the increase in yields on securities for the three- and six-month period ended June 30, 2016 was the volume of tax-exempt municipal securities purchased during the past 12 months, which increased tax equivalent yields when comparing the three- and six-month periods in 2016 with the same periods in 2015.

Interest-bearing liabilities averaged $2,065,486 during the three months ended June 30, 2016, compared to $1,246,732 for the same period in 2015, an increase of $818,754, or 65.7%. Total average interest-bearing deposits grew $747,851, including increases in average money market deposits of $194,813 and average time deposits of $522,525 for the three-month period ended June 30, 2016, as compared to the same period during 2015. Rapid growth in the loan portfolio also resulted in increases in average Federal Home Loan Bank (“FHLB”) advances of $34,165 and subordinated notes and other borrowings of $38,973, when comparing the three months ended June 30, 2016 with the same period in 2015.

For the three month periods ended June 30, 2016 and 2015, the cost of average interest-bearing liabilities increased 18 basis points to 0.85% from 0.67%. The increase was primarily due to increases in the cost of funds for FHLB advances and subordinated notes and other borrowings.

Interest-earning assets averaged $2,290,583 and $1,438,195 during the six months ended June 30, 2016 and 2015, respectively, an increase of $852,388, or 59.3%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past

year. Average loans increased 63.0%, and investment securities increased 56.6%, when comparing the six months ended June 30, 2016 with the same period in 2015. When comparing the six months ended June 30, 2016 and 2015, the yield on average interest earning assets, adjusted for tax equivalent yield increased 14 basis points to 4.25% compared to 4.11% for the same period during 2015. For the six months ended June 30, 2016, the tax equivalent yield on available for sale securities was 2.52%, and for the six months ended June 30, 2015, the yield on available for sale securities was 2.24%. For the six months ended June 30, 2016, the tax equivalent yield on held to maturity securities was 4.03%, and for the six months ended June 30, 2015, the yield on held to maturity securities was 2.79%. The primary driver for the increase in yields on securities for the three- and six-month period ended June 30, 2016 was the volume of tax-exempt municipal securities purchased during the past 12 months, which increased tax equivalent yields when comparing the three- and six-month periods in 2016 with the same periods in 2015.

Interest-bearing liabilities averaged $1,965,527 during the six months ended June 30, 2016, compared to $1,189,860 for the same period in 2015, an increase of $775,667, or 65.2%. Total average interest-bearing deposits grew $717,371, including increases in money market deposits of $184,775 and average time deposits of $493,194 for the six-month period ended June 30, 2016, as compared to the same period during 2015. Rapid growth in the loan portfolio also resulted in increases in average FHLB advances of $33,947 and subordinated notes and other borrowings of $20,039, when comparing the six months ended June 30, 2016 with the same period in 2015.

For the six month periods ended June 30, 2016 and 2015, the cost of average interest-bearing liabilities increased 13 basis points to 0.78% from 0.65%. The increase was primarily due to increase in the cost of funds from subordinated notes and other borrowings.

The tables below summarize average balances, annualized yields and rates, cost of funds, and the analysis of changes in interest income and interest expense for the three and six months ended June 30, 2016 and 2015:

Average Balances—Yields & Rates(7)

(Dollars are in thousands)


	Three Months Ended June 30,
	2016								2015
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans (1)(6)	$	1,497,556		$	18,955		5.09	%	$	909,705		$	12,173		5.37	%
Securities available for sale (6)		662,867			4,087		2.48	%		512,152			2,790		2.19	%
Securities held to maturity		190,718			1,868		3.94	%		48,676			336		2.77	%
Certificates of deposit at other financial institutions		1,065			4		1.51	%		250			2		3.21	%
Federal funds sold and other (2)		51,854			170		1.32	%		53,299			112		0.84	%

TOTAL INTEREST EARNING ASSETS	$	2,404,060		$	25,084		4.20	%	$	1,524,082		$	15,413		4.06	%
Allowance for loan losses		(13,049	)							(7,483	)
All other assets		82,475								73,183

TOTAL ASSETS	$	2,473,486							$	1,589,782
LIABILITIES & SHAREHOLDERS’ EQUITY
Deposits:
Interest checking	$	280,961		$	271		0.39	%	$	265,844		$	261		0.39	%
Money market		637,922			941		0.59	%		443,085			630		0.57	%
Savings		48,866			39		0.32	%		33,471			38		0.46	%
Time deposits		924,837			2,107		0.92	%		402,335			984		0.98	%
Federal Home Loan Bank advances		82,330			187		0.91	%		48,165			81		0.67	%
Federal funds purchased and other (3)		51,897			82		0.64	%		53,832			92		0.69	%
Subordinated Notes and other borrowings		38,973			725		7.48	%		—			—		—	%

TOTAL INTEREST BEARING LIABILITIES	$	2,065,486		$	4,352		0.85	%	$	1,246,732		$	2,086		0.67	%


	Three Months Ended June 30,
	2016							2015
	Average Balance		Interest Inc / Exp		Average Yield / Rate			Average Balance		Interest Inc / Exp		Average Yield / Rate
Demand deposits		200,849							157,511
Other liabilities		12,766							5,937
Total shareholders’ equity		194,385							179,602

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,473,486						$	1,589,782
NET INTEREST SPREAD (4)						3.35	%						3.39	%
NET INTEREST INCOME			$	20,732						$	13,327
NET INTEREST MARGIN (5)						3.47	%						3.51	%


	Six Months Ended June 30,
	2016								2015
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans (1)(6)	$	1,431,012		$	36,714		5.16	%	$	877,749		$	23,327		5.36	%
Securities available for sale (6)		625,876			7,833		2.52	%		460,458			5,111		2.24	%
Securities held to maturity		174,278			3,496		4.03	%		50,584			700		2.79	%
Certificates of deposit at other financial institutions		655			7		2.15	%		250			3		2.42	%
Federal funds sold and other (2)		58,762			336		1.15	%		49,154			198		0.81	%

TOTAL INTEREST EARNING ASSETS	$	2,290,583		$	48,386		4.25	%	$	1,438,195		$	29,339		4.11	%
Allowance for loan losses		(12,508	)							(7,262	)
All other assets		82,481								71,276

TOTAL ASSETS	$	2,360,556							$	1,502,209
LIABILITIES & SHAREHOLDERS’ EQUITY
Deposits:
Interest checking	$	307,513		$	597		0.39	%	$	283,398		$	435		0.31	%
Money market		603,503			1,810		0.60	%		418,719			1,215		0.59	%
Savings		47,338			81		0.34	%		32,051			73		0.46	%
Time deposits		864,778			3,947		0.92	%		371,593			1,823		0.99	%
Federal Home Loan Bank advances		69,665			296		0.85	%		35,718			146		0.82	%
Federal funds purchased and other (3)		52,691			168		0.64	%		48,381			163		0.68	%
Subordinated Notes and other borrowings		20,039			738		7.41	%		—			—		—	%

TOTAL INTEREST BEARING LIABILITIES	$	1,965,527		$	7,637		0.78	%	$	1,189,860		$	3,855		0.65	%
Demand deposits		189,149								153,827
Other liabilities		11,499								5,919
Total shareholders’ equity		194,381								152,603

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,360,556							$	1,502,209
NET INTEREST SPREAD (4)							3.47	%							3.46	%
NET INTEREST INCOME				$	40,749							$	25,484
NET INTEREST MARGIN (5)							3.58	%							3.57	%

(1)	Loan balances include both loans held in the Bank’s portfolio and mortgage loans held for sale and are net of deferred origination fees and costs. Non-accrual loans are included in total loan balances.

(2)	Includes federal funds sold, capital stock in the Federal Reserve Bank and Federal Home Loan Bank, and interest-bearing deposits at the Federal Reserve Bank.

(3)	Includes repurchase agreements.

(4)	Represents the average rate earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.

(5)	Represents net interest income (annualized) divided by total average earning assets.

(6)	Interest income and rates for 2015 exclude the effects of a tax-equivalent adjustment to adjust tax exempt investment income on tax exempt investment securities to a fully taxable basis due to immateriality.

(7)	Averages balances are average daily balances. Yields and rates are annualized.

The tables below detail the components of the changes in net interest income for the periods indicated. For each major category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.

Analysis of Changes in Interest Income and Expenses


	Net change three months ended June 30, 2016 versus June 30, 2015
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	7,825		$	(1,043	)	$	6,782
Securities available for sale		819			478			1,297
Securities held to maturity		977			555			1,532
Certificates of deposit at other financial institutions		7			(5	)		2
Federal funds sold and other		(4	)		62			58

TOTAL INTEREST INCOME	$	9,624		$	47		$	9,671

INTEREST EXPENSE
Deposits
Interest checking	$	10		$	—		$	10
Money market accounts		279			32			311
Savings		18			(17	)		1
Time deposits		1,261			(138	)		1,123
Federal Home Loan Bank advances		57			49			106
Other borrowed funds		(4	)		(6	)		(10	)
Subordinated Notes and other borrowings		725			—			725

TOTAL INTEREST EXPENSE	$	2,346		$	(80	)	$	2,266

NET INTEREST INCOME	$	7,278		$	127		$	7,405


	Net change six months ended June 30, 2016 versus June 30, 2015
	Volume		Rate			Net Change
INTEREST INCOME
Loans	$	14,810	$	(1,423	)	$	13,387
Securities available for sale		1,851		871			2,722
Securities held to maturity		1,721		1,075			2,796
Certificates of deposit at other financial institutions		5		(1	)		4
Federal funds sold and other		39		99			138

TOTAL INTEREST INCOME	$	18,426	$	621		$	19,047

INTEREST EXPENSE
Deposits
Interest checking	$	40	$	122		$	162
Money market accounts		565		30			595
Savings		36		(28	)		8
Time deposits		2,425		(301	)		2,124
Federal Home Loan Bank advances		140		10			150
Other borrowed funds		15		(10	)		5
Subordinated notes and other borrowings		738		—			738

TOTAL INTEREST EXPENSE	$	3,959	$	(177	)	$	3,782

NET INTEREST INCOME	$	14,467	$	798		$	15,265

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, should be adequate to provide coverage for probable losses incurred in the loan portfolio. The allowance is increased by the provision for loan losses and is decreased by charge-offs, net of recoveries on prior loan charge-offs.

The provision for loan losses was $1,567 and $805 for the three months ended June 30, 2016 and 2015, respectively, and $2,703 and $1,430 for the six months ended June 30, 2016 and 2015, respectively. The higher provision for the three and six months ended June 30, 2016 compared to the same periods in 2015 is due primarily to the Company’s loan growth during the three and six months ended June 30, 2016, compared to the same periods in 2015. Nonperforming loans at June 30, 2016 totaled $1,612 compared to $3,286 at December 31, 2015, representing 0.1% and 0.3% of total loans, respectively.

Non-Interest Income

Non-interest income for the three and six months ended June 30, 2016 was $4,626 and $7,711 compared to $2,851 and $6,066 for the same periods in 2015. The following is a summary of the components of non-interest income (in thousands):


	Three Months Ended June 30,					$ Increase (Decrease)			% Increase (Decrease)
	2016			2015		$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	46		$	18	$	28			155.6	%
Other service charges and fees		767			690		77			11.2	%
Net gains on sale of loans		2,309			1,463		846			57.8	%
Wealth management		529			301		228			75.7	%
Loan servicing fees, net		(4	)		60		(64	)		(106.7	%)
Gain on sales and calls of investment securities, net		795			109		686			629.4	%
Net gain on foreclosed assets		3			21		(18	)		(85.7	%)
Other		181			189		(8	)		(4.2	%)

Total non-interest income	$	4,626		$	2,851	$	1,775			62.3	%


	Six Months Ended June 30,				$ Increase (Decrease)			% Increase (Decrease)
	2016		2015		$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	95	$	34	$	61			179.4	%
Other service charges and fees		1,400		1,308		92			7.0	%
Net gains on sale of loans		3,917		3,110		807			25.9	%
Wealth management		897		587		310			52.8	%
Loan servicing fees, net		38		103		(65	)		(63.1	%)
Gain on sales and calls of investment securities, net		1,105		524		581			110.9	%
Net gain on foreclosed assets		6		27		(21	)		(77.8	%)
Other		253		373		(120	)		(32.2	%)

Total non-interest income	$	7,711	$	6,066	$	1,645			27.1	%

Service charges on deposit accounts for the three and six months ended June 30, 2016 increased $28 and $61, or 155.6% and 179.4%, from the same periods in 2015 due to changes made to the Company’s schedule of service charges and due to the reduction of the amount of service charges waived during 2016.

Net gain on sale of loans increased $846 and $807, or 57.8% and 25.9%, when comparing the three and six months ended June 30, 2016 to the same periods in 2015. The increase in both periods was primarily due to favorable mark-to-market pricing on mortgage loan derivatives, which is a component of net gains on sale of loans.

Wealth management income for the three and six months ended June 30, 2016 increased $228 and $310, or 75.7% and 52.8%, in comparison with the same periods in 2015. The increase was attributed to the growth in the client base and the assets under management in the wealth management division, as well as some improvement in the stock markets.

Net gain on sale of investment securities increased $686 and $581, or 629.4% and 110.9%, when comparing the three and six months ended June 30, 2016 with the same periods in 2015. The increase was primarily due to the gains on securities that were

recognized in the second quarter of 2016, which were related to management selling a number of smaller securities, to consolidate the number of securities carried in the portfolio, and selling securities of two municipalities whose credit rating had fallen below management’s credit score limit.

Other non-interest income decreased by $8 and $120, or 4.2% and 32.2%, when comparing three and six months ended June 30, 2016 with the same periods 2015. The decrease for the six months ended June 30, 2016 is primarily attributed to the loss of $98 recorded on the sale of the Company’s real estate in downtown Murfreesboro, Tennessee during first quarter 2016. That compares with a gain of $15 being recorded in first six months of 2015 on the sale of three of the Company’s branch locations in Rutherford County, Tennessee.

Non-Interest Expense

Non-interest expense for the three and six months ended June 30, 2016 was $12,913 and $24,744, compared to $10,572 and $20,193 for the same periods in 2015. The increases were the result of the following components listed in the table below (in thousands):


	Three Months Ended June 30,				$ Increase (Decrease)			% Increase (Decrease)
	2016		2015		$ Increase (Decrease)			% Increase (Decrease)
Salaries and employee benefits	$	7,603	$	6,071	$	1,532			25.2	%
Occupancy and equipment		1,755		1,699		56			3.3	%
FDIC assessment expense		405		216		189			87.5	%
Marketing		188		198		(10	)		(5.1	%)
Professional fees		977		507		470			92.7	%
Amortization of core deposit intangible		144		167		(23	)		(13.8	%)
Indirect expenses related to public offering		—		309		(309	)		(100.0	%)
Other

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