Franklin Financial Network Inc. - FORM 10-Q

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

Attached files

Attached files

Franklin Financial Network Inc. Reports

file	filename
EX-32 - EX-32 - Franklin Financial Network Inc.	d267679dex32.htm
EX-31.2 - EX-31.2 - Franklin Financial Network Inc.	d267679dex312.htm
EX-31.1 - EX-31.1 - Franklin Financial Network Inc.	d267679dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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 ☒

The number of shares outstanding of the registrant’s common stock, no par value per share, as of October 31, 2016, was 10,758,458.

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 Statements 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			27
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)


	September 30, 2016			December 31, 2015
	*(Unaudited)*
ASSETS
Cash and due from financial institutions	$	55,749		$	52,394
Certificates of deposit at other financial institutions		1,055			250
Securities available for sale		670,756			575,838
Securities held to maturity (fair value 2016—$243,946 and 2015—$161,969)		235,050			158,200
Loans held for sale, at fair value		26,819			14,079
Loans		1,654,058			1,303,826
Allowance for loan losses		(15,590	)		(11,587	)

Net loans		1,638,468			1,292,239

Restricted equity securities, at cost		11,829			7,998
Premises and equipment, net		8,796			7,640
Accrued interest receivable		7,871			7,299
Bank owned life insurance		23,105			22,619
Deferred tax asset		5,590			9,430
Assets held for sale		—			1,640
Foreclosed assets		—			200
Servicing rights, net		3,566			3,455
Goodwill		9,124			9,124
Core deposit intangible, net		1,612			2,043
Other assets		3,805			3,344

Total assets	$	2,703,195		$	2,167,792

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	232,118		$	176,742
Interest bearing		1,985,836			1,637,297

Total deposits		2,217,954			1,814,039
Federal funds purchased and repurchase agreements		45,843			101,086
Federal Home Loan Bank advances		162,000			57,000
Subordinated notes, net of issuance costs		58,292			—
Accrued interest payable		1,399			644
Other liabilities		8,063			6,207

Total liabilities		2,493,551			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 September 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; 10,757,483 and 10,571,377 shares issued and outstanding at September 30, 2016 and December 31 2015, respectively		150,852			147,784
Retained earnings		51,591			31,352
Accumulated other comprehensive income (loss)		7,201			(320	)

Total shareholders’ equity		209,644			188,816

Total liabilities and shareholders’ equity	$	2,703,195		$	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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Interest income and dividends
Loans, including fees	$	20,192		$	14,744		$	56,864		$	38,071
Securities:
Taxable		3,889			3,462			11,402			9,084
Tax-exempt		1,457			966			3,776			1,155
Dividends on restricted equity securities		133			100			354			250
Federal funds sold and other		53			29			175			80

Total interest income		25,724			19,301			72,571			48,640

Interest expense
Deposits		3,683			2,417			10,118			5,963
Federal funds purchased and repurchase agreements		69			69			237			232
Federal Home Loan Bank advances		215			79			511			225
Subordinated notes and other borrowings		1,082			—			1,820			—

Total interest expense		5,049			2,565			12,686			6,420

Net interest income		20,675			16,736			59,885			42,220
Provision for loan losses		1,392			1,724			4,095			3,154

Net interest income after provision for loan losses		19,283			15,012			55,790			39,066

Noninterest income
Service charges on deposit accounts		44			44			139			78
Other service charges and fees		845			679			2,245			1,987
Net gains on sale of loans		2,942			2,463			6,859			5,573
Wealth management		446			327			1,343			914
Loan servicing fees, net		(40	)		84			(2	)		187
Gain on sale or call of securities		430			5			1,535			529
Net gain on sale of foreclosed assets		30			3			36			30
Other		179			193			432			566

Total noninterest income		4,876			3,798			12,587			9,864

Noninterest expense
Salaries and employee benefits		7,979			6,208			22,099			17,960
Occupancy and equipment		2,001			1,683			5,563			4,961
FDIC assessment expense		570			362			1,388			792
Marketing		206			277			611			695
Professional fees		935			516			3,006			1,382
Amortization of core deposit intangible		138			160			431			499
Indirect expenses related to public offering		—			—			—			314
Other		1,879			1,647			5,354			4,443

Total noninterest expense		13,708			10,853			38,452			31,046

Income before income tax expense		10,451			7,957			29,925			17,884
Income tax expense		3,421			2,807			9,663			6,468

Net income		7,030			5,150			20,262			11,416
Dividends paid on Series A preferred stock		—			(25	)		(23	)		(75	)

Net income available to common shareholders	$	7,030		$	5,125		$	20,239		$	11,341

Earnings per share:
Basic	$	0.66		$	0.49		$	1.90		$	1.17
Diluted		0.62			0.46			1.80			1.12

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and Nine Months Ended September 30, 2016 and 2015

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

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net income	$	7,030		$	5,150		$	20,262		$	11,416
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gain (loss) arising during the period		(3,664	)		7,871			13,910			4,006
Reclassification adjustment for gains included in net income		(430	)		(5	)		(1,535	)		(529	)

Net unrealized gains (losses)		(4,094	)		7,866			12,375			3,477
Tax effect		1,606			(3,090	)		(4,854	)		(1,401	)

Total other comprehensive income (loss)		(2,488	)		4,776			7,521			2,076

Comprehensive income	$	4,542		$	9,926		$	27,783		$	13,492

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine Months Ended September 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		—			80,331			780			—			—			780
Exercise of common stock warrants		—			4,970			60			—			—			60
Dividends paid on Series A preferred stock		—			—			—			(75	)		—			(75	)
Issuance of restricted stock, net of forfeitures		—			28,229			—			—			—			—
Stock based compensation expense, net of restricted share forfeitures		—			—			619			—			—			619
Stock issued related to initial public offering, net of stock issuance costs		—			2,640,000			50,423			—			—			50,423
Stock issued (divestment) in conjunction with 401(k) employer match, net of distributions		—			14,689			365			—			—			365
Excess tax benefit from exercise of stock options		—			—			147			—			—			147
Net income		—			—			—			11,416			—			11,416
Other comprehensive income		—			—			—			—		$	2,076			2,076

Balance at September 30, 2015	$	10,000			10,524,630		$	146,645		$	26,713		$	4,252		$	187,610

Balance at December 31, 2015	$	10,000			10,571,377		$	147,784		$	31,352		$	(320	)	$	188,816
Exercise of common stock options, net		—			152,003			1,357									1,357
Exercise of common stock warrants		—			6,575			79									79
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		—			34,480			1,201			—			—			1,201
Stock issued (divestment) in conjunction with 401(k) employer match, net of distributions		—			(6,952	)		(185	)		—			—			(185	)
Excess tax benefit from restricted stock vesting		—			—			94			—			—			94
Excess tax benefit from exercise of stock options		—			—			522			—			—			522
Net income		—			—			—			20,262			—			20,262
Other comprehensive income		—			—			—			—			7,521			7,521

Balance at September 30, 2016	$	—			10,757,483		$	150,852		$	51,591		$	7,201		$	209,644

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)


	Nine Months Ended September 30,
	2016			2015
Cash flows from operating activities
Net income	$	20,262		$	11,416
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization on premises and equipment		986			996
Accretion of purchase accounting adjustments		(488	)		(1,551	)
Net amortization of securities		5,428			3,426
Amortization of loan servicing right asset		905			644
Amortization of core deposit intangible		431			499
Amortization of debt issuance costs		79			—
Provision for loan losses		4,095			3,154
Deferred income tax benefit		(1,015	)		(567	)
Origination of loans held for sale		(260,598	)		(236,831	)
Proceeds from sale of loans held for sale		253,701			245,194
Net gain on sale of loans		(6,859	)		(5,573	)
Gain on sale of available for sale securities		(1,535	)		(380	)
Gain on call of held to maturity securities		—			(149	)
Income from bank owned life insurance		(486	)		(444	)
Net gain on foreclosed assets		(36	)		(30	)
Loss on sale of assets held for sale		98			—
Stock-based compensation		1,201			619
Compensation expense related to common stock issued to 401(k) plan		404			356
Deferred gain on sale of loans		(46	)		(27	)
Net change in:
Accrued interest receivable and other assets		(1,033	)		(3,986	)
Accrued interest payable and other liabilities		2,261			2,190

Net cash from operating activities		17,755			18,956
Cash flows from investing activities
Securities available for sale :
Sales		74,203			52,064
Purchases		(223,432	)		(467,067	)
Maturities, prepayments and calls		64,502			187,222
Securities held to maturity :
Purchases		(92,646	)		(88,550	)
Maturities, prepayments and calls		14,088			9,394
Net change in loans		(349,944	)		(335,238	)
Purchase of bank owned life insurance		—			(10,344	)
Proceeds from sale of assets held for sale		1,542			4,080
Purchase of restricted equity securities		(3,831	)		(2,342	)
Proceeds from sale of foreclosed assets		336			531
Purchases of premises and equipment, net		(2,142	)		(692	)
Increase in certificates of deposits at other financial institutions		(805	)		—

Net cash from investing activities		(518,129	)		(650,942	)
Cash flows from financing activities
Increase in deposits		403,915			542,422
Decrease in federal funds purchased and repurchase agreements		(55,243	)		(1,460	)
Proceeds from Federal Home Loan Bank advances		305,000			157,000
Repayment of Federal Home Loan Bank advances		(200,000	)		(119,000	)
Proceeds from other borrowings		10,000			—
Repayment of other borrowings		(10,000	)		—
Proceeds from issuance of subordinated notes, net of issuance costs		58,213			—
Proceeds from exercise of common stock warrants		79			60
Proceeds from exercise of common stock options, including excess tax benefit		1,879			927
Excess tax benefit from restricted stock vesting		94			—
Proceeds from issuance of common stock, net of offering costs		—			50,423
Divestment of common stock issued to 401(k) plan		(185	)		—
Redemption of Series A preferred stock		(10,000	)		—
Dividends paid on preferred stock		(23	)		(75	)

Net cash from financing activities		503,729			630,297

Net change in cash and cash equivalents		3,355			(1,689	)
Cash and cash equivalents at beginning of period		52,394			49,347

Cash and cash equivalents at end of period	$	55,749		$	47,658

Supplemental information:
Interest paid	$	11,931		$	6,254
Income taxes paid		9,650			6,339

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 September 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
September 30, 2016
U.S. government sponsored entities and agencies	$	3,000	$	138	$	—		$	3,138
Mortgage-backed securities: residential		546,805		10,346		(354	)		556,797
Mortgage-backed securities: commercial		19,526		233		—			19,759
State and political subdivisions		89,576		1,820		(334	)		91,062

Total	$	658,907	$	12,537	$	(688	)	$	670,756


	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 September 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
September 30, 2016
U.S. government sponsored entities and agencies	$	203	$	7	$	—		$	210
Mortgage backed securities: residential		112,071		1,014		(124	)		112,961
State and political subdivisions		122,776		7,999		—			130,775

Total	$	235,050	$	9,020	$	(124	)	$	243,946


	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 September 30,					Nine Months Ended September 30,
	2016		2015			2016			2015
Proceeds	$	11,939	$	19,776		$	74,203		$	54,064
Gross gains		430	$	95			1,920			485
Gross losses		—		(90	)		(385	)		(105	)

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 September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Proceeds	$	—		—	$	—	$	2,300
Gross gains		—		—		—		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.


	September 30, 2016
	Amortized Cost		Fair Value
Available for sale
Over one year through five years	$	3,000	$	3,138
Over ten years		89,576		91,062
Mortgage-backed securities: residential		546,805		556,797
Mortgage-backed securities: commercial		19,526		19,759

Total	$	658,907	$	670,756

Held to maturity
Over one year through five years	$	706	$	750
Over five years through ten years		5,073		5,351
Over ten years		117,200		124,884
Mortgage-backed securities: residential		112,071		112,961

Total	$	235,050	$	243,946

Securities pledged at September 30, 2016 and December 31, 2015 had a carrying amount of $742,828 and $595,524, respectively, and were pledged to secure public deposits and repurchase agreements.

At September 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 September 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
September 30, 2016
Available for sale
Mortgage-backed securities: residential	$	36,585	$	(269	)	$	13,659	$	(85	)	$	50,244	$	(354	)
State and political subdivisions		43,314		(334	)		—		—			43,314		(334	)

Total available for sale	$	79,899	$	(603	)	$	13,659	$	(85	)	$	93,558	$	(688	)


	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	$	19,200	$	(54	)	$	3,826	$	(70	)	$	23,026	$	(124	)

Total held to maturity	$	19,200	$	(54	)	$	3,826	$	(70	)	$	23,026	$	(124	)


	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 and unrecognized 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 September 30, 2016 and December 31, 2015 were as follows:


	September 30, 2016			December 31, 2015
Loans that are not PCI loans
Construction and land development	$	474,255		$	372,767
Commercial real estate:
Nonfarm, nonresidential		403,382			353,268
Other		26,866			10,955
Residential real estate:
Closed-end 1-4 family		228,672			162,933
Other		142,374			112,001
Commercial and industrial		372,784			283,888
Consumer and other		3,458			6,577

Loans before net deferred loan fees		1,651,791			1,302,389
Deferred loan fees, net		(820	)		(2,476	)

Total loans that are not PCI loans		1,650,971			1,299,913

PCI loans
Construction and land development	$	81		$	78
Commercial real estate:
Nonfarm, nonresidential		576			1,460
Other		—			—
Residential real estate:
Closed-end 1-4 family		497			562
Other		—			1
Commercial and industrial		1,933			1,812
Consumer and other		—			—

Total PCI loans		3,087			3,913

Allowance for loan losses		(15,590	)		(11,587	)

Total loans, net of allowance for loan losses	$	1,638,468		$	1,292,239

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


	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Three Months Ended September 30, 2016
Allowance for loan losses:
Beginning balance	$	3,624		$	3,865	$	2,060		$	4,655		$	49		$	14,253
Provision for loan losses		427			43		451			455			16			1,392
Loans charged-off		(11	)		—		(40	)		—			(19	)		(70	)
Recoveries		—			—		13			—			2			15

Total ending allowance balance	$	4,040		$	3,908	$	2,484		$	5,110		$	48		$	15,590

Three Months Ended September 30, 2015
Allowance for loan losses:
Beginning balance	$	2,567		$	2,321	$	1,739		$	1,324		$	65		$	8,016
Provision for loan losses		461			135		(71	)		1,253			(54	)		1,724
Loans charged-off		—			—		(15	)		(15	)		(33	)		(63	)
Recoveries		—			—		6			—			61			67

Total ending allowance balance	$	3,028		$	2,456	$	1,659		$	2,562		$	39		$	9,744

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


	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Nine Months Ended September 30, 2016
Allowance for loan losses:
Beginning balance	$	3,186		$	3,146	$	1,861		$	3,358		$	36		$	11,587
Provision for loan losses		865			762		609			1,817			42			4,095
Loans charged-off		(11	)		—		(39	)		(65	)		(35	)		(150	)
Recoveries		—			—		53			—			5			58

Total ending allowance balance	$	4,040		$	3,908	$	2,484		$	5,110		$	48		$	15,590

Nine Months Ended September 30, 2015
Allowance for loan losses:
Beginning balance	$	2,690		$	1,494	$	1,791		$	650		$	55		$	6,680
Provision for loan losses	$	338			962		(114	)		1,927			41			3,154
Loans charged-off		—			—		(32	)		(15	)		(121	)		(168	)
Recoveries		—			—		14			—			64			78

Total ending allowance balance	$	3,028		$	2,456	$	1,659		$	2,562		$	39		$	9,744

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 September 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
September 30, 2016
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	115	$	—	$	115
Collectively evaluated for impairment		4,040		3,908		2,484		4,995		48		15,475
Purchased credit-impaired loans		—		—		—		—		—		—

Total ending allowance balance	$	4,040	$	3,908	$	2,484	$	5,110	$	48	$	15,590

Loans:
Individually evaluated for impairment	$	—	$	835	$	1,070	$	509	$	—	$	2,414
Collectively evaluated for impairment		474,255		429,413		369,976		372,275		3,458		1,649,377
Purchased credit-impaired loans		81		576		497		1,933		—		3,087

Total ending loans balance	$	474,336	$	430,824	$	371,543	$	374,717	$	3,458	$	1,654,878

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 September 30, 2016 include certain acquired loans. At September 30, 2016, these non-PCI loans had a carrying value of $82,669, comprised of contractually unpaid principal totaling $84,848 and discounts totaling $2,179. Management evaluated these loans for credit deterioration since acquisition and determined that $32 in allowance for loan losses was necessary at September 30, 2016.

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


	Unpaid Principal Balance^*		Recorded Investment		Allowance for Loan Losses Allocated
September 30, 2016
With no allowance recorded:
Commercial real estate:
Nonfarm, nonresidential	$	2,421	$	835	$	—
Residential real estate:
Closed-end 1-4 family		238		238		—
Other		832		832		—
Commercial and industrial		19		19		—
Consumer and other		—		—		—

Subtotal		3,510		1,924		—
With an allowance recorded:
Commercial and industrial		490		490		115

Subtotal		490		490		115

Total	$	4,000	$	2,414	$	115

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


^* Principal balance before partial charge-off.

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


	Three Months Ended September 30,				Nine Months Ended September 30,
Average Recorded Investment	2016		2015		2016		2015
With no allowance recorded:
Construction and land development	$	—	$	—	$	340	$	—
Commercial real estate:
Nonfarm, nonresidential		1,427		918		1,307		873
Residential real estate:
Closed-end 1-4 family		451		33		533		188
Other		837		712		768		317
Commercial and industrial		46		23		110		77
Consumer and other		—		25		10		8

Subtotal		2,761		1,711		3,068		1,463

With an allowance recorded:
Commercial and industrial	$	490	$	90	$	247	$	50
Residential real estate:
Closed-end 1-4 family		70		—		23		—
Consumer and other		—		16		—		10

Subtotal		560		106		270		60

Total	$	3,321	$	1,817	$	3,338	$	1,523

The impact on net interest income for these loans was not material to the Company’s results of operations for the three and nine months ended September 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 September 30, 2016 and December 31, 2015:


	Nonaccrual		Loans Past Due Over 90 Days
September 30, 2016
Construction and land development	$	—	$	149
Commercial real estate:
Nonfarm, nonresidential		835		—
Residential real estate:
Other		123		—
Commercial and industrial		490		—

Total	$	1,448	$	149

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 September 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
September 30, 2016
Construction and land development	$	1,950	$	—	$	149	$	2,099	$	472,156	$	81	$	474,336
Commercial real estate:
Nonfarm, nonresidential		79		—		835		914		402,468		576		403,958
Other		—		—		—		—		26,866		—		26,866
Residential real estate:
Closed-end 1-4 family		11		—		—		11		228,661		497		229,169
Other		714		—		123		837		141,537		—		142,374
Commercial and industrial		521		875		490		1,886		370,898		1,933		374,717
Consumer and other		—		—		—		—		3,458		—		3,458

	$	3,275	$	875	$	1,597	$	5,747	$	1,646,044	$	3,087	$	1,654,878


	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 September 30, 2016 and December 31, 2015:


	Pass		Special Mention		Substandard		Total
September 30, 2016
Construction and land development	$	472,980	$	—	$	1,356	$	474,336
Commercial real estate:
Nonfarm, nonresidential		395,852		1,791		6,315		403,958
Other		26,866		—		—		26,866
Residential real estate:
Closed-end 1-4 family		228,144		—		1,025		229,169
Other		141,305		—		1,069		142,374
Commercial and industrial		368,860		—		5,857		374,717
Consumer and other		3,458		—		—		3,458

	$	1,637,465	$	1,791	$	15,622	$	1,654,878


	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 September 30, 2016 and December 31, 2015.


	Sept 30, 2016			Dec 31, 2015
Contractually required principal and interest	$	4,276		$	5,618
Non-accretable difference		(321	)		(352	)

Cash flows expected to be collected		3,955			5,266
Accretable yield		(868	)		(1,353	)

Carrying value of acquired loans		3,087			3,913
Allowance for loan losses		—			(9	)

Carrying value less allowance for loan losses	$	3,087		$	3,904

Management adjusted estimates of future expected losses, cash flows and renewal assumptions during the quarter ended September 30, 2016. These adjustments resulted in changes in expected cash flows, accretable yield, and the non-accretable difference for the three and nine months ended September 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 September 30, 2016 and 2015.


Activity during the three month period ended September 30, 2016	Jun 30, 2016			Effect of Acquisitions		Income Accretion		All other Adjustments			Sep 30, 2016
Contractually required principal and interest	$	4,462		$	—	$	—	$	(186	)	$	4,276
Non-accretable difference		(319	)		—		—		(2	)		(321	)

Cash flows expected to be collected		4,143			—		—		(188	)		3,955
Accretable yield		(1,067	)		—		115		84			(868	)

Carrying value of acquired loans	$	3,076		$	—	$	115	$	(104	)	$	3,087


Activity during the three month period ended September 30, 2015	Jun 30, 2015			Effect of Acquisitions		Income Accretion		All other Adjustments			Sep 30, 2015
Contractually required principal and interest	$	6,000		$	—	$	—	$	(128	)	$	5,872
Non-accretable difference		(973	)		—		839		(173	)		(307	)

Cash flows expected to be collected		5,027			—		839		(301	)		5,565
Accretable yield		(749	)		—		447		(1,350	)		(1,652	)

Carrying value of acquired loans	$	4,278		$	—	$	1,286	$	(1,651	)	$	3,913

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 nine-month periods ended September 30, 2016 and 2015.


Activity during the nine month period ended September 30, 2016	Dec 31, 2015			Effect of Acquisitions		Income Accretion		All other Adjustments			Sep 30, 2016
Contractually required principal and interest	$	5,618		$	—	$	—	$	(1,342	)	$	4,276
Non-accretable difference		(352	)		—		—		31			(321	)

Cash flows expected to be collected		5,266			—		—		(1,311	)		3,955
Accretable yield		(1,353	)		—		444		41			(868	)

Carrying value of acquired loans	$	3,913		$	—	$	444	$	(1,270	)	$	3,087


Activity during the nine month period ended September 30, 2015	Dec 31, 2014			Effect of Acquisitions		Income Accretion		All other Adjustments			Sep 30, 2015
Contractually required principal and interest	$	6,532		$	—	$	—	$	(660	)	$	5,872
Non-accretable difference		(1,270	)		—		839		124			(307	)

Cash flows expected to be collected		5,262			—		839		(536	)		5,565
Accretable yield		(947	)		—		637		(1,342	)		(1,652	)

Carrying value of acquired loans	$	4,315		$	—	$	1,476	$	(1,878	)	$	3,913

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 September 30, 2016 and December 31, 2015 are as follows:


	September 30, 2016		December 31, 2015
Loan portfolios serviced for:
Federal Home Loan Mortgage Corporation	$	491,466	$	463,952
Other		3,249		4,037

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


	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Loan servicing fees, net:
Loan servicing fees	$	309		$	287		$	903		$	831
Amortization of loan servicing fees		(349	)		(203	)		(905	)		(644	)
Change in impairment		—			—			—			—

Total	$	(40	)	$	84		$	(2	)	$	187

The fair value of servicing rights was estimated by management to be approximately $3,948 at September 30, 2016. Fair value for September 30, 2016 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 14.7%. 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 September 30, 2016 and December 31, 2015, these short-term borrowings totaled $37,343 and $61,261, respectively, and were secured by securities with carrying amounts of $38,333 and $73,478, respectively. At September 30, 2016, all of the Company’s repurchase agreements had one-day maturities.

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


As of September 30, 2016	U.S. Government Sponsored Entities and Agencies Securities			Mortgage- Backed Securities: Residential			State and Political Subdivisions			Total
Fair value of securities pledged	$	210		$	59		$	40,565		$	40,834
Borrowings related to pledged amounts	$	—		$	—		$	37,343		$	37,343
Fair value pledged as a % of borrowings		—	%		—	%		109	%		109	%

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 6,575 and 4,970 warrants exercised during the nine months ended September 30, 2016 and 2015, respectively. A summary of the stock warrant activity for the nine months ended September 30, 2016 and 2015 follows:


	September 30, 2016		September 30, 2015
Stock warrants exercised:
Intrinsic value of warrants exercised	$	136	$	46
Cash received from warrants exercised		79		60

At September 30, 2016, there were 18,732 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 $406 and $248 and $1,201 and $619 for the three and nine months ended September 30, 2016 and 2015, respectively. The total income tax benefit related to vesting of restricted stock and exercises of stock options was $616 and $147 for the nine months ended September 30, 2016 and 2015. The total income tax benefit for the three months ended September 30, 2016 was $107. There was no excess tax benefit from the exercise of stock options for the three months ended September 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 September 30, 2016, there were 2,041,673 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.


	September 30, 2016			September 30, 2015
Risk-free interest rate		1.60	%		1.84	%
Expected term		7.5 years			7.5 years
Expected stock price volatility		30.09	%		25.00	%
Dividend yield		0.24	%		0.22	%

The weighted average fair value of options granted for the nine months ended September 30, 2016 and 2015 were $9.78 and $6.41, respectively.

A summary of the activity in the stock option plans for the nine months ended September 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		272,087			27.99
Exercised		(167,899	)		11.27
Forfeited, expired, or cancelled		(2,415	)		19.43

Outstanding at period end		1,414,564		$	16.12		6.49	$	30,103

Vested or expected to vest		1,343,836		$	16.12		6.49	$	28,598
Exercisable at period end		784,022		$	11.53		4.83	$	20,282


	For the nine months ended September 30,
	2016		2015
Stock options exercised:
Intrinsic value of options exercised	$	3,463	$	839
Cash received from options exercised		1,357		780
Tax benefit realized from option exercises		522		147

As of September 30, 2016, there was $3,583 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 4.1 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 nine months ended September 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		36,396			28.45
Vested		(32,607	)		16.70
Forfeited		(1,916	)		16.00

Non-vested at September 30, 2016		107,737		$	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 September 30, 2016, there was $1,917 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 nine months ended September 30, 2016 and 2015 was $974 and $520, 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 September 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 September 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 September 30, 2016 and December 31, 2015 for the Company and Bank:


	Actual					Required For Capital Adequacy Purposes⁽¹⁾					To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2016
Company common equity Tier 1 capital to risk-weighted assets	$	188,225		9.09	%	$	93,188		4.50	%		N/A		N/A
Company Total Capital to risk weighted assets	$	262,107		12.66	%	$	165,667		8.00	%		N/A		N/A
Company Tier 1 (Core) Capital to risk weighted assets	$	188,225		9.09	%	$	124,250		6.00	%		N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	188,225		7.15	%	$	105,361		4.00	%		N/A		N/A
Bank common equity Tier 1 capital to risk-weighted assets	$	243,995		11.77	%	$	93,314		4.50	%	$	134,787		6.50	%
Bank Total Capital to risk weighted assets	$	259,585		12.52	%	$	165,892		8.00	%	$	207,365		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	243,995		11.77	%	$	124,419		6.00	%	$	165,892		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	243,995		9.26	%	$	105,343		4.00	%	$	131,678		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	%

⁽¹⁾ NOTE: The capital conservation buffer is not included in capital adequacy amounts.

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. The Bank currently may not pay dividends without prior written approval from its primary regulatory agencies.

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 September 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	$	—	$	3,138	$	—
Mortgage-backed securities-residential		—		556,797		—
Mortgage-backed securities-commercial		—		19,759		—
State and political subdivisions		—		91,062		—

Total securities available for sale	$	—	$	670,056	$	—

Loans held for sale	$	—	$	26,819	$	—

Mortgage banking derivatives	$	—	$	858	$	—

Financial Liabilities
Mortgage banking derivatives	$	—	$	87	$	—


	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 September 30, 2016, the unpaid principal balance of loans held for sale was $25,937 resulting in an unrealized gain of $882 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 September 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 $326 and $248, respectively. For the nine months ended September 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 $558 and ($22), respectively. None of these loans were 90 days or more past due or on nonaccrual as of September 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 was one collateral dependent impaired loan carried at fair value as of September 30, 2016 that totaled $375. For the three and nine months ended September 30, 2016 and 2015, $115 and $0 in additional provision for loan losses was recorded related to impaired loans recorded at fair value of collateral. There were no collateral dependent impaired loans carried at fair value as of December 31, 2015.

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

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


	Carrying Amount		Fair Value Measurements at September 30, 2016 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	55,749	$	55,749	$	—	$	—	$	55,749
Certificates of deposit held at other financial institutions		1,055		—		1,055		—		1,055
Securities available for sale		670,756		—		670,756		—		670,756
Securities held to maturity		235,050		—		243,946		—		243,946
Loans held for sale		26,819		—		26,819		—		26,819
Net loans		1,638,468		—		—		1,621,695		1,621,695
Restricted equity securities		11,829		n/a		n/a		n/a		n/a
Servicing rights, net		3,566		—		3,948		—		3,948
Accrued interest receivable		7,871		—		3,634		4,237		7,871
Financial liabilities
Deposits	$	2,217,954	$	1,223,120	$	996,482	$	—	$	2,219,602
Federal funds purchased and repurchase agreements		45,843		—		45,843		—		45,843
Federal Home Loan Bank advances		162,000		—		162,024		—		162,024
Subordinated notes, net		58,292		—		—		61,867		61,867
Accrued interest payable		1,399		123		915		361		1,399


	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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Basic
Net income available to common shareholders	$	7,030		$	5,125		$	20,239		$	11,341
Less: earnings allocated to participating securities		(69	)		(52	)		(213	)		(127	)

Net income allocated to common shareholders	$	6,961		$	5,073		$	20,026		$	11,214

Weighted average common shares outstanding including participating securities		10,721,253			10,516,290			10,652,223			9,668,497
Less: Participating securities		(105,343	)		(107,502	)		(111,937	)		(108,617	)

Average shares		10,615,910			10,408,788			10,540,286			9,559,880

Basic earnings per common share	$	0.66		$	0.49		$	1.90		$	1.17


	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Diluted
Net income allocated to common shareholders	$	6,961	$	5,073	$	20,026	$	11,214
Weighted average common shares outstanding for basic earnings per common share		10,615,910		10,408,788		10,540,286		9,559,880
Add: Dilutive effects of assumed exercises of stock options		612,955		534,148		585,326		466,955
Add: Dilutive effects of assumed exercises of stock warrants		13,370		13,265		12,937		13,257

Average shares and dilutive potential common shares		11,242,235		10,956,201		11,138,549		10,040,092

Dilutive earnings per common share	$	0.62	$	0.46	$	1.80	$	1.12

For the three months ended September 30, 2016 and 2015, stock options for 272,087 and 226,040 shares of common stock were not considered in computing diluted earnings per common share because they were antidilutive. Stock options for 151,544 and 228,691 shares of common stock were not considered in computing diluted earnings per common share for the nine months ended September 30, 2016 and 2015 because they were antidilutive.

NOTE 10—SUBORDINATED NOTES

On March 31, 2016, the Company completed the issuance of $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.

On June 30, 2016, the Company completed the issuance of an additional $20,000 aggregate principal amount of its 7.00% fixed-to-floating rate subordinated notes due 2026 (the “June 2016 Notes”) to certain institutional accredited investors 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 have a stated maturity of July 1, 2026, and bear interest at a fixed rate of 7.00% per year 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 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 were $404 and are being amortized as interest expense over the ten-year term of the June 2016 Notes.

For regulatory capital purposes, the March 2016 Notes and the June 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.

As of September 30, 2016, the Company’s subordinated notes, net of issuance costs, totaled $58,292.

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 the Company’s Form 10-K that was filed with the SEC 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, 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 is considering potential early adoption during the fourth quarter of 2016. Had the Company adopted ASU 2016-09 during the quarter ended September 30, 2016, the impact to earnings would have been a decrease in income tax expense of approximately $183 and $755 for the three and nine months ended September 30, 2016, and the impact to diluted earnings per share would have been increases of $0.01 per share and $0.06 per share for the three and nine months ended September 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.

In August 2016, the FASB issued guidance within ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The amendments in this Update provide guidance on eight specific cash flow issues with the objective of reducing the existing diversity in presentation and classification in the statement of cash flows. The cash flow issues addressed include: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investments; 7) beneficial interest in securitization transactions; and 8) separately identifiable cash flows and the application of the predominance principle. The amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period; however, an entity is required to adopt all of the amendments in the same period. The amendments in this Update require application using a retrospective transition method to each period presented. Management is in currently evaluating the effects that the Update is expected to have on the Company’s Consolidated Statement of Cash Flows and is currently planning to adopt the guidance during the first quarter of 2018.

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

SEPTEMBER 30, 2016 AND 2015

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $7,030 and $20,262 for the three and nine months ended September 30, 2016, respectively, compared to $5,150 and $11,416 for the three and nine months ended September 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 nine months ended September 30, 2016 was $7,030 and $20,239, respectively, compared to $5,125 and $11,341 for the three and nine months ended September 30, 2015. The primary reason for the increase in net earnings available to common shareholders for the three and nine months ended September 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 nine months ended September 30, 2016, totaled $20,675 and $59,885, respectively, compared to $16,736 and $42,220 for the same periods in 2015, an increase of $3,939 and $17,665, or 23.5% and 41.8%, between the respective periods. For the three and nine months ended September 30, 2016, interest income increased $6,423 and $23,931, or 33.3% and 49.2%, respectively, due to growth in both the loan and investment securities portfolios. For the three and nine months ended September 30, 2016, interest expense increased $2,484 and $6,266, or 96.8% and 97.6%, respectively, as a result of increases in interest-bearing deposits, FHLB advances and subordinated notes.

Interest-earning assets averaged $2,576,294 and $1,846,372 during the three months ended September 30, 2016 and 2015, respectively, an increase of $729,922, or 39.5%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 55.1%, and investment securities increased 20.9%, when comparing the three months ended September 30, 2016 with the same period in 2015. When comparing the three months ended September 30, 2016 and 2015, the yield on average interest earning assets, adjusted for tax equivalent yield decreased 17 basis points to 4.12% compared to 4.29% for the same period during 2015. For the three months ended September 30, 2016, the tax equivalent yield on loans was 4.96%, compared with 5.61% tax equivalent yield for same period in 2015. The decrease in yield on loans when comparing these two periods is attributable to the Company’s receiving a full payoff during the third quarter of 2015 on a purchase credit-impaired loan relationship, which resulted in an increase in loan interest income for $1,155 for the three months ended September 30, 2015, of which $785 was a reallocation of unaccretable difference related to the portion of the relationship that had been charged off prior to the Company’s purchase of the relationship. For the three months ended September 30, 2016, the tax equivalent yield on available for sale securities was 2.42%, and for the three months ended September 30, 2015, the yield on available for sale securities was 2.60%. For the three months ended September 30, 2016, the tax equivalent yield on held to maturity securities was 3.75%, and for the three months ended September 30, 2015, the yield on held to maturity securities was 3.37%. The primary driver for the collective increase in yields on securities for the three-month period ended September 30, 2016 was the volume of tax-exempt municipal securities that have been purchased, which increased tax equivalent yields when comparing the three months ended September 30, 2016 with the same period in 2015.

Interest-bearing liabilities averaged $2,201,206 during the three months ended September 30, 2016, compared to $1,550,007 for the same period in 2015, an increase of $651,199, or 42.0%. Total average interest-bearing deposits grew $563,418, which included increases in average money market deposits of $103,244 and average time deposits of $432,061 for the three-month period ended

September 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 $29,783 and subordinated notes and other borrowings of $58,285, when comparing the three months ended September 30, 2016 with the same period in 2015. The growth in FHLB advances is discussed in more detail later in this document in the balance sheet discussion items in the section titled, “Federal Home Loan Bank Advances.”

For the three month periods ended September 30, 2016 and 2015, the cost of average interest-bearing liabilities increased 25 basis points to 0.91% from 0.66%. The increase was primarily due to increases in the cost of funds for FHLB advances and from subordinated notes and other borrowings.

Interest-earning assets averaged $2,427,824 and $1,575,748 during the nine months ended September 30, 2016 and 2015, respectively, an increase of $852,076, or 54.1%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 64.5%, and investment securities increased 41.3%, when comparing the nine months ended September 30, 2016 with the same period in 2015. When comparing the nine months ended September 30, 2016 and 2015, the yield on average interest earning assets, adjusted for tax equivalent yield decreased seven basis points to 4.13% compared to 4.20% for the same period during 2015. For the nine months ended September 30, 2016, the tax equivalent yield on loans was 4.95%, compared with 5.46% tax equivalent yield for the same period in 2015. The decrease in yield on loans when comparing these two periods is primarily attributable to the Company’s receiving a full payoff during the third quarter of 2015 on a purchase credit-impaired loan relationship, which resulted in an increase in loan interest income for $1,155 for the nine months ended September 30, 2015, of which $785 was a reallocation of unaccretable difference related to the portion of the relationship that had been charged off prior to the Company’s purchase of the relationship. For the nine months ended September 30, 2016, the tax equivalent yield on available for sale securities was 2.48%, and for the nine months ended September 30, 2015, the yield on available for sale securities was 2.42%. For the nine months ended September 30, 2016, the tax equivalent yield on held to maturity securities was 3.92%, and for the nine months ended September 30, 2015, the yield on held to maturity securities was 3.10%. The primary driver for the increase in yields on securities for the nine months ended September 30, 2016 was the volume of tax-exempt municipal securities purchased during the past 12 months.

Interest-bearing liabilities averaged $2,044,661 during the nine months ended September 30, 2016, compared to $1,311,229 for the same period in 2015, an increase of $733,432, or 55.9%. Total average interest-bearing deposits grew $665,258, which included increases in money market deposits of $157,287 and average time deposits of $472,321 for the nine-month period ended September 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 $32,522 and subordinated notes and other borrowings of $32,882, when comparing the nine months ended September 30, 2016 with the same period in 2015.

For the nine month periods ended September 30, 2016 and 2015, the cost of average interest-bearing liabilities increased 18 basis points to 0.83% from 0.65%. The increase was primarily due to increase in the cost of funds from FHLB advances and from subordinated notes.

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 nine months ended September 30, 2016 and 2015:

Average Balances—Yields & Rates(7)

(Dollars are in thousands)


	Three Months Ended September 30,
	2016								2015
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans (1)(6)	$	1,620,347		$	20,219		4.96	%	$	1,044,520		$	14,763		5.61	%
Securities available for sale (6)		671,725			4,084		2.42	%		674,991			4,422		2.60	%
Securities held to maturity (6)		233,986			2,203		3.75	%		74,332			632		3.37	%
Certificates of deposit at other financial institutions		941			4		1.69	%		250			2		3.17	%
Federal funds sold and other (2)		49,295			182		1.47	%		52,279			127		0.96	%

TOTAL INTEREST EARNING ASSETS	$	2,576,294		$	26,692		4.12	%	$	1,846,372		$	19,946		4.29	%
Allowance for loan losses		(14,508	)							(8,576	)
All other assets		86,466								74,570

TOTAL ASSETS	$	2,648,252							$	1,912,366
LIABILITIES & SHAREHOLDERS’ EQUITY
Deposits:
Interest checking	$	261,350		$	256		0.39	%	$	246,584		$	170		0.27	%
Money market		617,913			957		0.62	%		514,669			703		0.54	%
Savings		51,235			40		0.31	%		37,888			44		0.46	%
Time deposits		1,080,666			2,430		0.89	%		648,605			1,500		0.92	%
Federal funds purchased and other (3)		44,974			69		0.61	%		45,261			69		0.60	%
Federal Home Loan Bank advances		86,783			215		0.99	%		57,000			79		0.55	%
Subordinated Notes and other borrowings		58,285			1,082		7.39	%		—			—		—	%

TOTAL INTEREST BEARING LIABILITIES	$	2,201,206		$	5,049		0.91	%	$	1,550,007		$	2,565		0.66	%
Demand deposits		224,387								169,451
Other liabilities		16,650								11,368
Total shareholders’ equity		206,009								181,540

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,648,252							$	1,912,366
NET INTEREST SPREAD (4)							3.21	%							3.63	%
NET INTEREST INCOME				$	21,643							$	17,381
NET INTEREST MARGIN (5)							3.34	%							3.73	%

(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 include the effects of a tax-equivalent adjustment to adjust tax-exempt investment income on tax exempt investment securities and tax-exempt loans to a fully taxable basis.

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


	Nine Months Ended September 30,
	2016								2015
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans (1)(6)	$	1,535,894		$	56,933		4.95	%	$	933,950		$	38,127		5.46	%
Securities available for sale (6)		641,270			11,917		2.48	%		532,754			9,628		2.42	%
Securities held to maturity (6)		194,326			5,698		3.92	%		58,587			1,358		3.10	%
Certificates of deposit at other financial institutions		751			11		1.96	%		250			5		2.67	%
Federal funds sold and other (2)		55,583			518		1.24	%		50,207			325		0.87	%

TOTAL INTEREST EARNING ASSETS	$	2,427,824		$	75,077		4.13	%	$	1,575,748		$	49,443		4.20	%
Allowance for loan losses		(13,179	)							(7,705	)
All other assets		41,988								72,387

TOTAL ASSETS	$	2,456,633							$	1,640,430
LIABILITIES & SHAREHOLDERS’ EQUITY
Deposits:
Interest checking	$	292,013		$	853		0.39	%	$	270,992		$	605		0.30	%
Money market		608,341			2,767		0.61	%		451,054			1,918		0.57	%
Savings		48,647			121		0.33	%		34,018			117		0.46	%
Time deposits		937,266			6,377		0.91	%		464,945			3,323		0.96	%
Federal funds purchased and other (3)		50,100			237		0.63	%		47,330			232		0.66	%
Federal Home Loan Bank advances		75,412			511		0.91	%		42,890			225		0.70	%
Subordinated Notes and other borrowings		32,882			1,820		7.39	%		—			—		—	%

TOTAL INTEREST BEARING LIABILITIES	$	2,044,661		$	12,686		0.83	%	$	1,311,229		$	6,420		0.65	%
Demand deposits		200,981								159,093
Other liabilities		12,707								7,753
Total shareholders’ equity		198,284								162,355

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	2,456,633							$	1,640,430
NET INTEREST SPREAD (4)							3.30	%							3.55	%
NET INTEREST INCOME				$	62,391							$	43,023
NET INTEREST MARGIN (5)							3.43	%							3.65	%

(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 include the effects of a tax-equivalent adjustment to adjust tax-exempt investment income on tax exempt investment securities and tax-exempt loans to a fully taxable basis.

(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 on a tax-equivalent basis 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 September 30, 2016 versus September 30, 2015
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	8,103		$	(2,647	)	$	5,456
Securities available for sale		(34	)		(304	)		(338	)
Securities held to maturity		1,347			224			1,571
Certificates of deposit at other financial institutions		6			(4	)		2
Federal funds sold and other		(8	)		63			55

TOTAL INTEREST INCOME	$	9,414		$	(2,668	)	$	6,746

INTEREST EXPENSE
Deposits
Interest checking	$	7		$	79		$	86
Money market accounts		130			124			254
Savings		15			(19	)		(4	)
Time deposits		1,011			(81	)		930
Federal Home Loan Bank advances		40			96			136
Other borrowed funds		—			—			—
Subordinated Notes and other borrowings		1,082			—			1,082

TOTAL INTEREST EXPENSE	$	2,285		$	199		$	2,484

NET INTEREST INCOME	$	7,129		$	(2,867	)	$	4,262


	Net change nine months ended September 30, 2016 versus September 30, 2015
	Volume		Rate			Net Change
INTEREST INCOME
Loans	$	24,670	$	(5,864	)	$	18,806
Securities available for sale		2,001		288			2,289
Securities held to maturity		3,147		1,193			4,340
Certificates of deposit at other financial institutions		10		(4	)		6
Federal funds sold and other		39		154			193

TOTAL INTEREST INCOME	$	29,867	$	(4,233	)	$	25,634

INTEREST EXPENSE
Deposits
Interest checking	$	51	$	197		$	248
Money market accounts		667		182			849
Savings		51		(47	)		4
Time deposits		3,405		(351	)		3,054
Federal Home Loan Bank advances		167		119			286
Other borrowed funds		16		(11	)		5
Subordinated notes and other borrowings		1,820		—			1,820

TOTAL INTEREST EXPENSE	$	6,177	$	89		$	6,266

NET INTEREST INCOME	$	23,690	$	(4,322	)	$	19,368

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 $1,392 and $1,724 for the three months ended September 30, 2016 and 2015, respectively, and $4,095 and $3,154 for the nine months ended September 30, 2016 and 2015, respectively. The provision for the three months ended September 30, 2016 was less than the provision for the same period in 2015 due to loan growth in third quarter 2015 being greater than loan growth in third quarter 2016. The higher provision for the nine months ended September 30, 2016 compared to the same period in 2015 is due primarily to the Company’s loan growth during the nine months ended September 30, 2016, compared to the same period in 2015. Nonperforming loans at September 30, 2016 totaled $1,597 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 nine months ended September 30, 2016 was $4,876 and $12,587 compared to $3,798 and $9,864 for the same periods in 2015. The following is a summary of the components of non-interest income (in thousands):


	Three Months Ended September 30,					$ Increase (Decrease)			% Increase (Decrease)
	2016			2015		$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	44		$	44	$	—			—	%
Other service charges and fees		845			679		166			24.4	%
Net gains on sale of loans		2,942			2,463		479			19.4	%
Wealth management		446			327		119			36.4	%
Loan servicing fees, net		(40	)		84		(124	)		(147.6	%)
Gain on sale or call of securities		430			5		425			8,500.0	%
Net gain on sale of foreclosed assets		30			3		27			900.0	%
Other		179			193		(14	)		(7.3	%)

Total non-interest income	$	4,876		$	3,798	$	1,078			28.4	%


	Nine Months Ended September 30,					$ Increase (Decrease)			% Increase (Decrease)
	2016			2015		$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	139		$	78	$	61			78.2	%
Other service charges and fees		2,245			1,987		258			13.0	%
Net gains on sale of loans		6,859			5,573		1,286			23.1	%
Wealth management		1,343			914		429			46.9	%
Loan servicing fees, net		(2	)		187		(189	)		(101.1	%)
Gain on sale or call of securities		1,535			529		1,006			190.2	%
Net gain on sale of foreclosed assets		36			30		6			20.0	%
Other		432			566		(134	)		(23.7	%)

Total non-interest income	$	12,587		$	9,864	$	2,723			27.6	%

Service charges on deposit accounts for the nine months ended September 30, 2016 increased $61, or 78.2% from the same period 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.

Other service charges and fees for the three and nine months ended September 30, 2016 increased $166 and $258, or 24.4% and 13.0%, from the same periods in 2015 due to several variances. The larger variances for these comparative periods were as follows: (1) underwriting, processing and application fees related to mortgage lending activities increased $113 and $91; (2) unused commitment fees increased $39 and $95; and (3) ATM surcharge fees increased $22 and $64.

Net gain on sale of loans increased $479 and $1,286, or 19.4% and 23.1%, when comparing the three and nine months ended September 30, 2016 to the same periods in 2015. The increase in both periods was due to favorable mark-to-market pricing on mortgage loan derivatives and increased volume of mortgage loans during 2016.

Wealth management income for the three and nine months ended September 30, 2016 increased $119 and $429, or 36.4% and 46.9%, 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.

Gain on sale or call of investment securities increased $425 and $1,006, or 8,500.0% and 190.2%, when comparing the three and nine months ended September 30, 2016 with the same periods in 2015. The increase was primarily due to the gains on securities that were recognized in the second and third quarters of 2016, which were related to management selling a number of smaller securities to consolidate the number of securities carried in the portfolio and to reposition the Company’s investment portfolio into more tax-exempt municipal securities.

Other non-interest income decreased by $14 and $134, or 7.3% and 23.7%, when comparing three and nine months ended September 30, 2016 with the same periods 2015. The decrease for the nine months ended September 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 nine 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 nine months ended September 30, 2016 was $13,708 and $38,452, compared to $10,853 and $31,046 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 September 30,				$ Increase (Decrease)			% Increase (Decrease)
	2016		2015		$ Increase (Decrease)			% Increase (Decrease)
Salaries and employee benefits	$	7,979	$	6,208	$	1,771			28.5	%
Occupancy and equipment		2,001		1,683		318			18.9	%
FDIC assessment expense		570		362		208			57.5	%
Marketing		206		277		(71	)		(25.6	%)
Professional fees		935		516		419			81.2	%
Amortization of core deposit intangible		138		160		(22	)		(13.8	%)
Indirect expenses related to public offering		—		—		—			—	%
Other		1,879		1,647		232			14.1	%

Total non-interest expense	$	13,708	$	10,853	$	2,855			26.3	%


	Nine Months Ended September 30,				$ Increase (Decrease)			% Increase (Decrease)
	2016		2015		$ Increase (Decrease)			% Increase (Decrease)
Salaries and employee benefits	$	22,099	$	17,960	$	4,139			23.0	%
Occupancy and equipment		5,563		4,961		602			12.1	%
FDIC assessment expense		1,388		792		596			75.3	%
Marketing		611		695		(84	)		(12.1	%)
Professional fees		3,006		1,382		1,624			117.5	%
Amortization of core deposit intangible		431		499		(68	)		(13.6	%)
Indirect expenses related to public offering		—		314		(314	)		(100.0	%)
Other		5,354		4,443		911			20.5	%

Total non-interest expense	$	38,452	$	31,046	$	7,406			23.9	%

The increase in non-interest expense noted in the table above is related to the Company’s overall growth. The Company’s biggest variances for the three and nine months ended September 30, 2016, in comparison with the same periods of 2015, were in salaries and employee benefits, occupancy and equipment, FDIC assessment expense, professional fees and other non-interest expense.

Salaries and employee benefits increased $1,771 and $4,139, or 28.5% and 23.0%, when comparing the three and nine months ended September 30, 2016 with the same periods in 2015. The increases in both periods are primarily due to the Company’s staffing growth, which went from 219 full-time equivalent employees as of September 30, 2015, to 261 as of September 30, 2016, as the Company has worked to enhance its management team to properly oversee the Company’s growth and has added key commercial bankers and support staff to provide continued growth for the Company. In addition to the increase in salaries, mortgage commissions increased $732 and $887 when comparing the three and nine months ended September 30, 2016 with the same periods of 2015 due to the volume of loans closed during the three and nine months ended September 30, 2016. Stock-based compensation expense also increased $156 and $581 for the three and nine months ended September 30, 2016 in comparison with the same periods in 2015. Personnel-related insurance expense increased $92 and $235 for the three and nine months ended September 30, 2016 in comparison with the same periods in 2015 due to the Company’s increased number of employees. The Company also experienced growth in incentive expenses related to the Company’s financial performance.

Occupancy and equipment expense increased $318 and $602, or 18.9% and 12.1%, when comparing the three and nine months ended September 30, 2016 with the same periods in 2015. The variance for the three months ended September 30, 2016 versus the three months ended September 30, 2015 is attributable to increases in building rent expense ($232), software maintenance ($22), building maintenance ($20), utilities ($16), equipment maintenance ($14) and other furniture, fixtures and equipment expense ($18), which were offset by a decrease in property insurance expense ($13). The variance when comparing the nine months ended September 30, 2016 with the nine months ended September 30, 2015 is attributable to increases in building rent expense ($430), software maintenance fees ($77), equipment maintenance ($43), utilities ($29) and building maintenance ($27). During the first quarter of 2016, the Company opened two new leased facilities – a new branch location in Nolensville, Tennessee and an expansion of its headquarters in downtown Franklin, Tennessee, the latter of which is leased from a related party of the Company. The Company also began leasing space for its loan production office in Nashville, Tennessee during first quarter 2016.

The Company’s FDIC assessment expense increased $208 and $596, or 57.5% and 75.3%, when comparing the three and nine months ended September 30, 2016 with the same periods in 2015. The increases are due to the year-over-year asset growth of the Company assets, on which FDIC assessments are calculated, and due to the impact of the change in the calculation methodology implemented by the FDIC effective July 1, 2016.

Professional fees increased $419 and $1,624, or 81.2% and 117.5%, when comparing the three and nine months ended September 30, 2016 with the same periods in 2015. The increase for the three months ended September 30, 2016 and the same period in 2015 is due to increases in other professional fees ($225), compliance fees ($165), accounting/audit fees ($58), and brokerage settlement expenses ($23). The increase, when comparing the nine months ended September 30, 2016 and 2015, is due to increases in other professional fees ($675), merger-related expenses ($317), accounting/audit fees ($263), compliance fees ($160), brokerage settlement expenses ($89) legal fees ($72), and SEC filing expense ($47). The increases in other professional fees are related to the design and implementation of subsidiaries (Franklin Synergy Risk Management, Inc., Franklin Synergy Investments of Tennessee, Inc., Franklin Synergy Investments of Nevada, Inc., and Franklin Synergy Preferred Capital, Inc.), a consulting engagement related to the Company’s core systems and related processes, and professional placement service fees for the hiring of key lending and management professionals.

For the three and nine months ended September 30, 2016, other non-interest expenses increased $232 and $911, or 14.1% and 20.5%, from the same periods during 2015. The increase in other non-interest expense for the three months ended September 30, 2016 versus September 30, 2015 is attributed to increases in the following expense types: insurance loss reserves ($139); and electronic banking expenses ($96). The increase in other non-interest expense for the nine months ended September 30, 2016 versus September 30, 2015 is attributed to increases in various types of expenses, with the following expense types having the largest increases: insurance expense ($204); electronic banking expenses ($180); insurance loss reserves ($139); loan-related expenses ($115); regulatory expenses ($91); franchise taxes ($68); and board-related expenses ($57).

Income Tax Expense

The Company recognized income tax expense for the three and nine months ended September 30, 2016, of $3,421 and $9,663, respectively, compared to $2,807 and $6,468, respectively, for the three and nine months ended September 30, 2015. The Company’s year-to-date income tax expense for the nine months ended September 30, 2016 reflects an effective income tax rate of 32.3% compared to 36.2% for the same period in 2015. The decrease in the effective tax rate resulted from the Company’s investments in tax-exempt municipal securities, from the establishment and funding of a real estate investment trust subsidiary of Franklin Synergy Bank in the first quarter of 2016, and from the establishment of a captive insurance subsidiary at the end of 2015.

COMPARISON OF BALANCE SHEETS AT SEPTEMBER 30, 2016 AND DECEMBER 31, 2015

Overview

The Company’s total assets increased by $535,403, or 24.7%, from December 31, 2015 to September 30, 2016. The increase in total assets has primarily been the result of organic growth in the loan and investment securities portfolios.

Loans

Lending-related income is the most important component of the Company’s net interest income and is a major contributor to profitability. The loan portfolio is the largest component of earning assets, and therefore generates the largest portion of revenues. For purposes of the discussion in this section, the term “loans” refers to loans, excluding loans held for sale, unless otherwise noted.

The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, at September 30, 2016 and December 31, 2015 were $1,654,058 and $1,303,826, respectively, an increase of $350,232, or 26.9%. Growth in the loan portfolio is primarily due to increased market penetration and a healthy local economy. The Company has also attracted a number of experienced commercial and mortgage lenders over the last year to increase penetration in its primary markets, Williamson County and Rutherford County.

The table below provides a summary of the loan portfolio composition for the periods noted.


	September 30, 2016						December 31, 2015
Types of Loans	Amount			% of Total Loans			Amount			% of Total Loans
Total loans, excluding PCI loans
Real estate:
Construction and land development	$	474,255			28.7	%	$	372,767			28.5	%
Commercial		430,248			26.0	%		364,223			27.9	%
Residential		371,046			22.4	%		274,934			21.1	%
Commercial and industrial		372,784			22.5	%		283,888			21.7	%
Consumer and other		3,458			0.2	%		6,577			0.5	%

Total loans—gross, excluding PCI loans		1,651,791			99.8	%		1,302,389			99.7	%

Total PCI loans		3,087			0.2	%		3,913			0.3	%

Total gross loans		1,654,878			100.0	%		1,306,302			100.0	%

Less: deferred loan fees, net		(820	)					(2,476	)
Allowance for loan losses		(15,590	)					(11,587	)

Total loans, net allowance for loan losses	$	1,638,468					$	1,292,239

As presented in the above table, gross loans increased 26.7% during the first nine months of 2016, due to organic growth as a result of continued market penetration and the strength of the local economies. During this period, the Company experienced growth in real estate loans of 26.0% with growth occurring in the construction and land development (27.2%), commercial real estate (18.1%) and residential real estate (35.0%) segments. The Company also experienced growth of 31.3% in the commercial and industrial segment during the first nine months of 2016.

Real estate loans comprised 77.2% of the loan portfolio at September 30, 2016. The largest portion of the real estate segment as of September 30, 2016, was construction and land development loans, which totaled $474,336 at September 30, 2016, and comprised 37.2% of total real estate loans and 28.7% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development.

Commercial real estate loans totaled $430,824 at September 30, 2016, and comprised 33.7% of real estate loans and 26.0% of the total loan portfolio. The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm, nonresidential real estate properties and multi-family residential properties.

The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit and other junior lien mortgage loans. Residential real estate loans totaled $371,543 and comprised 29.1% of real estate loans and 22.5% of total loans at September 30, 2016.

Commercial and industrial loans totaled $374,717 at September 30, 2016 and grew 31.2% during the first nine months of 2016. Loans in this classification comprised 22.6% of total loans at September 30, 2016. The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and healthcare loans.

The repayment of loans is a source of additional liquidity for the Company. The following table sets forth the loans maturing within specific intervals at September 30, 2016, excluding unearned net fees and costs.

Loan Maturity Schedule


	September 30, 2016
	One year or less		Over one year to five years		Over five years		Total
Real estate:
Construction and land development	$	240,131	$	154,043	$	80,162	$	474,336
Commercial		23,838		101,685		305,301		430,824
Residential		26,885		109,889		234,769		371,543
Commercial and industrial		54,808		256,336		63,573		374,717
Consumer and other		1,778		1,571		109		3,458

Total	$	347,440	$	623,524	$	683,914	$	1,654,878

Fixed interest rate	$	203,971	$	327,758	$	240,183	$	771,912
Variable interest rate		143,469		295,766		443,731		882,966

Total	$	347,440	$	623,524	$	683,914	$	1,654,878

The information presented in the above table is based upon the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity structure of the loan portfolio.

Allowance for Loan Losses

The Company maintains an allowance for loan losses that management believes is adequate to absorb the probable incurred losses inherent in the Company’s loan portfolio. The allowance is increased by provisions for loan losses charged to earnings and is decreased by loan charge-offs net of recoveries of prior period loan charge-offs. The level of the allowance is determined on a quarterly basis, although management is engaged in monitoring the adequacy of the allowance on a more frequent basis. In estimating the allowance balance, the following factors are considered:

•

past loan experience;

•

the nature and volume of the portfolio;

•

risks known about specific borrowers;

•

underlying estimated values of collateral securing loans;

•

current and anticipated economic conditions; and

•

other factors which may affect the allowance for probable incurred losses.

The allowance for loan losses consists of two primary components: (1) a specific component which relates to loans that are individually classified as impaired and (2) a general component which 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 Company’s loss history and loss history from peer group data over the past three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.

The following loan portfolio segments have been identified: (1) Construction and land development loans, (2) Commercial real estate loans, (3) Residential real estate, (4) Commercial and industrial loans, and (5) Consumer and other loans. Management evaluates the risks associated with these segments based upon specific characteristics associated with the loan segments. These risk characteristics include, but are not limited to, the value of the underlying collateral, adverse economic conditions, and the borrower’s cash flow. While the total allowance consists of a specific portion and a general portion, both portions of the allowance are available to provide for probable incurred loan losses in the entire portfolio.

In the table below, the components, as discussed above, of the allowance for loan losses are shown at September 30, 2016 and December 31, 2015.


	September 30, 2016							December 31, 2015							Increase (Decrease)
	Loan Balance		ALLL Balance		%			Loan Balance		ALLL Balance		%			Loan Balance			ALLL Balance
Non impaired loans	$	1,566,708	$	15,443		0.99	%	$	1,198,891	$	11,465		0.96	%	$	367,817		$	3,978		3 bps
Non-PCI acquired loans (Note 1)		82,669		32		0.04	%		99,328		—		—	%		(16,659	)		32		4 bps
Impaired loans		2,414		115		4.76	%		4,170		113		2.71	%		(1,756	)		2		205 bps

Non-PCI loans		1,651,791		15,590		0.94	%		1,302,389		11,578		0.89	%		349,402			4,012		5 bps
PCI loans		3,087		—		—	%		3,913		9		0.23	%		(826	)		(9	)	-23 bps

Total loans	$	1,654,878	$	15,590		0.94	%	$	1,306,302	$	11,587		0.89	%	$	348,576		$	4,003		5 bps

Note 1:

Acquired loans that are not PCI loans. These are performing loans recorded at estimated fair value at the acquisition date. The fair value adjustment at the acquisition date was approximately $5,014 of the outstanding non-PCI loan balances acquired. This amount is accreted into interest income over the remaining lives of the related loans on a level yield basis. Based on the analysis performed by management as of September 30, 2016, $32 in allowance for loan loss was recorded at September 30, 2016 related to the loans acquired from MidSouth.

At September 30, 2016, the allowance for loan losses was $15,590, compared to $11,587 at December 31, 2015. The allowance for loan losses as a percentage of total loans was 0.94% and 0.89% at September 30, 2016 and December 31, 2015, respectively. Loan growth during the first nine months of 2016 is the primary reason for the increase in the allowance amount.

The table below sets forth the activity in the allowance for loan losses for the periods presented.


	Nine Months Ended September 30, 2016			Nine Months Ended September 30, 2015
Beginning balance	$	11,587		$	6,680
Loans charged-off:
Construction & land development		11			—
Commercial real estate		—			—
Residential real estate		39			32
Commercial & industrial		65			15
Consumer & other		35			121

Total loans charged-off		150			168
Recoveries on loans previously charged-off:
Construction & land development		—			—
Commercial real estate		—			—
Residential real estate		53			14
Commercial & industrial		—			—
Consumer & other		5			64

Total loan recoveries		58			78
Net recoveries (charge-offs)		(92	)		(90	)
Provision for loan losses charged to expense		4,095			3,154

Total allowance at end of period	$	15,590		$	9,744

Total loans, gross, at end of period (1)	$	1,654,878		$	1,125,941

Average gross loans (1)	$	1,525,359		$	921,412

Allowance to total loans		0.94	%		0.87	%

Net charge-offs (recoveries) to average loans, annualized		0.01	%		0.01	%

(1)	Loan balances exclude loans held for sale

While no portion of the allowance is in any way restricted to any individual loan or group of loans, and the entire allowance is available to absorb losses from any and all loans, the following table summarizes the allocation of allowance for loan losses by loan category and loans in each category as a percentage of total loans, for the periods presented.


	September 30, 2016					December 31, 2015
	Amount		% of Allowance to Total			Amount		% of Allowance to Total
Real estate loans:
Construction and land development	$	4,040		25.9	%	$	3,186		27.5	%
Commercial		3,908		25.1	%		3,146		27.1	%
Residential		2,484		15.9	%		1,861		16.1	%

Total real estate		10,432		66.9	%		8,193		70.7	%

Commercial and industrial		5,110		32.8	%		3,358		29.0	%
Consumer and other		48		0.3	%		36		0.3	%

		15,590		100.0	%		11,587		100.0	%

Nonperforming Assets

Non-performing loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest. Non-performing assets consist of non-performing loans plus OREO (i.e., real estate acquired through foreclosure or deed in lieu of foreclosure). Loans are placed on non-accrual status when they are past due 90 days and management believes the borrower’s financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. When a loan is placed on non-accrual status, interest accruals cease and uncollected interest is reversed and charged against current income. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The primary component of non-performing loans is non-accrual loans, which as of September 30, 2016 totaled $1,448. The other component of non-performing loans are loans past due greater than 90 days and still accruing interest. Loans past due greater than 90 days are placed on non-accrual status, unless they are both well-secured and in the process of collection. There were outstanding loans totaling $149 that were past due 90 days or more and still accruing interest at September 30, 2016.

The table below summarizes non-performing loans and assets for the periods presented.


	September 30, 2016			December 31, 2015
Non-accrual loans	$	1,448		$	908
Past due loans 90 days or more and still accruing interest		149			2,378

Total non-performing loans		1,597			3,286
Foreclosed real estate (“OREO”)		—			200

Total non-performing assets		1,597			3,486
Total non-performing loans as a percentage of total loans		0.1	%		0.3	%
Total non-performing assets as a percentage of total assets		0.1	%		0.2	%
Allowance for loan losses as a percentage of non-performing loans		976	%		353	%

As of September 30, 2016, there were three loans on non-accrual status. The amount and number are further delineated by collateral category and number of loans in the table below.


	Total Amount		Percentage of Total Non- Accrual Loans			Number of Non- Accrual Loans
Construction & land development	$	—		—	%		—
Commercial real estate		835		57.7	%		1
Residential real estate		123		8.5	%		1
Commercial & industrial		490		33.8	%		1
Consumer		—		—	%		—

Total non-accrual loans	$	1,448		100.0	%		3

Investment Securities and Other Earning Assets

The investment securities portfolio is intended to provide the Company with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is intended to be structured with minimal credit exposure to the Company and consists of both securities classified as available-for-sale and securities classified as held-to-maturity. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management deem it to be in the Company’s best interest to do so. Securities available-for-sale, consisting primarily of U.S. government sponsored enterprises and mortgage-backed securities, were $670,756 at September 30, 2016, compared to $575,838 at December 31, 2015, an increase of $94,918 or 16.5%. The increase in available-for-sale securities was primarily attributed to the securities purchased during the first nine months of 2016 as part of the Company’s leveraging strategy to deploy capital from the issuance of subordinated notes at the end of the first and second quarters of 2016.

The held-to-maturity securities are carried at amortized cost. This portfolio, consisting of U.S. government sponsored enterprises, mortgage-backed securities and municipal securities, totaled $235,050 at September 30, 2016, compared to $158,200 at December 31, 2015, an increase of $76,850, or 48.6%. The increase is attributable to securities that were purchased during the second quarter of 2016 as part of the Company’s leveraging strategy to deploy capital from the issuance of subordinated notes at the end of the first and second quarters of 2016.

The combined portfolios represented 33.5% and 33.9% of total assets at September 30, 2016 and December 31, 2015, respectively. At September 30, 2016, the Company had no securities that were classified as having Other Than Temporary Impairment.

The Company also had other investments of $11,829 and $7,998 at September 30, 2016 and December 31, 2015, respectively, consisting of capital stock in the Federal Reserve and the Federal Home Loan Bank (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System). The Federal Home Loan Bank and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus, not liquid, have no ready market or quoted market value, and are carried at cost.

Bank Premises and Equipment

Bank premises and equipment totaled $8,796 at September 30, 2016 compared to $7,640 at December 31, 2015, an increase of $1,156, or 15.1%. This increase was the result of adding leasehold improvements and furniture and equipment as needed in the normal course of business and related to the opening of the Nolensville branch in January 2016.

Assets Held for Sale

At September 30, 2016, the balance in assets held for sale was zero, compared with the balance of $1,640 at December 31, 2015. The Company’s College Street branch real estate in Murfreesboro, Tennessee was reclassified at December 31, 2015 as held for sale, since the property had been identified to be sold, and the sale of the property was probable at that time. The sale of the property settled on March 29, 2016, and a loss of $98 was realized as a result of the sale and was recorded in other noninterest income.

Deposits

Deposits represent the Company’s largest source of funds. The Company competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds,

money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives.

At September 30, 2016, total deposits were $2,217,954, an increase of $403,915, or 22.3%, compared to $1,814,039 at December 31, 2015. The growth in deposits is attributable to growth in brokered deposits, time deposits, money market deposits, and noninterest-bearing deposits.

Brokered deposits are an integral part of the Company’s funding strategy. Total brokered deposits decreased 1.5% from $478,257 at December 31, 2015 to $471,187 at September 30, 2016, primarily due to the Company’s strategy to reduce dependence on brokered deposits by allowing matured brokered certificates of deposit to be redeemed rather than renewing them or replacing them with other brokered deposits

Public funds deposits in the form of county deposits are a part of the Company’s funding strategy and are usually cyclical in nature, with the highest period of growth being during the first quarter of each calendar year. County deposits increased $26,410, or 8.1%, from $327,766 at December 31, 2015 to $354,176 at September 30, 2016. This growth was attributed to the addition of more county entities during 2016, which brought additional deposits into the Company during 2016.

Time deposits excluding brokered deposits as of September 30, 2016, amounted to $720,417, compared to $470,284 as of December 31, 2015, an increase of $250,133, or 53.2%. Of the increase in time deposits, 64.0% is attributed to the Company’s addition of Local Government Investment Pool (LGIP) deposits during 2016, which have become a component of the Company’s funding strategy. As of September 30, 2016, the Company’s LGIP deposits amounted to $280,000, compared with $120,000 of those deposits at December 31, 2015.

Other non-maturity deposits also increased during the first nine months of 2016. Noninterest-bearing checking deposits grew $55,375, or 31.3%; money market accounts increased $65,407, or 31.4%; savings deposits increased $7,519, or 17.2%; and interest-bearing checking accounts increased $6,141, or 5.6%, when comparing September 30, 2016 with December 31, 2015.

The following table shows time deposits in denominations of $100 or more by category based on time remaining until maturity.

Maturity of non-brokered time deposits of $100 or more


	September 30, 2016
Three months or less	$	316,713
Three through six months		57,739
Six through twelve months		59,151
Over twelve months		136,297

Total	$	569,900

Federal Funds Purchased and Repurchase Agreements

As of September 30, 2016, the Company had $8,500 in federal funds purchased from correspondent banks compared to $39,825 outstanding as of December 31, 2015. Securities sold under agreements to repurchase had an outstanding balance of $37,343 as of September 30, 2016, compared to $61,261 as of December 31, 2015. Securities sold under agreements to repurchase are financing arrangements that mature daily or within a short period of time. At maturity, the securities underlying the agreements are returned to the Company.

Federal Home Loan Bank Advances

The Company has established a line of credit with the Federal Home Bank of Cincinnati which is secured by a blanket pledge of 1-4 family residential mortgages and home equity lines of credit. At September 30, 2016 and at December 31, 2015, advances totaled $162,000 and $57,000, respectively. The Company strategically added $110,000 in FHLB advances in the third quarter of 2016, replacing brokered deposits that were maturing in the third quarter.

At September 30, 2016, the scheduled maturities and weighted average interest rates of these advances were as follows:


Scheduled Maturities	Amount		Weighted Average Rates
2016		110,000		0.49	%
2017		10,000		1.27	%
2018		7,000		1.61	%
2019		35,000		1.30	%

Total	$	162,000		0.76	%

Subordinated 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 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 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 March 2016 Notes.

The sale of the March 2016 Notes initially 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, which had been used to redeem the shares of Series A Preferred Stock issued to Treasury in connection with the Company’s participation in the SBLF, 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.

On June 30, 2016, the Company issued $20,000 in aggregate principal amount of fixed-to-floating rate subordinated Notes due 2026 (the “June 2016 Notes”) in a private offering to certain institutional accredited investors. 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 6.04%, 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.

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 March 2016 Notes, 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 sale of the June 2016 Notes initially yielded net proceeds of approximately $19,660 after deducting the estimated expenses payable by the Company. The net proceeds from the offering of the June 2016 Notes were used to inject capital into the Bank to fund future growth.

The issuance costs related to the June 2016 Notes amounted to $404 and are being amortized as interest expense over the ten-year term of the June 2016 Notes.

For regulatory capital purposes, the March 2016 Notes and the June 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 the consolidated financial statements.

Liquidity

Liquidity is defined as the ability of the Bank to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis and the ability of the Company to fund the servicing of its subordinated notes.

Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, management focuses on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet the Company’s needs. The Company’s source of funds to pay interest on the previously discussed subordinated notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. Under the terms of the informal agreement with the Reserve Bank, described in “Other Events” in Management’s Discussion and Analysis and in “ITEM 1A. RISK FACTORS” under “PART II OTHER INFORMATION,” the Bank is required to receive prior written approval from its regulatory agencies to pay dividends to the Company.

Funds are available from a number of basic banking activity sources including the core deposit base, the repayment and maturity of loans, payments of principal and interest as well as sales of investments classified as available-for-sale, and sales of brokered deposits. As of September 30, 2016, $670,756 of the investment securities portfolio was classified as available-for-sale and is reported at fair value on the consolidated balance sheet. Another $235,050 of the portfolio was classified as held-to-maturity and is reported at amortized cost. Approximately $742,828 of the total $905,806 investment securities portfolio on hand at September 30, 2016, was pledged to secure public deposits and repurchase agreements. Other funding sources available include repurchase agreements, federal funds purchased, and borrowings from the Federal Home Loan Bank.

Shareholders’ Equity

As of September 30, 2016, the Company’s shareholders’ equity was $209,644, as compared with $188,816 as of December 31, 2015. The increase in shareholders’ equity was due to the Company’s earnings of $20,262 in the first nine months of 2016, the increase in accumulated other comprehensive income of $7,521, exercises of the Company’s warrants and stock options of $1,436, and $1,817 related to the Company’s share-based compensation. These were offset by a $10,000 reduction in preferred stock due to the Company’s redemption of the Series A Preferred Stock related to the SBLF on March 25, 2016 and due to net divestments of $185 in conjunction with the Company’s 401(k) employer match.

Effects of Inflation and Changing Prices

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation affects financial institutions’ increased cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and shareholders’ equity. Commercial and other loan originations and refinancings tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities.

Off Balance Sheet Arrangements

The Company generally does not have any off-balance sheet arrangements other than approved and unfunded loans and lines and letters of credit to customers in the ordinary course of business. At September 30, 2016, the Company had unfunded loan commitments outstanding of $67,489, unused lines of credit of $448,542, and outstanding standby letters of credit of $23,995.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

Some of the financial data included in our selected historical consolidated financial information are not measures of financial performance recognized by GAAP. Our management uses these non-GAAP financial measures in its analysis of our performance:

•

“Common shareholders’ equity” is defined as total shareholders’ equity at end of period less the liquidation preference value of the preferred stock;

•

“Tangible common shareholders’ equity” is common shareholders’ equity less goodwill and other intangible assets;

•

“Total tangible assets” is defined as total assets less goodwill and other intangible assets;

•

“Other intangible assets” is defined as the sum of core deposit intangible and SBA servicing rights;

•

“Tangible book value per share” is defined as tangible common shareholders’ equity divided by total common shares outstanding. This measure is important to investors interested in changes from period-to-period in book value per share exclusive of changes in intangible assets;

•

“Tangible common shareholders’ equity ratio” is defined as the ratio of tangible common shareholders’ equity divided by total tangible assets. We believe that this measure is important to many investors in the marketplace who are interested in relative changes from period-to period in common equity and total assets, each exclusive of changes in intangible assets;

•

“Return on Average Tangible Common Equity” is defined as net income available to common shareholders divided by average tangible common shareholders’ equity;

•

“Efficiency ratio” is defined as noninterest expenses divided by our operating revenue, which is equal to net interest income plus noninterest income;

•

“Adjusted yield on loans” is our yield on loans after excluding loan accretion from our acquired loan portfolio. Our management uses this metric to better assess the impact of purchase accounting on our yield on loans, as the effect of loan discount accretion is expected to decrease as the acquired loans mature or roll off of our balance sheet;

•

“Net interest margin” is defined as annualized net interest income divided by average interest-earning assets for the period;

•

“Adjusted net interest margin” is net interest margin after excluding loan accretion from the acquired loan portfolio and premiums for acquired time deposits. Our management uses this metric to better assess the impact of purchase accounting on net interest margin, as the effect of loan discount accretion and accretion of net discounts and premiums related to deposits is expected to decrease as the acquired loans and deposits mature or roll off of our balance sheet.

We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use.

The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:


	As of or for the Three Months Ended
(Amounts in thousands, except share/ per share data and percentages)	Sept 30, 2016			Jun 30, 2016			Mar 31, 2016			Dec 31, 2015			Sept 30, 2015
Total shareholders’ equity	$	209,644		$	204,276		$	191,910		$	188,816		$	187,610
Less: Preferred stock		—			—			—			10,000			10,000

Total common shareholders’ equity		209,644			204,276			191,910			178,816			177,610
Common shares outstanding		10,757,483			10,689,481			10,586,592			10,571,377			10,524,630

Book value per share	$	19.49		$	19.11		$	18.13		$	16.92		$	16.88

Total shareholders’ equity	$	209,644		$	204,276		$	191,910		$	188,816		$	187,610
Less: Preferred stock		—			—			—			10,000			10,000

Total common shareholders’ equity		209,644			204,276			191,910			178,816			177,610
Less: Goodwill and other intangibles		10,774			10,916			11,070			11,231			11,373

Tangible common shareholders’ equity	$	198,870		$	193,360		$	180,840		$	167,585		$	166,237
Common shares outstanding		10,757,483			10,689,481			10,586,592			10,571,377			10,524,630

Tangible book value per share	$	18.49		$	18.09		$	17.08		$	15.85		$	15.80

Average total shareholders’ equity		206,009			194,385			194,383			188,460			181,540
Less: Average preferred stock		—			—			9,231			10,000			10,000
Less: Average goodwill and other intangibles		10,885			11,006			11,165			11,309			11,469

Average tangible common shareholders’ equity	$	195,154		$	183,379		$	173,987		$	167,151		$	160,071

Net income available to common shareholders	$	7,030		$	6,999		$	6,210		$	4,639		$	5,125
Average tangible common equity		195,154			183,379			173,987			167,151			160,071

Return on average tangible common equity		14.33	%		15.35	%		14.36	%		11.01	%		12.70	%


Efficiency Ratio:
Net interest income	$	20,675		$	19,934		$	19,276		$	17,195		$	16,736
Noninterest income		4,876			4,626			3,085			2,992			3,798

Operating revenue		25,551			24,560			22,361			20,187			20,534
Expense
Total noninterest expense		13,708			12,913			11,831			11,094			10,853

Efficiency ratio		53.65	%		52.58	%		52.91	%		54.96	%		52.85	%

Annualized interest and fees on loans(1)	$	80,329		$	76,136		$	71,358		$	61,506		$	58,495
Average loans		1,620,347			1,497,556			1,364,467			1,232,218			1,044,520

Yield on loans		4.96	%		5.08	%		5.23	%		4.99	%		5.60	%

Annualized accretion income on acquired loans	$	841		$	1,108		$	1,447		$	1,409		$	4,374
Less: Effect of accretion income on acquired loans		(0.05	%)		(0.07	%)		(0.11	%)		(0.11	%)		(0.42	%)

Adjusted yield on loans		4.91	%		5.01	%		5.12	%		4.88	%		5.18	%

⁽¹⁾	This item does not include tax-equivalent adjustments.


	As of or for the Three Months Ended
(Amounts in thousands, except share/ per share data and percentages)	Sept 30, 2016			Jun 30, 2016			Mar 31, 2016			Dec 31, 2015			Sept 30, 2015
Annualized net interest income(1)	$	82,251		$	80,174		$	77,528		$	68,219		$	66,398
Average earning assets		2,576,294			2,404,060			2,177,905			2,009,481			1,846,372

Net interest margin		3.19	%		3.33	%		3.56	%		3.39	%		3.60	%

Annualized accretion income on acquired loans	$	841		$	1,108		$	1,447		$	1,409		$	4,374

Less: Effect of accretion income on acquired loans		(0.03	%)		(0.05	%)		(0.07	%)		(0.07	%)		(0.24	%)

Annualized premium amortization of acquired deposits	$	—		$	—		$	—		$	—		$	4

Less: Effect of premium amortization of acquired deposits		(0.00	%)		(0.00	%)		(0.00	%)		(0.00	%)		(0.00	%)

Adjusted net interest margin		3.16	%		3.28	%		3.49	%		3.32	%		3.36	%

⁽¹⁾	This item does not include tax-equivalent adjustments.

FRANKLIN FINANCIAL NETWORK, INC.

SUMMARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)

(Amounts in thousands, except per share data and percentages)


	As of and for the three months ended
	Sept 30, 2016		Jun 30, 2016		Mar 31, 2016		Dec 31, 2015		Sept 30, 2015
Income Statement Data ($):
Interest income		25,724		24,286		22,561		20,081		19,301
Interest expense		5,049		4,352		3,285		2,886		2,565
Net interest income		20,675		19,934		19,276		17,195		16,736
Provision for loan losses		1,392		1,567		1,136		1,876		1,724
Noninterest income		4,876		4,626		3,085		2,992		3,798
Noninterest expense		13,708		12,913		11,831		11,094		10,853
Net Income before taxes		10,451		10,080		9,394		7,217		7,957
Provision for taxes		3,421		3,081		3,161		2,553		2,807
Net income		7,030		6,999		6,233		4,664		5,150
Earnings before interest and taxes		15,500		14,432		12,679		10,103		10,522
Net income available to common shareholders		7,030		6,999		6,210		4,639		5,125
Earnings per share, basic		0.66		0.66		0.59		0.44		0.49
Earnings per share, diluted		0.62		0.62		0.56		0.41		0.46
Profitability (%)
Return on average assets		1.06		1.14		1.12		0.89		1.07
Return on average equity		13.58		14.48		12.90		9.82		11.25
Return on average tangible common equity		14.33		15.35		14.36		11.01		12.70
Efficiency ratio		53.65		52.58		52.91		54.96		52.85
Net Interest margin (1)		3.19		3.33		3.56		3.39		3.60
Balance Sheet Data ($):
Loans (including HFS)		1,680,877		1,567,537		1,433,623		1,317,905		1,138,492
Loan loss reserve		15,590		14,253		12,676		11,587		9,744
Cash		55,749		72,050		62,054		52,394		47,658
Securities		905,806		909,531		746,781		734,038		756,554
Goodwill		9,124		9,124		9,124		9,124		9,124
Intangible assets		1,650		1,792		1,946		2,107		2,249
Assets		2,703,195		2,607,101		2,300,094		2,167,792		2,002,538
Deposits		2,217,954		2,249,735		1,953,573		1,814,039		1,714,594
Liabilities		2,493,551		2,402,825		2,108,184		1,978,976		1,814,928
Total equity		209,644		204,276		191,910		188,816		187,610
Common equity		209,644		204,276		191,910		178,816		177,610
Tangible common equity		198,870		193,360		180,840		167,585		166,237
Asset Quality (%)
Nonperforming loans/ total loans (2)		0.10		0.10		0.12		0.25		0.07
Nonperforming assets / total loans(2) + foreclosed assets		0.10		0.12		0.14		0.27		0.09
Loan loss reserve / loans(2)		0.94		0.92		0.89		0.89		0.87
Net charge-offs / average loans		0.01		0.00		0.01		0.01		0.00
Capital (%)
Tangible common equity to tangible assets		7.39		7.45		7.90		7.77		8.35
Leverage ratio		7.15		7.33		7.69		8.48		8.90
Common equity Tier 1 ratio		9.09		9.22		9.60		10.08		11.03
Tier 1 risk-based capital ratio		9.09		9.22		9.60		10.51		11.52
Total risk-based capital ratio		12.66		12.93		12.49		11.21		12.18

⁽¹⁾	Net interest margins shown in the table above do not include tax-equivalent adjustments.

⁽²⁾	Total loans in this ratio exclude loans held for sale.

Emerging Growth Company Status

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the effectiveness of our Registration Statement on Form S-4, which was declared effective by the SEC on May 14, 2014; (2) the last day of the fiscal year in which we have more than $1.0 billion in annual revenues; (3) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act; or (4) the date on which we have, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.

Further, the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. The Company has elected to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, it adopts the new or revised standard at the time public companies adopt the new or revised standard. This election is irrevocable.

Other Events

On November 3, 2016, the Bank entered into an informal agreement with the Federal Reserve Bank of Atlanta (“Reserve Bank”) and the Tennessee Department of Financial Institutions (“TDFI”) in the form of a Memorandum of Understanding (“MOU”). Under the terms of the MOU, the Bank agreed, among other things, to (1) enhance and periodically update its Commercial Real Estate (“CRE”) concentration risk management policy; (2) augment credit risk management practices; and (3) enhance capital and liquidity plans. The Bank has also agreed that it will seek prior written approval of the Reserve Bank and the TDFI to pay dividends to the Company, which dividends are used primarily for the purpose of servicing the Company’s subordinated debt.

The Company also expects to execute an agreement with the Board of Governors of the Federal Reserve System (the “Agreement”) under section 4(m)(2) of the Bank Holding Company Act, which will include specific actions designed to address the Bank’s risk profile and to strengthen the underlying condition of the Bank. Until the Bank and Company satisfy the requirements of the MOU and the Agreement, any plans for business combinations or location expansion will be limited and subject to prior written approval from the appropriate regulatory body.

Management believes the effect of these regulatory actions will not have a material impact on the Bank’s ability to continue to serve its customers and communities. In addition, the company’s ongoing investment in its people and technology has and will continue to support solid growth, asset quality measures, and safety and soundness standards.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Based upon the nature of the Company’s operations, the Company is not subject to foreign currency exchange or commodity price risk.

Management seeks to maintain profitability in both immediate and long-term earnings through funds management/interest rate risk management. Interest rate risk (sensitivity) management deals with the potential impact on earnings associated with changing interest rates using various rate change (shock) scenarios. The Company’s rate sensitivity position has an important impact on earnings. Senior management monitors the Company’s rate sensitivity position throughout each month, and then the Asset Liability Committee (“ALCO”) of the Bank meets on a quarterly basis to analyze the rate sensitivity position and other aspects of asset/liability management. These meetings cover the spread between the cost of funds (primarily time deposits) and interest yields generated primarily through loans and investments, rate shock analyses, liquidity and dependency positions, and other areas necessary for proper balance sheet management.

Management believes interest rate risk is best measured by earnings simulation modeling. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 and 200 basis points. All rates are increased or decreased parallel to the change in prime rate. As a result of the simulation, over a 12-month time period ended September 30, 2016, net interest income was estimated to decrease 1.14% and 4.20% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to decrease 5.71% and 16.91% in a 100 basis points and 200 basis points declining rate assumption, respectively. These results are in line with the Company’s guidelines for rate sensitivity.

The following chart reflects the Company’s sensitivity to changes in interest rates as indicated as of September 30, 2016.


Projected Interest Rate Change	Net Interest Income	Net Interest Income $ Change from Base	% Change from Base
-200	60,738	-12,360	-16.91%
-100	68,923	-4,175	-5.71%
Base	73,098	—	0.00%
+100	72,266	-832	-1.14%
+200	70,030	-3,067	-4.20%
+300	67,468	-5,630	-7.70%
+400	65,627	-7,470	-10.22%

The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, changes in the shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of pay downs and maturities of loans, investments and deposits, changes in spreads between key market rates, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, these results do not include any management action that might be taken in responding to or anticipating changes in interest rates. The simulation results are one indicator of interest rate risk, and actual net interest income is largely impacted by the allocation of assets, liabilities, and product mix.

ITEM 4. CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures. The Company’s chief executive officer and chief financial officer have evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2016, the end of the fiscal quarter covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are effective.

(b) Changes in Internal Controls. There has been no change in our internal control over financial reporting that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, the Company believes would have a material adverse impact on the Company’s financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March 15, 2016, as supplemented by the risk factors disclosed in our Quarterly Report on Form 10-Q for the quarters ended March 31, 2016 and June 30, 2016, other than the additional disclosure of the risk factors listed below.

We are Required to Comply with the Terms of a Memorandum of Understanding (“MOU”) that the Bank has Entered into with the Reserve Bank and the TDFI, and Lack of Compliance Could Result in Additional Regulatory Actions.

On November 3, 2016, the Bank entered into an MOU with the Reserve Bank and the TDFI. Under the terms of the MOU, the Bank agreed, among other things, to enhance its policies, practices and processes to reflect the Bank’s increasingly complex business model and risk profile. The Bank has also agreed that it will seek prior written approval of the Reserve Bank and the TDFI to pay dividends to the Company, which dividends are used primarily for the purpose of servicing the Company’s subordinated debt.

The MOU will remain in effect until stayed, modified, terminated or suspended by the Reserve Bank and the TDFI. Management has been actively implementing plans and processes to comply with the requirements of the MOU. The Reserve Bank and the TDFI may determine in their sole discretion that the matters covered by the MOU have not been addressed satisfactorily, which could result in limitations on our business, including restricting growth and requiring increased capital, and negatively affect our ability to implement our business plan or the value of our common stock, as well as our financial condition, liquidity and results of operations.

The Rights of Our Common Shareholders Are Subordinate to the Rights of the Holders of Our Debt Securities and May Be Subordinate to the Holders of Any Class of Preferred Stock That We May Issue in the Future

On March 31, 2016, we completed the public offering of $40,000,000 aggregate principal amount of fixed-to-floating rate subordinated Notes due 2026 (the “March 2016 Notes”). The net proceeds from the offering of the March 2016 Notes was used, in part, to pay down a line of credit, which we used on March 25, 2016 to redeem 10,000 outstanding shares of our Series A Preferred Stock issued to the Treasury pursuant to our participation in the Small Business Lending Fund program.

On June 30, 2016, we completed the private offering of $20,000,000 aggregate principal amount of fixed-to-floating rate subordinated Notes due 2026 (the “June 2016 Notes”). The net proceeds from the offering of the June 2016 Notes were used to inject capital into Franklin Synergy Bank, the Company’s primary subsidiary, to fund growth and for other corporate purposes.

Upon our voluntary or involuntary dissolution, liquidation, or winding up of affairs, holders of shares of our common stock will not receive a distribution, if any, until after the payment in full of our debts and other liabilities, and the payment of any accrued but unpaid dividends and any liquidation preference on outstanding shares of preferred stock. Our Board of Directors has the authority to issue in the aggregate up to 1,000,000 shares of preferred stock and to determine the terms of each issue of preferred stock without shareholder approval. Accordingly, you should assume that any shares of preferred stock that we may issue in the future will be senior to our common stock and could have a preference on liquidating distributions or a preference on dividends that could limit our ability to pay dividends to the holders of our common stock. Because our decision to issue debt or equity securities or incur other borrowings in the future will depend on market conditions and other factors beyond our control, the amount, timing, nature or success of our future capital-raising efforts is uncertain. Thus, common shareholders bear the risk that our future issuances of debt or equity securities or our incurrence of other borrowings will negatively affect the market price of our common stock.

The Amount of Interest Payable on the March 2016 Notes Will Vary Beginning on March 30, 2021

The interest rate on the March 2016 Notes will vary beginning on March 30, 2021. From and including the date of issuance of the March 2016 Notes, to but excluding March 30, 2021, the March 2016 Notes will bear interest at an initial rate of 6.875% per annum. From and including March 30, 2021 and thereafter, the March 2016 Notes will bear interest at a floating rate equal to three-month LIBOR as calculated on each applicable date of determination, plus a spread of 5.636%. If interest rates rise, the cost of the March 2016 Notes may increase, thereby negatively affecting our net income.

The Amount of Interest Payable on the June 2016 Notes Will Vary Beginning on July 1, 2021

The interest rate on the June 2016 Notes will vary beginning on July 1, 2021. From and including the date of issuance of the June 2016 Notes, to and including June 30, 2021, the June 2016 Notes will bear interest at an initial rate of 7.00% per annum. From and including July 1, 2021 and thereafter, the June 2016 Notes will bear interest at a floating rate equal to three-month LIBOR as calculated on each applicable date of determination, plus a spread of 6.04%. If interest rates rise, the cost of the June 2016 Notes may increase, thereby negatively affecting our net income.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

Shares of the Company’s common stock were issued during the third quarter of 2016 pursuant to the exercise of warrants and options issued by the Company, as follows:


Date of Sale	Number of Shares of Common Stock Sold		Type of Issuance	Price Per Share		Aggregate Price
07/22/2016		500	Warrants Exercised	$	12.00	$	6,000.00
		500	Warrants Exercised	$	12.00	$	6,000.00
		125	Warrants Exercised	$	12.00	$	1,500.00
07/28/2016		4,000	Options Exercised	$	10.00	$	40,000.00
		6,000	Options Exercised	$	11.75	$	70,500.00
		1,296	Options Exercised	$	10.00	$	12,960.00
		600	Options Exercised	$	13.00	$	7,800.00
		480	Options Exercised	$	13.50	$	6,480.00
		290	Options Exercised	$	20.69	$	6,000.10
08/03/2016		401	Options Exercised	$	8.57	$	3,436.57
08/04/2016		877	Options Exercised	$	8.57	$	7,515.89
08/09/2016		7,500	Options Exercised	$	10.00	$	75,000.00
		781	Options Exercised	$	10.00	$	7,810.00
		1,719	Options Exercised	$	10.00	$	17,190.00
08/10/2016		50	Warrants Exercised	$	12.00	$	600.00
08/12/2016		7,500	Options Exercised	$	10.00	$	75,000.00
		2,313	Options Exercised	$	11.75	$	27,177.75
		2,225	Options Exercised	$	10.00	$	22,250.00
		3,500	Options Exercised	$	10.50	$	36,750.00
		4,500	Options Exercised	$	12.00	$	54,000.00
		1,229	Options Exercised	$	13.00	$	15,977.00
		819	Options Exercised	$	13.50	$	11,056.50
		438	Options Exercised	$	20.69	$	9,062.22
08/16/2016		1,141	Options Exercised	$	11.75	$	13,406.75
		652	Options Exercised	$	10.00	$	6,520.00


Date of Sale	Number of Shares of Common Stock Sold		Type of Issuance	Price Per Share		Aggregate Price
		1,139	Options Exercised	$	10.50	$	11,959.50
08/17/2016		839	Options Exercised	$	10.00	$	8,390.00
08/18/2016		1,842	Options Exercised	$	10.00	$	18,420.00
		12	Options Exercised	$	10.50	$	126.00
08/25/2016		2,680	Options Exercised	$	11.75	$	31,490.00
		60	Options Exercised	$	11.75	$	705.00
		398	Options Exercised	$	10.50	$	4,179.00
		106	Options Exercised	$	20.69	$	4,179.00
08/26/2016		2,526	Options Exercised	$	10.50	$	26,523.00
08/29/2016		839	Options Exercised	$	10.00	$	8,390.00
08/30/2016		4,569	Options Exercised	$	11.75	$	53,685.75
09/01/2016		125	Warrants Exercised	$	12.00	$	1,500.00
09/06/2016		839	Options Exercised	$	10.00	$	8,390.00
		838	Options Exercised	$	10.00	$	8,380.00
09/07/2016		1,000	Options Exercised	$	10.00	$	10,000.00
09/08/2016		1,000	Options Exercised	$	10.00	$	10,000.00
		1,000	Options Exercised	$	10.00	$	10,000.00
		10	Options Exercised	$	10.00	$	100.00
		990	Options Exercised	$	10.00	$	9,900.00
		125	Warrants Exercised	$	12.00	$	1,500.00
09/12/2016		1,000	Options Exercised	$	10.00	$	10,000.00
09/13/2016		6,196	Options Exercised	$	10.50	$	65,058.00
09/16/2016		500	Warrants Exercised	$	12.00	$	6,000.00
		750	Warrants Exercised	$	12.00	$	9,000.00
09/20/2016		1,278	Options Exercised	$	8.57	$	10,952.46
		125	Warrants Exercised	$	12.00	$	1,500.00

Neither the exercises of the warrants and options nor their original issuances involved any underwriters, underwriting discounts or commissions, or any public offering, and the Company believes that such transactions were exempt from the registration requirements of the Securities Act in reliance on Section 4(a)(2) of the Securities Act (or Rule 506 of Regulation D promulgated thereunder) as transactions by an issuer not involving a public offering.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS


Exhibit No.		Description

10.1		Standard Form of Agreement Between Owner and Contractor, by and between Franklin Synergy Bank and Century Skanska (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 13, 2016)

31.1*		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).

32*		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (Section 906 Certification).

101*		Interactive Data Files.

*	Filed herewith

SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

EXHIBIT INDEX


Exhibit No.		Description

10.1		Standard Form of Agreement Between Owner and Contractor, by and between Franklin Synergy Bank and Century Skanska (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 13, 2016)

31.1*		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).

31.2*		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).

32*		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (Section 906 Certification).

101*		Interactive Data Files.

*	Filed herewith

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