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Table of Contents
Index to Financial Statements

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

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

For the fiscal year ended December 31, 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)

Securities registered pursuant to Section 12(b) of the Act:

Common Stock

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ☐  Yes    ☒  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ☐  Yes    ☒  No

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

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.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting company  

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2016 was $304,542,479.36 (computed on the basis of $31.36 per share).

The number of shares outstanding of the registrant’s common stock, no par value per share, as of February 28, 2017 was 13,059,162.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III is incorporated by reference to portions of the definitive proxy statement to be filed within 120 days after December 31, 2016, pursuant to Regulation 14A under the Securities Exchange Act of 1934 in connection with the annual meeting of stockholders to be held on May 25, 2017.

 

 

 


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

PART I      2  

ITEM 1.

 

BUSINESS.

     2  

ITEM 1A.

 

RISK FACTORS.

     13  

ITEM 1B.

 

UNRESOLVED STAFF COMMENTS.

     29  

ITEM 2.

 

PROPERTIES.

     29  

ITEM 3.

 

LEGAL PROCEEDINGS.

     29  

ITEM 4.

 

MINE SAFETY DISCLOSURES.

     29  
PART II      30  

ITEM 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

     30  

ITEM 6.

 

SELECTED FINANCIAL DATA.

     33  

ITEM 7.

 

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

     34  

ITEM 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     61  

ITEM 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     62  

ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

     62  

ITEM 9A.

 

CONTROLS AND PROCEDURES.

     62  

ITEM 9B.

 

OTHER INFORMATION.

     63  
PART III      64  

ITEM 10.

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

     64  

ITEM 11.

 

EXECUTIVE COMPENSATION.

     64  

ITEM 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

     64  

ITEM 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

     64  

ITEM 14.

 

PRINCIPAL ACCOUNTING FEES AND SERVICES.

     64  
PART IV      65  

ITEM 15.

 

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

     65  
 

EXHIBIT INDEX

     65  

ITEM 16.

 

FORM 10-K SUMMARY.

     71  
SIGNATURES      72  
INDEX TO FINANCIAL STATEMENTS      F-1  


Table of Contents
Index to Financial Statements

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements regarding, among other things, our anticipated financial and operating results. Forward-looking statements reflect our management’s current assumptions, beliefs, and expectations. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “objective,” “should,” “hope,” “pursue,” “seek,” and similar expressions are intended to identify forward-looking statements. While we believe that the expectations reflected in our forward-looking statements are reasonable, we can give no assurance that such expectations will prove correct. Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the future results, performance, or achievements expressed in or implied by any forward-looking statement we make. Some of the relevant risks and uncertainties that could cause our actual performance to differ materially from the forward-looking statements contained in this report are discussed below under the heading “Risk Factors” and elsewhere in this Annual Report on Form 10-K. We caution readers that these discussions of important risks and uncertainties are not exclusive, and our business may be subject to other risks and uncertainties which are not detailed there. Readers are cautioned not to place undue reliance on our forward-looking statements. We make forward-looking statements as of the date on which this Annual Report on Form 10-K is filed with the Securities and Exchange Commission (“SEC”), and we assume no obligation to update the forward-looking statements after the date hereof whether as a result of new information or events, changed circumstances, or otherwise, except as required by law.

 

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Index to Financial Statements

PART I

 

ITEM 1. BUSINESS.

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 in the demographically attractive and growing Williamson and Rutherford Counties within the Nashville metropolitan 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.

As of December 31, 2016, we had consolidated total assets of $2.9 billion, total loans, including loans held for sale, of $1.8 billion, total deposits of $2.4 billion and total equity of $270.4 million.

Our principal executive office is located at 722 Columbia Avenue, Franklin, Tennessee 37064-2828, and our telephone number is (615) 236-2265. Our website is www.franklinsynergybank.com. The information contained on or accessible from our website does not constitute a part of this report and is not incorporated by reference herein.

Our History and Growth

We were formed as a Tennessee corporation in April 2007 and commenced banking operations through the newly-formed Franklin Synergy Bank in November 2007. We were established with the initial objective of building a locally-managed commercial bank to service the needs of Franklin, Tennessee and the greater Williamson County area. Our mission statement is to build a legacy company by creating shareholder value, cultivating strong customer relationships and fostering an extraordinary team of directors, officers and employees. We were formed by a core management team of veteran bankers based in Middle Tennessee led by our Chairman and Chief Executive Officer, Richard Herrington. Many of our founders built Franklin Financial Corporation (which is not directly affiliated with our company), which was founded in 1988, and grew the newly-formed real estate-oriented bank to nine branches and $785 million in assets as of June 30, 2002, before announcing the sale of the bank to Fifth Third Bancorp, Inc. in July 2002. Mr. Herrington and certain members of this management team subsequently joined Cumberland Bancorp, Inc. (later renamed Civitas BankGroup, Inc.), a troubled Tennessee-based bank holding company, in December 2002, to lead its restructuring. The team led a dramatic improvement of Cumberland’s asset quality and profitability, by decreasing nonperforming loans to total loans from 2.25% in 2003 to 0.31% in 2006 and growing net income from $1.1 million in 2003 to $6.7 million in 2006, before it was acquired by Greene County Bancshares, Inc. in May 2007.

On July 1, 2014, we completed our acquisition of MidSouth Bank (“MidSouth”) which enabled us to increase our footprint in Middle Tennessee and in the Nashville metropolitan area, specifically in the attractive Rutherford County market. The acquisition also diversified our revenue mix by expanding our retail customer base and increasing our capacity to provide wealth management services, including trust powers which we believe is a competitive advantage to drive new relationships with higher income customers.

Our Market

We operate 12 branches in Williamson and Rutherford Counties and one loan production office within the Nashville metropolitan area. Our markets are among the most attractive, both in Tennessee, and the Southeast, and compare favorably to some of the more well-known and higher-profile markets in the U.S., although our markets are not dependent on commodity pricing. We believe that our focus on, and success in, growing market share in Williamson and Rutherford Counties will enhance our long-term value and profitability compared to financial institutions of our size in other regions of the country. The markets in which we operate are characterized by strong demographics including high incomes, increasing population, a growing workforce and unemployment that tends to be below the national rate.

Our Business Strategy

We consider ourselves to be bankers, not just lenders. Our core business strategy is to provide our banking customers with a full suite of financial services by cultivating strong long-term customer relationships and by developing an extraordinary team of officers and employees focused on the customer experience. We are focused on providing convenience and personal service to our customers that is superior to that of the out-of-state super-regional and national financial institutions operating in our markets, while simultaneously managing risk and profitability by remaining selective when expanding our customer base and making loans. We also prioritize our client’s financial security and privacy and assist the communities in which we do business through socially responsible leadership. Our unique culture is a cornerstone to our business and has resulted in substantial but stable growth and profitability.

 

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By continuing to offer several value-added products and services within our core areas of strength, such as mortgage lending and wealth management, to invest in technology to improve our systems and the customer experience, and to leverage strong relationships with consumers, professionals, local governments and businesses within our community, we believe we can gain greater market share, which will improve our operational efficiency and increase profitability. As evidence of the success of our strategy, our deposit market share in Williamson County has increased from 3.4% in 2009 to a market-leading deposit share of approximately 25.8% per the Federal Deposit Insurance Corporation’s (“FDIC’s”) Summary of Deposits report as of June 30, 2016, despite the presence of more institutions competing for deposits.

Our Competitive Strengths

We believe that we have a unique operating culture that differentiates us from our competitors and enables us to organically grow our business and enhance shareholder value. This unique operating culture includes:

 

    a commitment to provide superior and personal service to our customers, both through our employees and via our continued investment in cutting edge technologies in areas of deposit taking, loan origination and risk management;

 

    a focus on building long-term relationships with our customers; and

 

    community leadership, as we look to engage with local civic, professional and charitable organizations and exhort our employees to do so as well.

Our culture forms the basis for our competitive strengths, which we believe allow us to leverage our market opportunity and grow our business profitability. In particular, we believe that the following strengths differentiate us from our competitors and provide a strong foundation from which to deliver growth and profitability, all while enhancing shareholder value:

Well Positioned in Attractive Markets

We believe that we are well positioned to grow our business profitably in the demographically attractive and growing markets within the Nashville metropolitan area in which we operate. We believe that our target market segments, small to medium size for profit businesses and the consumer base working or living in and near our geographical footprint, demand the convenience and personal service that a smaller, independent financial institution such as we can offer. We believe the heavy out-of-state banking presence (out-of-state super-regional and national financial institutions control approximately 62.3% of local deposits in the Nashville-Davidson-Murfreesboro-Franklin metropolitan statistical area (the “Nashville MSA”)) provides an opportunity for a strong local bank like us to add greater market share from customers who are looking for more personal banking services and a more customer-friendly experience. Through our efforts to expand our deposit base, we currently have the largest market share of deposits in Williamson County.

Experienced Management Team

We have an experienced management team with a history of working together in our target markets and a track record of delivering growth and shareholder value. Many members of our executive leadership team have been with us since inception and many have worked together at previous banks, including both large financial institutions and community banks. Our Chief Executive Officer, President, Chief Mortgage Officer, Chief Financial Officer, Chief Investment Officer and Chief Credit Officer have worked in our local market for a number of years and have experienced a variety of economic cycles. This deep local experience has given us the ability to understand and react to market changes and maintain strong profitability and growth without sacrificing asset quality.

Our management team has a proven track record of delivering shareholder value. Richard Herrington co-founded Franklin Financial Corporation (Franklin National Bank) in 1988, where he and his management team grew assets by a compound annual growth rate (“CAGR”) of 27.5% from 1995 – 2002 and positioned the bank to eventually be sold to Fifth Third Bancorp, Inc., which was announced in 2002 and closed in 2004, for 5.4 times tangible book value. According to SNL Financial, this multiple represents the 9th highest price to book multiple for all bank transactions announced in the past 20 years where deal value was in excess of $50 million. He then served as Chief Executive Officer at Cumberland Bancorp, Inc. (later renamed Civitas BankGroup, Inc.), where he and his team restructured the bank and significantly bolstered profitability, growing net income by a CAGR of 82% from 2003 – 2006, before selling the bank to Greene County Bancshares, Inc. in 2007 for 3.0 times tangible book value.

The members of our Board of Directors have diverse industry experiences and have deep and long-term ties to the local community. We believe that we have an ideal blend of directors that have been with our management team at previous banks as well as directors that have joined our Board in recent years.

 

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Local Real Estate Lending Expertise

We are real estate bankers that have focused on Middle Tennessee collateral since 1989. Our in-depth knowledge of the commercial customers, real estate development and credit in Williamson and Rutherford Counties gives us a competitive advantage in loan production, deposit attraction and ancillary revenue generation as we grow market share. Even when the local loan market gets competitive, we do not compromise on pricing and structuring of loan facilities, as our bankers are able to provide customized solutions delivered with a relatively quick turnaround time, as a result of the fact that our underwriting and banking operations occur locally.

With our firm principles of lending on Middle Tennessee collateral, our local real estate expertise and our localized delivery apparatus, we are poised to capture greater market share in the demographically-attractive and growing Williamson and Rutherford Counties.

Successful Balance of Growth and Profitability

We understand the importance of successfully balancing growth and profitability with asset quality to enhance shareholder value. The following highlights the key aspects of our approach to maintaining this balance:

 

    Consistent, Strong and Disciplined Growth. Our approach balances both disciplined growth and profitability. Our community-focused business model has resulted in loan growth with a CAGR of 41% from December 31, 2009 to December 31, 2016. Since opening in 2007, we have expanded into the very attractive Rutherford County market, and we have added a loan production office in Davidson County. Additionally, we have increased focus on small business lending and have grown our commercial and industrial (“C&I”) loans, which represent approximately 21% of our portfolio at December 31, 2016, by a CAGR of nearly 69% since 2009. We have grown our deposit market share in Williamson County and are the top local financial institution in the county by deposits with a market share of nearly 26%. Our growth has resulted in improved profitability, as reflected by return on average assets increasing from negative in 2009 to 1.10% for 2016.

 

    Disciplined Credit Risk Management. Our robust approach to risk management has enabled growth of our loan portfolio without compromising credit. Our credit risk management strategy is based on prudent underwriting criteria and local knowledge. Our lending decisions are centralized and committee-focused, with committees meeting multiple times per week. We are collateral lenders, with strong focus on secondary sources of repayment, especially collateral based in Williamson and Rutherford Counties. As a result of the implementation of our risk management strategy, less than 2% of our total loans are unsecured.

We believe that by maintaining our consistent origination and underwriting strategy, we will be able to maintain our consistent growth across shifting market environments.

Products and Services

The Bank operates as a full-service financial institution for its customers in its expanded market area with a full line of financial products, including:

Commercial Banking

Traditional commercial banking services are the mainstay of the Bank. The Bank’s focus is to service small to medium-sized businesses and self-employed professionals. Certain not-for-profit and governmental entities also find the Bank’s services attractive.

The Bank’s focus in the commercial banking market is to provide high quality service for its customers supported by the latest bank technology. In the credit service area, the Bank endeavors to give its commercial customers access to a highly-trained team of credit and deposit service specialists who remain with the customer relationship for long periods of time. Credit decision-making is customized to meet the borrower’s financial needs and designed for rapid response. Credit judgments involve the Bank’s senior management and, where legally required, involve the directors of the Bank. Government guaranteed lending services such as the Small Business Administration (“SBA”) may be utilized as needed.

Consumer Banking

The Bank offers a broad range of financial services designed to meet the credit, savings, and transactional needs of local consumers. First mortgage real estate loans, home equity loans, and other personal loans are the focus of consumer lending. Consumer depository and transaction needs are met through dual delivery systems of traditional branches and the Internet, including mobile banking.

 

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Mortgage Loans

Our mortgage loan department originates single-family, fixed rate residential mortgage loans that we sell in the secondary market. Construction loans also are available for residential and commercial purposes.

Deposits

The Bank’s deposit products include demand, interest-bearing transaction accounts, money market accounts, certificates of deposit (“CDs”), municipal deposits, savings, and deposit accounts. CDs offer various maturities ranging from thirty days to five years. The Bank generates relationships by personal contacts within the conventional trading markets for such services by its officers, directors, and employees, who include persons with banking experience in these markets. The Bank also solicits local deposits through the Internet and offers Internet-only deposit accounts to supplement traditional depository accounts. Loan customers are encouraged to bring their deposit business to the Bank, including transaction accounts, CDs, and retirement accounts. This practice further increases the deposit base for the Bank and assists in controlling overall market costs related to deposit acquisition.

Wealth Management/Trust Services

As a result of the MidSouth acquisition, the Bank has increased its capacity to provide wealth management services, including trust services, as the Bank is now authorized to exercise trust powers, which provides the Bank with a competitive advantage. As of December 31, 2016, our wealth management and trust services division managed $323.7 million in assets.

Other Products and Services

In order to meet all financial needs of the customers, the Bank offers retirement planning, financial planning, investment services and insurance products through its financial services department. Some of these products may be outsourced through relationships with other financial institutions.

Recent Trends

From a financial perspective, management believes the Bank has reached key milestones significantly faster than most banks in the United States during their first nine full years of operation. As of December 31, 2016, the Bank had $1.8 billion in loans, including loans held for sale; assets of $2.9 billion, $2.4 billion in deposits, $270.4 million of equity, and was number one in deposit market share in Williamson County based on deposits at June 30, 2016. On November 16, 2016, we launched a secondary public offering for our common stock. In the offering, we issued 2,242,500 shares of our common stock at a price of $32.00 per share. The secondary public offering was completed during November 2016.

Management addresses changes in banking over recent years and embarks on new initiatives as appropriate. In the past, banks needed branches on every corner; today that is considered an outdated way of doing business. Many of the Bank’s customers like to visit with personnel at the Bank, and the Bank will continue to offer a welcoming environment. Other customers prefer to bank online and through mobile channels. The Bank provides a full range of banking products and services designed to attract all types of customers.

The Bank continues to enhance banking convenience by offering the option of opening accounts online and through mobile channels (savings accounts, checking accounts and CDs). Customers can access banking services at their convenience. The Bank’s remote deposit system allows consumers to deposit checks online without the need to come to a branch. Business customers enjoy this convenience as well.

Local businesses are important to the Bank. The Bank has many products that can help its corporate customers become more profitable, including sweep accounts, credit card processing, remote capture and automated lock box. A unique offering is workplace banking, which allows employers to offer a special banking benefits package to their employees. The Bank also can meet the borrowing needs of businesses through traditional working capital loans, as well as accounts receivable loans and business expansion loans. One of the Bank’s specialties is customizing services to the unique needs of the business.

 

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Competition

All phases of FFN’s and the Bank’s business are highly competitive. FFN and the Bank are subject to intense competition from various financial institutions and other companies or firms that offer financial services. The Bank competes for deposits with other commercial banks, savings and loan associations, credit unions and issuers of commercial paper and other securities, such as money-market and mutual funds. In making loans, the Bank competes with other commercial banks, savings and loan associations, consumer finance companies, credit unions, leasing companies, and other lenders. Information about specific competition in Williamson County and Rutherford County is included under “RISK FACTORS—Competition For Deposits and Loans is Expected To Be Intense, and No Assurance Can Be Given That We Will Be Successful in Our Efforts to Compete with Other Financial Institutions.”

While the direction of recent and proposed federal legislation seems to favor increased competition between banks and different types of financial or other institutions for both deposits and loans, it is not possible to forecast the impact such developments may have on commercial banking in general or as to the Bank or FFN in particular. The Bank will continue to compete with these and other financial institutions, many of which have far greater assets and financial resources than the Bank and whose common stock may be more widely traded than that of FFN. See “BUSINESS—Supervision and Regulation.” No assurance can be given that the Bank will be successful in its efforts to compete with such other institutions.

Enterprise Risk Management

We place significant emphasis on risk mitigation as an integral component of our organizational culture. We believe that our emphasis on risk management is manifested in our solid asset quality statistics and our credit risk management procedures discussed above.

We also focus on risk management in numerous other areas throughout our organization, including with respect to asset/liability management, regulatory compliance and internal controls. We have implemented an extensive asset/liability management process aided by simulation models provided by reputable third parties. We engage in ongoing internal audit and review of all areas of our operations and regulatory compliance.

We have implemented management assessment and testing of internal controls consistent with the Sarbanes-Oxley Act and have engaged an experienced independent public accounting firm to assist us with respect to compliance.

Employees

Management employs officers who have substantial experience and proven records in the banking industry and proven histories in business and commerce, and pays competitive salaries to attract and retain such persons. It is not anticipated that we will experience any substantial difficulty in attracting and retaining the desired caliber of officers and other employees. We offer a typical health and disability insurance plan to our employees and those of our subsidiary, as well as a 401(k) Plan and officer equity-based incentive awards.

FFN currently has eight directors and the Bank currently has 11 directors, and as of December 31, 2016, we and our bank subsidiary had 267 full-time employees and one part-time employee. We consider our relationship with our employees to be excellent. Furthermore, we are not subject to any collective bargaining agreements.

Trademarks

We obtained registrations with the United States Patent and Trademark Office for the protection of the trademarks “FRANKLIN SYNERGY BANK®” and “FRANKLIN FINANCIAL NETWORK®.” Management does not believe these trademarks are confusingly similar to trademarks used by other institutions in the financial services business and intends to protect the use of these trademarks nationwide.

Policies and Procedures

The Board of Directors of the Bank has established a statement of lending policies and procedures being used by loan officers of the Bank when making loans. Asset quality is of utmost importance and an independent loan review process has been established to monitor the Bank’s lending function. It is imperative that the Board of Directors and management have an independent and objective evaluation of the quality of specific individual loans and of the overall quality of the total portfolio.

The Board of Directors of the Bank also has established an investment policy that guides the Bank officers in determining the investment portfolio of the Bank. Other policies include a code of ethics, audit policy, loan policy, fair lending, compliance, bank secrecy, personnel and information system policies.

 

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Under the Community Reinvestment Act of 1977 (the “CRA”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”) evaluates the Bank’s record of helping to meet the credit needs of its community consistent with safe and sound operations. The Federal Reserve also takes this record into account when deciding on certain applications submitted by the Bank. The Bank’s assessment area is Williamson County, Rutherford County and Davidson County for business loans, mortgage, and general financial services.

The Bank is a fair and equal credit lender. Management’s lending objectives are to make credit products available to all segments of the Bank’s market and community. Williamson County has one moderate census tract, Davidson County has thirty-eight moderate income census tracts and twenty-nine low income tracts, and Rutherford County has seven moderate census tracts and two low census tracts. Products are being developed and marketed to individuals and businesses located in those census tracts.

Supervision and Regulation

The following summaries of statutes and regulations affecting banks and their holding companies do not purport to be complete. Such summaries are qualified in their entirety by reference to the statutes and regulations described.

Bank Holding Company Regulation

FFN is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “Holding Company Act”), and is registered with the Federal Reserve. Banking subsidiaries of bank holding companies are subject to restrictions under federal law, which limit the transfer of funds by the subsidiary banks to their respective holding companies and non-banking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases. Under Section 23A of the Federal Reserve Act, such transfers by any subsidiary bank to its holding company or any nonbanking subsidiary are limited in amount to 10% of the subsidiary bank’s capital and surplus and, with respect to FFN and all such non-banking subsidiaries, to an aggregate of 20% of such bank’s capital and surplus. Banking subsidiaries of bank holding companies are also subject to the provisions of Section 23B of the Federal Reserve Act, which, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Furthermore, such loans and extensions of credit are required to be secured in specified amounts. The Holding Company Act also prohibits, subject to certain exceptions, a bank holding company from engaging in or acquiring direct or indirect control of more than 5% of the voting stock of any company engaged in non-banking activities. An exception to this prohibition is for activities expressly found by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto, such as consumer lending and other activities that have been approved by the Federal Reserve by regulation or order. Certain servicing activities are also permissible for a bank holding company if conducted for or on behalf of the bank holding company or any of its affiliates. FFN has elected to be a financial holding company under Regulation Y, allowing FFN to engage in certain financial activities without the prior approval of the Federal Reserve.

As a bank holding company, FFN is required to file with the Federal Reserve semi-annual reports and such additional information as the Federal Reserve may require. The Federal Reserve may also make examinations of FFN and its non-bank affiliates.

According to federal law and Federal Reserve policy, bank holding companies are expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each such subsidiary. This support may be required at times when a bank holding company may not be able to provide such support. Furthermore, in the event of a loss suffered or anticipated by the FDIC—either as a result of default of a banking or thrift subsidiary of FFN or related to FDIC assistance provided to a subsidiary in danger of default—the other banking subsidiaries of FFN may be assessed for the FDIC’s loss, subject to certain exceptions.

Regulation Y generally requires persons acting directly or indirectly or in concert with one or more persons to give the Federal Reserve 60 days advanced written notice before acquiring control of a bank holding company. Under the regulation, control is defined as the ownership or control with the power to vote 25% or more of any class of voting securities of the bank holding company. The regulation also provides for a presumption of control if a person owns, controls, or holds with the power to vote 10% or more (but less than 25%) of any class of voting securities. A bank holding company may be limited to ownership of 5% ownership of voting securities. If the person or persons making the acquisition is a company, prior approval from the Federal Reserve may be required.

Various federal and state statutory provisions limit the amount of dividends subsidiary banks can pay to their holding companies without regulatory approval. The payment of dividends by any bank also may be affected by other factors, such as the maintenance of adequate capital for such subsidiary bank. In addition to the foregoing restrictions, the Federal Reserve has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company experiencing earnings weaknesses should not pay cash dividends that exceed its net income or that could only be

 

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funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Federal Reserve may also order a bank holding company to terminate an activity or control of a non-bank subsidiary if such activity or control constitutes a significant risk to the financial safety, soundness, or stability of a subsidiary bank and is inconsistent with sound banking principles. Furthermore, the Tennessee Department of Financial Institutions (“TDFI”) also has authority to prohibit the payment of dividends by a Tennessee bank when it determines such payment to be an unsafe and unsound banking practice.

A bank holding company and its subsidiaries are also prohibited from acquiring any voting shares of, or interest in, any banks located outside of the state in which the operations of the bank holding company’s subsidiaries are located, unless the bank holding company and its subsidiaries are well-capitalized and well managed.

In approving acquisitions by holding companies of banks and companies engaged in the banking-related activities described above, the Federal Reserve considers a number of factors, including the expected benefits to the public such as greater convenience, increased competition, or gains in efficiency, as weighed against the risks of possible adverse effects such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices. The Federal Reserve is also empowered to differentiate between new activities and activities commenced through the acquisition of a going concern.

The Attorney General of the United States may, within 30 days after approval by the Federal Reserve of an acquisition, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts. Failure of the Attorney General to challenge an acquisition does not, however, exempt the holding company from complying with both state and federal antitrust laws after the acquisition is consummated or immunize the acquisition from future challenge under the anti-monopolization provisions of the Sherman Act.

Capital Guidelines

The Federal Reserve has issued risk-based capital guidelines for bank holding companies and member banks. Under the guidelines, the minimum ratio of capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. To be considered a “well capitalized” bank or bank holding company under the guidelines, a bank or bank holding company must have a total risk-based capital ratio of 10% or greater. At least half of the total capital is to be comprised of common equity, retained earnings, and a limited amount of perpetual preferred stock, after subtracting goodwill and certain other adjustments (“Tier 1 capital”). The remainder may consist of perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, other preferred stock not qualifying for Tier 1 capital, and a limited amount of loan loss reserves (“Tier 2 capital”). The Bank is subject to similar capital requirements adopted by the Federal Reserve. In addition, the Federal Reserve and the FDIC have adopted a minimum leverage ratio (Tier 1 capital to total assets) of 3% or 4% based on supervisory considerations. Generally, banking organizations are expected to operate well above the minimum required capital level of 3% unless they meet certain specified criteria, including that they have the highest regulatory ratings. Most banking organizations are required to maintain a leverage ratio of 3% or 4%, as applicable, plus an additional cushion of at least 1% to 2%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance upon intangible assets.

In July 2013, the federal banking regulators, in response to the statutory requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), adopted regulations implementing the Basel Capital Adequacy Accord (“Basel III”), which had been approved by the Basel member central bank governors in 2010 as an agreement among the countries’ central banks and bank regulators on the amount of capital banks must hold as a cushion against losses and insolvency. The new minimum capital to risk-weighted assets (“RWA”) requirements are a Common Equity Tier 1 Capital ratio of 4.5% and a Tier 1 Capital ratio of 6.0%, and a Total Capital ratio of 8.0%. The minimum leverage ratio (Tier 1 capital to total assets) is 4.0%. The new rule also changes the definition of capital, mainly by adopting stricter eligibility criteria for regulatory capital instruments, and new constraints on the inclusion of minority interests, mortgage-servicing assets, deferred tax assets, and certain investments in the capital of unconsolidated financial institutions. In addition, the new rule requires that most regulatory capital deductions be made from Common Equity Tier 1 Capital.

Under the Basel III rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of Common Equity Tier 1 Capital above its minimum risk-based capital requirements. The buffer is measured relative to RWA. Phase-in of the capital conservation buffer requirements began on January 1, 2016 and the requirements will be fully phased in on January 1, 2019. The capital conservation buffer threshold for 2016 is 0.625%. A banking organization with a buffer greater than 2.5% once the capital conservation buffer is fully phased in would not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. Effectively, the Basel III framework will require us to meet minimum capital ratios of (i) 7% for Common Equity Tier 1 Capital, (ii) 8.5% Tier 1 Capital, and (iii) 10.5% Total Capital. The eligible retained income of a banking organization is

 

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defined as its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income. When the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer will exceed the prompt corrective action (“PCA”) well-capitalized thresholds.

Under the new rule, mortgage-servicing assets and deferred tax assets are subject to stricter limitations than those applicable under the current general risk-based capital rule. More specifically, certain deferred tax assets arising from temporary differences, mortgage-servicing assets, and significant investments in the capital of unconsolidated financial institutions in the form of common stock are each subject to an individual limit of 10% of Common Equity Tier 1 Capital elements and are subject to an aggregate limit of 15% of Common Equity Tier 1 Capital elements. The amount of these items in excess of the 10% and 15% thresholds are to be deducted from Common Equity Tier 1 Capital. Amounts of mortgage-servicing assets, deferred tax assets, and significant investments in unconsolidated financial institutions that are not deducted due to the aforementioned 10% and 15% thresholds must be assigned a 250% risk weight. Finally, the new rule increases the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

The new minimum capital requirements of Basel III were effective on January 1, 2015, whereas the capital conservation buffer and the deductions from Common Equity Tier 1 Capital phase in over time. Similarly, nonqualifying capital instruments phase out over time, except as described above.

Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a financial institution could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits, and other restrictions on its business.

Tennessee Banking Act; Federal Deposit Insurance Act

The Bank is incorporated under the banking laws of the State of Tennessee and, as such, is subject to the applicable provisions of those laws. The Bank is subject to the supervision of the TDFI and to regular examination by that department. The Bank is a member of the Federal Reserve and therefore is subject to Federal Reserve regulations and policies and is subject to regular exam by the Federal Reserve. The Bank’s deposits are insured by the FDIC through the Deposit Insurance Fund, or “DIF,” and the Bank is, therefore, subject to the provisions of the Federal Deposit Insurance Act (“FDIA”).

The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. Under the Dodd-Frank Act, the FDIC was required to adopt regulations that would base deposit insurance assessments on total assets less capital rather than deposit liabilities and to include off-balance sheet liabilities of institutions and their affiliates in risk-based assessments. EESA (as defined below) provided for a temporary increase in the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. This increased level of basic deposit insurance was made permanent by the Dodd-Frank Act. The Dodd-Frank Act also repealed the prohibition on paying interest on demand transaction accounts, but did not extend unlimited insurance protection for these accounts.

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Tennessee statutes and the federal law regulate a variety of the banking activities of the Bank, including required reserves, investments, loans, mergers and consolidations, issuances of securities, payments of dividends, and the establishment of branches. There are certain limitations under federal and Tennessee law on the payment of dividends by banks. A state bank, with the approval of the TDFI, may transfer funds from its surplus account to the undivided profits (retained earnings) account or any part of its paid-in-capital account. The payment of dividends by any bank is dependent upon its earnings and financial condition and, in addition to the limitations referred to above, is subject to the statutory power of certain federal and state regulatory agencies to act to prevent what they deem unsafe or unsound banking practices. The payment of dividends could, depending upon the financial condition of the Bank, be deemed to constitute such an unsafe or unsound practice. Also, without regulatory approval, a dividend only can be paid to the extent of the net income of the Bank for that year plus the net income of the prior two years. The FDIA prohibits a state bank, the deposits of which are insured by the FDIC, from paying dividends if it is in default in the payment of any assessments due the FDIC.

State banks also are subject to regulation respecting the maintenance of certain minimum capital levels (see above), and the Bank is required to file annual reports and such additional information as the Tennessee Banking Act and Federal Reserve regulations require. The Bank also is subject to certain restrictions on loan amounts, interest rates, “insider” loans to officers, directors and principal shareholders, tie-in arrangements, privacy, transactions with affiliates, and many other matters. Strict compliance at all times with state and federal banking laws is required.

 

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Tennessee law contains limitations on the interest rates that may be charged on various types of loans and restrictions on the nature and amount of loans that may be granted and on the types of investments which may be made. The operations of banks are also affected by various consumer laws and regulations, including those relating to equal credit opportunity and regulation of consumer lending practices. All Tennessee banks must become and remain insured banks under the FDIA. (See 12 U.S.C. § 1811, et seq.).

Under Tennessee law, state banks are prohibited from lending to any one person, firm, or corporation amounts more than 15% of its equity capital accounts, except (i) in the case of certain loans secured by negotiable title documents covering readily marketable nonperishable staples or (ii) the Bank may make a loan to one person, firm or corporation of up to 25% of its equity capital accounts with the prior written approval of the Bank’s Board of Directors or finance committee (however titled).

The TDFI and the Federal Reserve will examine the Bank periodically for compliance with various regulatory requirements. Such examinations, however, are for the protection of the DIF and for depositors and not for the protection of investors and shareholders.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)

FDICIA substantially revised the depository institution regulatory and funding provisions of the FDIA, and made revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking regulators to take “prompt corrective action” in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” Under applicable regulations, a FDIC-insured depository institution is defined to be well capitalized if it maintains a Leverage Ratio of at least 5%, a risk adjusted Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10% and is not subject to a directive, order or written agreement to meet and maintain specific capital levels. An insured depository institution is defined to be adequately capitalized if it meets all of its minimum capital requirements as described above in the first paragraph of the section entitled “Capital Guidelines.” In addition, an insured depository institution is considered undercapitalized if it fails to meet any minimum required measure; significantly undercapitalized if it has a total risk-based capital ratio of less than 6%, a tier 1 risked-based capital ratio less than 3% or a leverage ratio less than 3%; and critically undercapitalized if it fails to maintain a level of tangible equity equal to not less than 2% of total assets. An insured depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.

FDICIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. A depository institution’s holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator generally within 90 days of the date on which they became critically undercapitalized.

The capital-based prompt corrective action provision of FDICIA and their implementing regulations apply to FDIC-insured depository institutions and are not directly applicable to the holding companies which control those institutions. However, the Federal Reserve has indicated that, in regulating bank holding companies, it will take appropriate action at the holding company level based on an assessment of the effectiveness of supervisory actions imposed upon subsidiary depository institutions pursuant to these provisions and regulations.

The FDIC has adopted regulations under FDICIA governing the receipt of brokered deposits and pass-through insurance. Under the regulations, a bank cannot accept or rollover or renew brokered deposits unless it is well capitalized or it is adequately capitalized and receives a waiver from the FDIC. A bank that cannot receive brokered deposits also cannot offer “pass-through” insurance on certain employee benefit accounts. Whether or not it has obtained this waiver, an adequately capitalized bank may not pay an interest rate on any deposits in excess of 75 basis points over certain index prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized.

FDICIA contains numerous other provisions, including accounting, audit and reporting requirements, limitations on the FDIC’s payment of deposits at foreign branches, new regulatory standards in such areas as asset quality, earnings and compensation and revised regulatory standards for, among other things, powers of state banks, real estate lending and capital adequacy. FDICIA also requires that a depository institution provide 90 days prior notice of the closing of any branches.

 

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The Dodd-Frank Act

In July 2010, the Dodd-Frank Act was signed into law, incorporating numerous financial institution regulatory reforms. Many of these reforms were implemented over the course of 2011-2013 and continue to be implemented through regulations being adopted by various federal banking and securities regulations. The following discussion describes the material elements of the regulatory framework. Many of the Dodd-Frank Act provisions are stated to only apply to larger financial institutions and do not directly impact community-based institutions like the Bank. For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of the Bank’s operations. Other provisions that have impacted or will impact the Bank:

 

    Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling and increase the size of the floor of the DIF, and offset the impact of the increase in the minimum floor on institutions with less than $10 billion in assets.

 

    Make permanent the $250,000 limit for federal deposit insurance.

 

    Repeal the federal prohibition on payment of interest on demand deposits, thereby permitting depositing institutions to pay interest on business transaction and other accounts.

 

    Centralize responsibility for consumer financial protection by creating the Consumer Financial Protection Bureau (the “CFPB”), responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.

 

    Restrict the preemption of state law by federal law and disallow national bank subsidiaries from availing themselves of such preemption.

 

    Impose new requirements for mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.

 

    Apply the same leverage and risk based capital requirements that apply to insured depository institutions to holding companies.

 

    Permit national and state banks to establish de novo interstate branches at any location where a bank based in that state could establish a branch, and require that bank holding companies and banks be well-capitalized and well managed in order to acquire banks located outside their home state.

 

    Impose new limits on affiliated transactions and cause derivative transactions to be subject to lending limits.

 

    Implement corporate governance revisions, including with regard to executive compensation and proxy access to shareholders that apply to all public companies not just financial institutions.

FDIC Insurance Premiums

The Bank is required to pay quarterly FDIC deposit insurance assessments to the DIF. The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based upon statutory factors that include the balance of insured deposits as well as the degree of risk the institution poses to the insurance fund. The FDIC uses a risk-based premium system that assesses higher rates on those institutions that pose greater risks to the DIF.

On March 15, 2016, the FDIC adopted a rule in accordance with provisions of the Dodd-Frank Act that requires large institutions to bear the burden of raising the Reserve Ratio from 1.15% to 1.35%. Since the Reserve Ratio has reached 1.15%, the FDIC will collect assessment surcharges from large institutions. Once the reserve ratio reaches 1.38%, small institutions will receive credits to offset their contribution to raising the Reserve Ratio to 1.35%. On April 26, 2016, the FDIC Board of Directors approved the final rule to improve the deposit insurance assessment system for established small insured depository institutions (generally, those banks with less than $10 billion in total assets that have been insured for at least five years). The final rule was effective July 1, 2016. Since the reserve ratio of the DIF reached 1.15 percent before that date, the final rule determined assessment rates beginning July 1, 2016. Effective July 1, 2016, the initial base assessment rates for all insured institutions were reduced from 5 to 35 basis points to 3 to 30 basis points. Total base assessment rates after possible adjustments were reduced from 2.5 to 45 basis points to 1.5 to 40 basis points. Although the base assessment rates were reduced, the assessment calculation includes pricing adjustments for certain financial

 

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ratios that relate to asset growth, loan mix, funding ratios, and nonperforming assets, which in the case of the Bank, have adversely impacted the Company’s earnings due to increased premium assessments. Additional increases in premiums will impact FFN’s earnings adversely. Depending on any future losses that the FDIC insurance fund may suffer due to failed institutions, there can be no assurance that there will not be additional significant premium increases in order to replenish the fund.

Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a federal bank regulatory agency.

The CRA

The CRA requires that, in connection with examinations of financial institutions within its jurisdiction, the FDIC and the state banking regulators, as applicable, evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on us. Additionally, we must publicly disclose the terms of various CRA-related agreements.

Other Regulations

Interest and other charges that our subsidiary bank collects or contracts for are subject to state usury laws and federal laws concerning interest rates. Our bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

 

    The federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

    The Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

    The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

    The Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;

 

    The Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

    The rules and regulations of the various governmental agencies charged with the responsibility of implementing these federal laws.

In addition, our bank subsidiary’s deposit operations are subject to the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement this act, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

Effects of Governmental Policies

The Bank’s earnings are affected by the difference between the interest earned by the Bank on its loans and investments and the interest paid by the Bank on its deposits or other borrowings. The yields on its assets and the rates paid on its liabilities are sensitive to changes in prevailing market rates of interest. Thus, the earnings and growth of the Bank are influenced by general economic conditions, fiscal policies of the federal government, and the policies of regulatory agencies, particularly the Federal Reserve, which establishes national monetary policy. The nature and impact of any future changes in fiscal or monetary policies cannot be predicted.

Commercial banks are affected by the credit policy of various regulatory authorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. Government securities, changes in reserve requirements on bank deposits, changes in the discount rate on bank borrowings and limitations on interest rates that banks may pay on time and savings deposits. The Federal Reserve uses these means in varying combinations to influence overall growth of bank loans, investments and deposits, and also to affect interest rates charged on loans, received on investments or paid for deposits.

The monetary and fiscal policies of regulatory authorities, including the Federal Reserve, also affect the banking industry. Through changes in the reserve requirements against bank deposits, open market operations in U.S. Government securities and changes in the discount rate on bank borrowings, the Federal Reserve influences the cost and availability of funds obtained for lending and investing. No prediction can be made with respect to possible future changes in interest rates, deposit levels or loan demand or with respect to the impact of such changes on the business and earnings of the Bank.

 

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From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial institutions. The nature and extent of the future legislative and regulatory changes affecting financial institutions and the resulting impact on those institutions is very unpredictable at this time. Bills are currently pending which may have the effect of changing the way the Bank conducts its business.

Recent Developments

Civic Acquisition

As previously disclosed in the Current Report on Form 8-K of FFN, which was filed on December 14, 2015, FFN and the Bank entered into an Agreement and Plan of Reorganization and Bank Merger (the “Merger Agreement”) with Civic Bank & Trust (“Civic”), a Tennessee banking corporation, on December 14, 2015. Under the terms of the Merger Agreement, Civic will merge with and into the Bank, with the Bank as the surviving Tennessee banking corporation (the “Civic Merger”). On May 9, 2016, FFN, the Bank and Civic amended the Merger Agreement solely to (i) extend the termination date set forth in the Merger Agreement until March 31, 2017, subject to extension by FFN until June 30, 2017, if FFN has provided Civic with evidence reasonably satisfactory to Civic that an application for approval of the merger has been filed with and accepted for processing by the Federal Reserve on or before March 31, 2017, and (ii) increase the cap on Civic’s transaction expenses from $650,000 to $775,000. FFN and Civic have determined that additional time will be required to obtain regulatory approvals and to satisfy various closing conditions necessary to complete the merger. FFN has learned that federal bank regulators have identified concerns during the course of routine supervisory activities regarding the robustness of the Bank’s procedures, systems and processes related to certain of its compliance programs, given the rapid growth and increasing complexity of the Bank. The Bank is proactively reviewing and supplementing its procedures, systems and processes related to its compliance programs and recruiting experienced compliance personnel to address such concerns.

New Offices and Branches

During 2016, the Bank opened a new branch in Nolensville, Tennessee in Williamson County, located at 7177 Nolensville Pike, Suite A-3, Nolensville, Tennessee 37135, relocated a loan production office to Music Row at 33 Music Square West, Unit 110B, Nashville, Tennessee 37203, and opened a new mortgage loan operations facility, on the campus of its headquarters at 722 Columbia Avenue, Franklin, Tennessee 37064.

Available Information

Our website is located at www.franklinsynergybank.com. We make available free of charge through this website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Reference to our website does not constitute incorporation by reference of the information contained on the site and should not be considered part of this document.

All filings made by us with the SEC may be copied or read at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC as we do. The website is http://www.sec.gov.

 

ITEM 1A. RISK FACTORS.

Our business and its future performance may be affected by various factors, the most significant of which are discussed below.

Risks Related to Our Business

We May Not Be Able to Implement Our Growth Strategy Effectively

Our business has grown quickly. Furthermore, our strategy focuses on organic growth, supplemented by opportunistic acquisitions. We may not be able to execute aspects of our growth strategy to sustain our historical rate of growth or may not be able to grow at all. More specifically, we may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances, obtain the personnel or funding necessary for additional growth or find suitable acquisition candidates. Various factors, such as economic conditions and competition, may impede or prohibit the growth of our operations, the opening of new branches and the consummation of acquisitions.

 

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Competition For Deposits and Loans Is Expected To Be Intense, and No Assurance Can Be Given That We Will Be Successful in Our Efforts to Compete with Other Financial Institutions

The commercial banking industry in Williamson County, Tennessee consists of 33 banks and two savings and loan institutions, with 102 total offices and total deposits of $7.8 billion as of June 30, 2016, which is the most recent date such information has been released by the FDIC. The commercial banking industry in Rutherford County, Tennessee consists of 22 banks and no savings and loan institutions, with 76 total offices and total deposits of $3.7 billion as of June 30, 2016, which is the most recent date such information has been released by the FDIC. Offices affiliated with out-of-state financial institutions have entered Tennessee in recent years to offer all financial services, including lending and deposit gathering activities. Also, changes to laws on interstate banking and branching now permit banks and bank holding companies headquartered outside Tennessee to move into Williamson County and Rutherford County more easily. In addition, there are credit unions, finance companies, securities brokerage firms, and other types of businesses offering financial services. Technological advances and the growth of e-commerce have made it possible for non-financial institutions to offer products and services that traditionally have been offered by banking institutions. Competition for deposit and loan opportunities in our market area is expected to be intense because of existing competitors and the geographic expansion into the market area by other institutions. See “BUSINESS—Supervision and Regulation.” No assurance can be given that we will be successful in our efforts to compete with other such institutions.

There Can Be No Assurance That the Bank Will Not Incur Excessive Loan Losses

An allowance for loan losses account is accumulated through monthly provisions against income. This account is a valuation allowance established for probable incurred credit losses inherent in the loan portfolio. Banks are susceptible to risks associated with their loan portfolios. The Bank’s loan customers may include a disproportionate number of individuals and entities seeking to establish a new banking relationship because they are dissatisfied with the amount or terms of credit offered by their current banks, or they may have demonstrated less than satisfactory performance in previous banking relationships. If the Bank lends to individuals who have demonstrated less than satisfactory performance in previous banking relationships, the Bank could experience disproportionate loan losses, which could have a significantly negative impact on the Bank’s earnings. Although management is aware of the potential risks associated with extending credit to customers with whom they have not had a prior lending relationship, there can be no assurance that the Bank will not incur excessive loan losses. Bank regulators may disagree with the Bank’s characterization of the collectability of loans and may require the Bank to downgrade credits and increase our provision for loan losses that would negatively impact results of operations and capital levels.

Changes in Interest Rates May Reduce the Bank’s Profitability

We incur interest rate risk. The Bank’s profitability is dependent, to a large extent, upon net interest income, which is the difference between its interest income on interest-earning assets, such as loans and investment securities and interest expense on interest-bearing liabilities, such as deposits and borrowings. The Bank will continue to be affected by changes in interest rates and other economic factors beyond its control, particularly to the extent that such factors affect the overall volume of our lending and deposit activities. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. Furthermore, an increase in interest rates may negatively affect the market value of securities in our investment portfolio. A reduction in the market value of our portfolio will increase the unrealized loss position of our available-for-sale investments. Any of these events could materially adversely affect our results of operations or financial condition.

If We Fail to Effectively Manage Credit Risk and Interest Rate Risk, Our Business and Financial Condition Will Suffer

We must effectively manage credit risk. There are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting and guidelines, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. There is no assurance that our credit risk monitoring and loan approval procedures are, or will be, adequate or will reduce the inherent risks associated with lending. Our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. Any failure to manage such credit risks may materially adversely affect our business and our consolidated results of operations and financial condition.

 

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The Bank Depends on Its Ability to Attract Deposits

The acquisition of local deposits is a primary objective of the Bank. If customers move money out of bank deposits and into other investments, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income. In addition to the traditional deposit accounts solicited in its community, the Bank also solicits local deposits through the Internet and will offer Internet-only deposit accounts to supplement traditional depository accounts. The Bank is a member of the FHLB for use as a general funding source and may use Internet funds and brokered deposits to balance funding needs. The ability of the Bank to accept brokered deposits is dependent on its ability to remain “well capitalized.”

The Bank May Be Required to Rely on Secondary Sources of Liquidity to Meet Withdrawal Needs or Fund Operations, and There Can Be No Assurance That These Sources Will Be Sufficient to Meet Future Liquidity Demands

The primary source of the Bank’s funds is customer deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in general economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Accordingly, the Bank may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. These sources include Internet funds, brokered certificates of deposit, investment securities, borrowings from the Federal Reserve, FHLB advances, and federal funds lines of credit from correspondent banks. While management believes that these sources are currently adequate, there can be no assurance that they will be sufficient to meet future liquidity demands. The Bank may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should these sources not be adequate.

Economic Challenges, Especially Those Affecting the Local Economy Where We Operate, Could Affect Our Financial Condition and Results of Operations

If the communities in which we operate do not grow or if prevailing local or national economic conditions are unfavorable, our business may not succeed. Adverse economic conditions to the extent they develop in our primary market area, which currently is limited to Williamson County and Rutherford County, Tennessee and the surrounding areas, could reduce our growth rate, affect the ability of our customers to repay their loans, and generally affect our financial condition and results of operations. Moreover, management cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market area if they do occur. Continued adverse market or economic conditions may increase the risk that the Bank’s borrowers will be unable to timely make their loan payments. Furthermore, even if the Bank’s borrowers continue to make timely loan payments, a deterioration in the real estate market could cause a decline in the appraised values of such mortgaged properties. In the event of such a deterioration, the Bank may be forced to write down the value of the loans, which could have a negative effect on the Bank’s capital ratios and earnings.

The Bank’s loan portfolio is real-estate focused. While real estate lending is the expertise of our lending staff and management, risks associated with this type of lending are heavily influenced by the economic environment. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions.

As of December 31, 2016, approximately 78% of the Bank’s total loans were real-estate secured. One-to-four family residential properties accounted for 23% of the Bank’s portfolio, owner-occupied commercial real estate was 9% and other commercial real estate was 9% of the total loan portfolio. Total construction and land development lending accounted for 35% of total loans with residential construction lending totaling 16%, commercial construction lending totaling 5% and land development lending totaling 7%. Other real estate lending, including multi-family and farmland, accounted for 2% of the total loan portfolio. A sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market or economic conditions in the state of Tennessee, or more specifically the Bank’s market area in Williamson County and Rutherford County in Middle Tennessee, could adversely affect the value of our assets, revenues, results of operations, and financial condition.

 

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Our Financial Condition and Results of Operations Could be Affected if Long-Term Business Strategies Are Not Effectively Executed

Although the Bank’s primary focus in the near term will be organically growing its balance sheet, over the longer term, management may pursue a growth strategy for the Bank’s business through de novo branching. The Bank’s prospects must be considered in light of the risks, expenses, and difficulties occasionally encountered by financial services companies in growth stages, which may include the following:

 

    Operating Results: There is no assurance that existing offices or future offices will maintain or achieve deposit levels, loan balances, or other operating results necessary to avoid losses or produce profits. The Bank’s growth strategy necessarily entails growth in overhead expenses as it routinely adds new offices and staff. Historical results may not be indicative of future results or results that may be achieved as the Bank continues to increase the number and concentration of the Bank’s branch offices.

 

    Development of Offices: There are considerable costs involved in opening branches, and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, de novo branches may be expected to negatively impact earnings during this period of time until the branches reach certain economies of scale.

 

    Regulatory and Economic Factors: Growth and expansion plans may be adversely affected by a number of regulatory and economic developments or other events. Failure to obtain required regulatory approvals, changes in laws and regulations, or other regulatory developments and changes in prevailing economic conditions or other unanticipated events may prevent or adversely affect continued growth and expansion. Failure to successfully address the issues identified above could have a material adverse effect on the Bank’s business, future prospects, financial condition, or results of operations, and could adversely affect the Bank’s ability to successfully implement its longer term business strategy.

The Accuracy of Our Financial Statements and Related Disclosures Could be Affected if the Judgments, Assumptions or Estimates Used in Our Critical Accounting Policies are Inaccurate

The preparation of financial statements and related disclosure in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in the section entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” in this report, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures.

Negative Public Opinion or Failure to Maintain Our Reputation in the Communities We Serve Could Adversely Affect Our Business and Prevent Us from Growing Our Business

As a community bank, our reputation within the communities we serve is critical to our success. We have set ourselves apart from our competitors by building strong personal and professional relationships with our customers and by being an active member of the communities we serve. As such, we strive to enhance our reputation by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve and delivering superior service to our customers. If our reputation is negatively affected by the actions of our employees or otherwise, we may be less successful in attracting new customers, and our business, financial condition, results of operations and prospects could be materially and adversely affected. Further, negative public opinion can expose us to litigation and regulatory action as we seek to implement our growth strategy, such as delays in regulatory approval based on unfounded complaints, which could impede the timeliness of regulatory approval for acquisitions we may make.

The Obligations Associated with Being a Public Company Require Significant Resources and Management Attention, Which Could Increase Our Costs of Operations and May Divert Focus from Our Business Operations

As a public company, we are required to file periodic reports containing our consolidated financial statements with the SEC within a specified time following the completion of quarterly and annual periods. As a public company, we also incur significant legal, accounting, insurance and other expenses. Compliance with these reporting requirements and other rules of the SEC and the rules of the New York Stock Exchange (“NYSE”) or any exchange on which our common stock may be listed in the future could increase our legal and financial compliance costs and make some activities more time consuming and costly. Furthermore, the need to maintain the corporate infrastructure demanded of a public company may divert management’s attention from implementing our growth strategy, which could prevent us from successfully implementing our strategic initiatives and improving our business, results of operations and financial condition. We have made, and will continue to make, changes to our internal controls and procedures for financial reporting

 

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and accounting systems to meet our reporting obligations as a public company. However, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements. We anticipate that these costs will materially increase our general and administrative expenses.

If We Fail to Correct Any Material Weakness That We Identify in Our Internal Control over Financial Reporting or Otherwise Fail to Maintain Effective Internal Control over Financial Reporting, We May Not Be Able to Report Our Financial Results Accurately and Timely

Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for evaluating and reporting on our system of internal control. Our internal control processes are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”). As a public company, we are required to comply with the Sarbanes-Oxley Act and other rules that govern public companies. We are required to certify our compliance with Section 404 of the Sarbanes-Oxley Act, which requires us to furnish annually a report by management on the effectiveness of our internal control over financial reporting. In addition, unless we remain an emerging growth company and elect additional transitional relief available to emerging growth companies, our independent registered public accounting firm will be required to report on the effectiveness of our internal control over financial reporting, beginning as of the first annual report after ceasing to be an emerging growth company.

If we identify material weaknesses in our internal control over financial reporting in the future and we cannot comply with the requirements of the Sarbanes-Oxley Act in a timely manner or attest that our internal control over financial reporting is effective, or if our independent registered public accounting firm cannot express an opinion as to the effectiveness of our internal control over financial reporting when required, we may not be able to report our financial results accurately and timely. As a result, investors, counterparties and customers may lose confidence in the accuracy and completeness of our financial reports; our liquidity, access to capital markets and perceptions of our creditworthiness could be adversely affected; and the market price of our common stock could decline. In addition, we could become subject to investigations by the stock exchange on which our securities are listed, the SEC, the Federal Reserve, the FDIC, or other regulatory authorities, which could require additional financial and management resources. These events could have an adverse effect on our business, financial condition and results of operations.

A Failure in, or Breach of, Our Operational or Security Systems or Infrastructure, or Those of Our Third Party Vendors and Other Service Providers or Other Third Parties, Including as a Result of Cyber Attacks, Could Disrupt Our Businesses, Result in the Disclosure or Misuse of Confidential or Proprietary Information, Damage Our Reputation, Increase Our Costs, and Cause Losses

We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as us have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, and terrorists, activists, and other external parties. As customer, public, and regulatory expectations regarding operational and information security have increased, our operating systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting, and data processing systems, or other operating systems and facilities, may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and as described below, cyber attacks.

Our business relies on its digital technologies, computer and email systems, software and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems and networks and our customers’ devices may become the target of cyber attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ or other third parties’ confidential information. Third parties with whom we do business or who facilitate our business activities, including financial intermediaries, or vendors that provide service or security solutions for our operations, and other unaffiliated third parties, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. In addition, hardware, software or applications we develop or procure from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security.

 

 

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While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remain heightened because of the evolving nature of these threats. As a result, cyber security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the networks, systems or devices that our clients use to access our products and services, could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition. Furthermore, if such attacks are not detected immediately, their effect could be compounded. To date, to our knowledge, we have not experienced any material impact relating to cyber-attacks or other information security breaches.

The Bank Is Subject to General Banking Risks

Several risks are inherent in the business of banking. Factors outside the Bank’s control, such as instability in interest rates, a depressed economy, government regulation, and federal monetary policy, for example, could adversely impact the banking industry. Banks are also exposed to risk of loss as a result of fraud, embezzlement, insider abuse, and mismanagement. Extensions of credit create a risk that loans cannot, or will not, be repaid.

Earnings are affected by the ability of the Bank to properly originate, underwrite and service loans. The Bank could sustain losses if it incorrectly assesses the creditworthiness of its borrowers or fails to detect or respond to deterioration in asset quality in a timely manner. Rapid changes in loan and deposit terms could result in a risk of loss from changes in interest rates. In managing its loans and investments (assets) and its borrowings and deposits (liabilities), the Bank will run the risk of having insufficient liquid assets to meet withdrawal requests.

Beyond general banking risk, we will take limited risk in mortgage banking, wealth management, trust services or other financial services being offered. Such risks could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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Because We Engage in Lending Secured By Real Estate and May Be Forced to Foreclose on the Collateral Property and Own The Underlying Real Estate, We May Be Subject to the Increased Costs and Risk Associated with the Ownership of Real Property, Which Could Have an Adverse Effect on Our Business or Results of Operations

A significant portion of our loan portfolio is secured by real estate property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans, in which case, we are exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including:

 

    general or local economic conditions;

 

    environmental cleanup liability;

 

    neighborhood values;

 

    interest rates;

 

    real estate tax rates;

 

    operating expenses of the mortgaged properties;

 

    supply of and demand for rental units or properties;

 

    ability to obtain and maintain adequate occupancy of the properties;

 

    zoning laws;

 

    governmental rules, regulations and fiscal policies; and

 

    tornadoes or other natural or man-made disasters.

Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may also adversely affect our operating expenses.

We Are Subject to Environmental Liability Risk Associated with Lending Activities

A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more of these properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxic substances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us.

Our Loan Portfolio Includes a Meaningful Amount of Real Estate Construction and Development Loans, Which Have a Greater Credit Risk Than Residential Mortgage Loans

The percentage of loans in real estate construction and development in our portfolio was approximately 28% of total loans at December 31, 2016. These loans make up approximately 32% of our non-performing loans at December 31, 2016. This type of lending is generally considered to have relatively high credit risks because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and operation of the related real estate project. The credit quality of many of these loan types deteriorated during the challenging economic period of 2008 to 2012 due to the adverse conditions in the real estate market during that period and that type of deterioration could occur again. Weakness in residential real estate market prices in the Middle Tennessee area as well as demand could result in price reductions in home and land values adversely affecting the value of collateral securing the construction and development loans that we hold. Should we experience the return of these adverse economic and real estate market conditions we may experience increases in non-performing loans and other real estate owned, increased losses and expenses from the management and disposition of non-performing assets (“NPAs”), increases in provision for loan losses, and increases in operating expenses as a result of the allocation of management time and resources to the collection and work out of loans, all of which would negatively impact our financial condition and results of operations.

 

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We Are Dependent on Key Personnel

We are materially dependent on the performance of our executive management team, loan officers, and other support personnel. The loss of the services of any of these employees could have a material adverse effect on our business, results of operations, and financial condition. Many of these key officers have important customer relationships, which are instrumental to the Bank’s operations. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition, and results of operations. Management believes that future results also will depend, in part, upon attracting and retaining highly skilled and qualified management, especially in the new market areas into which we may enter, as well as in sales and marketing personnel. Competition for such personnel is intense, and management cannot be sure that we will be successful in attracting or retaining such personnel.

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

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.

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

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.

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.

Risks Related to the Regulation of Our Business

We Are Subject to Extensive Regulation

We are subject to extensive governmental regulation and control. Compliance with state and federal banking laws has a material effect on our business and operations. Our operations will at all times be subject to state and federal banking laws, regulations, and procedures. The laws and regulations applicable to the banking industry could change at any time and are subject to interpretation, and management cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably. Non-banking financial institutions, such as securities brokerage firms, insurance companies, and money market funds are now permitted to offer services which compete directly with services offered by banks. See “BUSINESS—Supervision and Regulation.”

The Regulatory Environment for the Financial Services Industry Is Being Significantly Impacted by Financial Regulatory Reform Initiatives, Which May Adversely Impact Our Business, Results of Operations and Financial Condition.

The Dodd-Frank Act contains comprehensive provisions governing the practices and oversight of financial institutions and other participants in the financial markets. See “BUSINESS—Supervision and Regulation.” The Dodd-Frank Act established, among other requirements, a new financial industry regulator, the CFPB, to centralize responsibility for consumer financial protection with broad rulemaking authority to administer and carry out the purposes and objectives of the “Federal consumer financial laws and to prevent evasions thereof,” with respect to all financial institutions that offer financial products and services to consumers, including deposit products, residential mortgages, home-equity loans and credit cards and contains provisions on mortgage-related matters, such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties. The CFPB is also authorized to

 

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prescribe rules applicable to any covered person or service provider, identifying and prohibiting “unfair, deceptive, or abusive acts or practices” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service (“UDAAP authority”). The ongoing broad rulemaking powers of the CFPB and its UDAAP authority have the potential to have a significant impact on the operations of financial institutions offering consumer financial products or services. The CFPB has indicated that they are examining proposing new rules on overdrafts and other consumer financial products or services and if any such rule limits our ability to provide such financial products or services it may have an adverse effect on our business. Additional legislative or regulatory action that may impact our business may result from the multiple studies mandated under the Dodd-Frank Act. Although the applicability of certain elements of the Dodd-Frank Act is limited to institutions with more than $10 billion in assets, there can be no guarantee that such applicability will not be extended in the future or that regulators or other third parties will not seek to impose such requirements on institutions with less than $10 billion in assets. Finally, President Donald Trump and the Congressional majority have indicated that the Dodd-Frank Act will be under further scrutiny and some of the provisions of the Dodd-Frank Act rules promulgated thereunder may be revised, repealed or amended. We cannot predict with any degree of certainty what impact, if any, these or future reforms will have on our business, financial condition, or results of operations.

The evolving regulatory environment causes uncertainty with respect to the manner in which we conduct our businesses and requirements that may be imposed by our regulators. Regulators have implemented and continue to propose new regulations and issue supervisory guidance and have been increasing their examination and enforcement action activities. We expect that regulators will continue taking formal enforcement actions against financial institutions in addition to addressing supervisory concerns through non-public supervisory actions or findings. We are unable to predict the nature, extent or impact of any additional changes to statutes or regulations, including the interpretation, implementation or enforcement thereof, which may occur in the future.

The impact of the evolving regulatory environment on our business and operations depends upon a number of factors including final implementing regulations, guidance and interpretations of the regulatory agencies, supervisory priorities and actions, the actions of our competitors and other marketplace participants, and the behavior of consumers. The evolving regulatory environment could require us to limit or change our business practices, limit our product offerings, require continued investment of management time and resources in compliance efforts, limit fees we can charge for services, require us to meet more stringent capital, liquidity and leverage ratio requirements, increase costs, impact the value of our assets, or otherwise adversely affect our businesses. The regulatory environment and enhanced examination and supervisory expectations and scrutiny can also potentially impact our ability to pursue business opportunities and obtain required regulatory approvals for potential investments and acquisitions.

Compliance and other regulatory requirements and expenditures have increased significantly for us and other financial services firms, and we expect them to continue to increase as regulators adopt new rules, interpret existing rules and increase their scrutiny of financial institutions, including controls and operational processes. We may face additional compliance and regulatory risk to the extent that we enter into new lines of business or new business arrangements with third-party service providers, alternative payment providers or other industry participants, including providers or participants that may not be regulated financial institutions. The additional expense, time and resources needed to comply with ongoing regulatory requirements may adversely impact our business and results of operations. In addition, regulatory findings and ratings could negatively impact our business strategies.

We Are Affected by Governmental Monetary Policies

Like all regulated financial institutions, we are affected by monetary policies implemented by the Federal Reserve and other federal instrumentalities. A primary instrument of monetary policy employed by the Federal Reserve is the restriction or expansion of the money supply through open market operations. This instrument of monetary policy frequently causes volatile fluctuations in interest rates, and it can have a direct, adverse effect on the operating results of financial institutions. Borrowings by the United States government to finance the government debt may also cause fluctuations in interest rates and have similar effects on the operating results of such institutions. See “BUSINESS—Supervision and Regulation.”

The Impact of the Changing Regulatory Capital Requirements and Capital Rules Is Uncertain

Under rules adopted by the Federal Reserve and FDIC, the leverage and risk-based capital ratios of bank holding companies may not be lower than the leverage and risk-based capital ratios for insured depository institutions. These rules became effective as to FFN and the Bank on January 1, 2015 and include new minimum risk-based capital and leverage ratios. Moreover, these rules refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements now applicable to bank holding companies and banks subject to the rules are: (i) a Common Equity Tier 1 Capital ratio of 4.5%; (ii) a Tier 1 Risk-Based Capital ratio of 6%; (iii) a total Risk-Based Capital ratio of 8%; and (iv) a Tier 1 Leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% (being phased in over three years) above the new regulatory minimum capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in: (i) a Common Equity Tier 1 Risk-Based Capital ratio of 7.0%, (ii) a Tier 1 Risk-Based Capital ratio of 8.5%, and (iii) a total Risk-Based Capital ratio of 10.5%. The capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital levels fall below the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

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The application of these more stringent capital requirements to FFN and the Bank could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if FFN or the Bank were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of the final rules could result in FFN or the Bank having to lengthen the term of their funding, restructure their business models and/or increase their holdings of liquid assets. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy and could limit FFN’s and the Bank’s ability to make distributions, including paying dividends or buying back shares. See “BUSINESS—Supervision and Regulation.”

The Expanding Body of Federal, State and Local Regulation and/or the Licensing of Loan Servicing, Collections or Other Aspects of Our Business May Increase the Cost of Compliance And the Risks of Noncompliance

We service our own loans, and loan servicing is subject to extensive regulation by federal, state and local governmental authorities as well as to various laws and judicial and administrative decisions imposing requirements and restrictions on those activities. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan servicing activities including delaying or temporarily preventing foreclosures or forcing the modification of certain mortgages. If regulators impose new or more restrictive requirements, we may incur additional significant costs to comply with such requirements which may further adversely affect us. In addition, our failure to comply with these laws and regulations could possibly lead to: civil and criminal liability; loss of licensure; damage to our reputation in the industry; fines and penalties and litigation, including class action lawsuits; and administrative enforcement actions. Any of these outcomes could materially and adversely affect our business, financial condition, results of operations and prospects.

Federal and State Regulators Periodically Examine Our Business and We May Be Required to Remediate Adverse Examination Findings

The Federal Reserve, the FDIC, and the TDFI periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, a banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, they may take a number of different remedial actions as they deem appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil money penalties, to fine or remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. Any regulatory action against us could have an adverse effect on our business, financial condition and results of operations.

We are Required to Comply with the Terms of a Memorandum of Understanding (“MOU”) that the Bank has Entered into with the Federal Reserve Bank of Atlanta (“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.

Our Growth May Be Limited by Regulatory Restrictions

In addition to the MOU discussed above, the Company has executed an agreement with the Board of Governors of the Federal Reserve System under section 4(m)(2) of the Bank Holding Company Act (the “Agreement”), which includes specific actions designed to address the Bank’s risk profile and to strengthen the underlying condition of the Bank. Until FFN and the Bank satisfy the

 

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requirements of the MOU and the Agreement, any plans for business combinations, including our ability to close our pending merger with Civic, or location expansion will be limited and subject to prior written approval from the appropriate regulatory body. In the future, we may become subject to additional supervisory actions and/or enhanced regulation that could have a material negative effect on business, operating flexibility, financial condition, and the value of our common stock.

Our FDIC Deposit Insurance Premiums and Assessments May Increase

The deposits of our subsidiary bank are insured by the FDIC up to legal limits and, accordingly, subject our bank subsidiary to the payment of FDIC deposit insurance assessments. The Bank’s regular assessments are based on its average consolidated total assets minus average tangible equity as well as by risk classification, which includes regulatory capital levels and the level of supervisory concern. High levels of bank failures since the beginning of the financial crisis and increases in the statutory deposit insurance limits have increased resolution costs to the FDIC and put significant pressure on the DIF. In order to maintain a strong funding position and restore the reserve ratios of the DIF, the FDIC has, in the past, increased deposit insurance assessment rates and charged a special assessment to all FDIC-insured financial institutions. Further increases in assessment rates or special assessments may occur in the future, especially if there are significant additional financial institution failures. Any future special assessments, increases in assessment rates or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could have an adverse effect on our business, financial condition and results of operations.

We Are Required to Act As a Source of Financial and Managerial Strength For Our Bank in Times of Stress

Under federal law and longstanding Federal Reserve policy, we are expected to act as a source of financial and managerial strength to our bank, and to commit resources to support our bank if necessary. We may be required to commit additional resources to our bank at times when we may not be in a financial position to provide such resources or when it may not be in our, or our shareholders’ or creditors’, best interests to do so. Providing such support is more likely during times of financial stress for us and our bank, which may make any capital we are required to raise to provide such support more expensive than it might otherwise be. In addition, any capital loans we make to our bank are subordinate in right of payment to depositors and to certain other indebtedness of our bank. In the event of our bankruptcy, any commitment by us to a federal banking regulator to maintain the capital of our bank will be assumed by the bankruptcy trustee and entitled to priority of payment. See “BUSINESS—Supervision and Regulation—Bank Holding Company Regulation.”

Future Acquisitions Generally Will Require Regulatory Approvals and Failure to Obtain Them Would Restrict Our Growth

We may decide to explore complementing and expanding our products and services by pursuing strategic acquisitions. Generally, any acquisition of target financial institutions, branches or other banking assets by us will require approval by and cooperation from, a number of governmental regulatory agencies, possibly including the Federal Reserve, and the FDIC, as well as state banking regulators. In acting on applications, federal banking regulators consider, among other factors:

 

    The effect of the acquisition on competition;

 

    The financial condition, liquidity, results of operations, capital levels and future prospects of the applicant and the bank(s) involved;

 

    The quantity and complexity of previously consummated acquisitions;

 

    The managerial resources of the applicant and the bank(s) involved;

 

    The convenience and needs of the community, including the record of performance under the CRA;

 

    The effectiveness of the applicant in combating money-laundering activities;

 

    The applicant’s regulatory compliance record; and

 

    The extent to which the acquisition would result in greater or more concentrated risk to the stability of the United States banking or financial system.

Such regulators could deny our application based on the above criteria or other considerations, which would restrict our growth, or the regulatory approvals may not be granted on terms that are acceptable to us. For example, we could be required to sell branches as a condition to receiving regulatory approvals and such a condition may not be acceptable to us or may reduce the benefit of any acquisition.

 

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Index to Financial Statements

We Face a Risk of Noncompliance and Enforcement Action with the Bank Secrecy Act and Other Anti-Money Laundering Statutes and Regulations

The Bank Secrecy Act (the “BSA”), the USA PATRIOT Act of 2001 (the “Patriot Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have an adverse effect on our business, financial condition and results of operations.

Risks Related to the Civic Merger

Regulatory Approvals May Not Be Received, May Continue to Take Longer Than Expected or May Impose Conditions That Are Not Presently Anticipated or Cannot Be Met

We have not received the regulatory approvals required to consummate the Civic Merger. Before the transactions contemplated in the Merger Agreement may be completed, including the Civic Merger, prior approval of our applications and notices filed with the FRB and TDFI must be obtained. These governmental agencies may impose additional conditions on the completion of the Civic Merger or require changes to the terms of the Merger Agreement. Such conditions or changes could have the effect of further delaying completion of the transactions contemplated in the Merger Agreement or imposing additional costs on or limiting the Bank’s or Civic’s revenues, any of which might have a material adverse effect on FFN following the Civic Merger. There can be no assurance as to whether the regulatory approvals will be received, the timing of those approvals, or whether any conditions will be imposed.

We Have Incurred and Will Incur Substantial Expenses Related to Our Pending Acquisition of Civic

We have incurred and will incur substantial expenses in connection with our pending acquisition of Civic and integrating the operations of the acquired business of Civic with our operations. There are a number of factors beyond our control that could affect the total amount or the timing of our transaction and integration expenses and such expenses may exceed our initial projections. Many of the expenses that will be incurred, by their nature, are difficult to accurately estimate at the present time. As a result, the transaction and integration expenses associated with our pending acquisition of Civic could exceed the savings that we expect to achieve from the realization of economies of scale and cost savings related to the integration of the acquired business of Civic following the completion of the acquisition.

Fluctuations in the Trading Price of FFN Common Stock Preceding the Effective Time of the Civic Merger Will Change the Number of Shares of FFN Common Stock That Civic Shareholders Will Receive in the Civic Merger.

At the effective time of the Civic Merger, all outstanding shares of common stock of Civic will be exchanged for that number of shares of common stock of FFN with an aggregate value of $28,625,000, calculated by dividing this aggregate value by the volume weighted average closing price of FFN’s common stock for the 20 consecutive trading days ending on and including the 10th trading day preceding the effective date of the Civic Merger; provided, however, that the market value per share of FFN’s common stock used to determine the number of shares of FFN common stock to be issued will be no more than $29.50 per share, and no less than $26.50 per share. Accordingly, the value of the shares of FFN common stock Civic shareholders will receive will not change, although the number of shares of common stock received will vary with the market price for FFN common stock, within the $26.50 to $29.50 range of market value, such that the number of shares of FFN common stock issued in the Civic Merger to holders of Civic common stock will be between 970,338 and 1,080,188 shares.

The market price of FFN’s common stock at the time the Civic Merger is completed may vary from the price of FFN’s common stock on the date the Merger Agreement was executed and/or on the date of the Civic special meeting as a result of various factors that are beyond the control of FFN and Civic, including but not limited to general market and economic conditions, changes in our respective businesses, operations and prospects, and regulatory considerations. In addition to the approval of the Merger Agreement by Civic shareholders, completion of the Civic Merger is subject to satisfaction of other conditions that may not occur until after the Civic special meeting. Therefore, at the time of the Civic special meeting Civic shareholders will not know or be able to calculate the precise consideration they will receive at the effective time of the Civic Merger.

Before or after the Civic Merger, the market value of FFN common stock may decrease and be lower than the FFN market price that is used in calculating the consideration to be received by holders of Civic common stock in the Civic Merger.

 

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FFN May Not Be Able to Successfully Integrate Civic or to Realize the Anticipated Benefits of the Civic Merger

The Civic Merger involves the combination of two banks that previously have operated independently. A successful combination of the operations of the two entities will depend substantially on FFN’s ability to consolidate operations, systems and procedures and to eliminate redundancies and costs. FFN also intends to utilize most if not all of Civic’s employees, a plan that may or may not be completely feasible as the growth of the banks and FFN continues and the demands of the marketplace dictate. FFN may not be able to combine the operations of Civic and FSB without encountering difficulties, such as:

 

    the loss of key employees;

 

    disruption of operations and business;

 

    inability to maintain and increase competitive presence;

 

    deposit attrition, customer loss and revenue loss;

 

    possible inconsistencies and disruptions during the period needed to integrate standards, control procedures and policies;

 

    unexpected problems with costs, operations, personnel, technology and credit; and/or

 

    problems with the assimilation of new operations, sites or personnel, which could divert resources from regular banking operations.

Additionally, general market and economic conditions or governmental actions affecting the financial industry generally may inhibit the successful integration of Civic and the Bank.

Further, FFN, the Bank and Civic entered into the Merger Agreement with the expectation that the Civic Merger will result in various benefits including, among other things, benefits relating to enhanced revenues, a strengthened market position for the combined company, cross-selling opportunities, technology, cost savings and operating efficiencies. Achieving the anticipated benefits of the Civic Merger is subject to a number of uncertainties, including whether FFN integrates Civic in an efficient and effective manner, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected revenues and diversion of management’s time and energy and could materially impact FFN’s business, financial condition and operating results. Finally, any cost savings that are realized may be offset by losses in revenues or other charges to earnings.

The Combined Company Will Incur Significant Transaction and Merger-Related Costs in Connection With the Merger

FFN and Civic expect to incur costs associated with combining the operations of Civic and the Bank. FFN and Civic will need to collect additional information in order to formulate detailed integration plans to deliver planned synergies. Additional unanticipated costs may be incurred in the integration of the businesses of FFN and Civic. Although FFN and Civic expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, may offset incremental transaction and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.

Whether or not the Civic Merger is consummated, FFN and Civic will incur substantial expenses, such as legal, accounting and financial advisory fees, in pursuing the Civic Merger. Completion of the Civic Merger is conditioned upon the receipt of all material governmental authorizations, consents, orders and approvals, including approval by federal and state banking regulators.

Directors and Officers of Civic have Potential Conflicts of Interest in the Merger

You should be aware that some directors and officers of Civic have interests in the Civic Merger that are different from, or in addition to, the interests of Civic shareholders generally.

For example, certain of the executive officers of Civic have been offered change in control agreements by the Bank that provide the executive officer with payments upon a change in control of FFN or the Bank. Also, FFN has agreed to add Anil Patel, MD, to the boards of FFN and the Bank, and Dr. Patel will receive compensation for serving on these boards. These agreements may create potential conflicts of interest by creating vested interests in those persons in the completion of the Civic Merger. In addition, FFN agreed in the Merger Agreement to provide liability insurance to Civic officers and directors. These and certain other additional interests of Civic’s directors and officers may cause some of these persons to view the proposed transaction differently than you view it, although Civic’s board and officers currently have comparable director and officer insurance coverages.

 

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Index to Financial Statements

Failure to Complete the Civic Merger Could Cause FFN’s Stock Price to Decline

If the Civic Merger is not completed for any reason, FFN’s stock price may decline because costs related to the Civic Merger, such as legal, accounting and financial advisory fees, must be paid even if the Civic Merger is not completed. In addition, if the Civic Merger is not completed, FFN’s stock price may decline to the extent that the current market price reflects a market assumption that the Civic Merger will be completed or due to questions about why (or whose “fault” it was that) the Civic Merger was not completed.

Risks Related to an Investment in Our Common Stock

Shares of Our Common Stock Are Not Insured

Shares of our common stock are not deposits and are not insured by the FDIC or any other entity and you will bear the risk of loss if the value or market price of our common stock is adversely affected.

An Active, Liquid Market for Our Common Stock May Not Develop or Be Sustained, Which May Impair the Ability of Our Shareholders to Sell Their Shares

We listed our common stock on the NYSE on March 26, 2015 under the symbol “FSB” in connection with our initial public offering. Even though our common stock is now listed , there is limited trading volume and an active, liquid trading market for our common stock may not develop or be sustained. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace and independent decisions of willing buyers and sellers of our common stock, over which we have no control. If an active, liquid trading market for our common stock does not develop, shareholders may not be able to sell their shares at the volume, prices and times desired. Moreover, the lack of an established market could materially and adversely affect the value of our common stock. The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common stock in the future.

The Market Price of Our Common Stock May Fluctuate Significantly

The market price of our common stock could fluctuate significantly due to a number of factors, including, but not limited to:

 

    our quarterly or annual earnings, or those of other companies in our industry;

 

    actual or anticipated fluctuations in our operating results, financial condition or asset quality;

 

    changes in economic or business conditions;

 

    the public reaction to our press releases, other public announcements or statements and our filings with the SEC;

 

    perceptions in the market place involving our competitors and/or us;

 

    changes in business, legal or regulatory conditions, or other developments affecting participants in our industry, and publicity regarding our business or any of our significant customers or competitors;

 

    changes in governmental monetary policies, including the policies of the Federal Reserve;

 

    regulatory actions that impact us, including actions taken by the Federal Reserve and the TDFI;

 

    changes in financial estimates and recommendations by securities analysts following our stock, or the failure of securities analysts to cover or continue to cover our common stock;

 

    changes in earnings estimates by securities analysts or our performance as compared to those estimates;

 

    significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving our competitors or us;

 

    the trading volume of our common stock;

 

    future sales of our common stock;

 

    our treatment as an “emerging growth company” under federal securities laws;

 

    additions or departures of key personnel;

 

    changes in accounting standards, policies, guidance, interpretations or principles;

 

    failure to integrate acquisitions or realize anticipated benefits from our acquisitions;

 

    rapidly changing technology; and

 

 

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Index to Financial Statements
    other news, announcements or disclosures (whether by us or others) related to us, our competitors, our core market or the bank and non-bank financial services industries.

If any of the foregoing occurs, it could cause our stock price to fall and expose us to litigation that, even if our defense is successful, could distract management and be costly to defend.

Shares of Our Common Stock Are Subject to Dilution and the Market Price of Our Common Stock Could Decline Due to the Number of Outstanding Shares of Our Common Stock Eligible for Future Sale

Actual or anticipated issuances or sales of additional amounts of our common stock in the future could cause the market price of our common stock to decline significantly and make it more difficult for us to sell equity securities in the future at a time and on terms that we deem appropriate. The issuance of any shares of our common stock in the future also would dilute the percentage ownership interest held by shareholders prior to such issuance. As of December 31, 2016, we had 13,036,954 shares of common stock issued and outstanding. Of the outstanding shares of common stock, all of the 2,640,000 shares that were sold in our initial public offering are freely tradable, except that any shares purchased by “affiliates” (as that term is defined in Rule 144 under the Securities Act of 1933, as amended (the “Securities Act”)), may be sold publicly only in compliance with certain limitations. In addition, 2,766,191 shares of our outstanding common stock were issued pursuant to a registration statement on Form S-4 in connection with the acquisition of MidSouth Bank in July 2014 and are freely tradable. On October 28, 2015, we filed a registration statement on Form S-8 under the Securities Act to register an aggregate of 4,000,000 shares of our common stock for issuance under our 2007 Omnibus Equity Incentive Plan. In addition, on November 30, 2015, we filed a registration statement on Form S-3 under the Securities Act to register, among other things, an aggregate of 1,690,598 shares of our common stock held by our existing shareholders that are currently freely tradable. On November 21, 2016, we issued 2,242,500 shares of our common stock in an underwritten public offering pursuant to our effective shelf registration statement on Form S-3. The remaining shares of our common stock may be sold in the market over time in accordance with Rule 144 under the Securities Act or otherwise in future public offerings. Accordingly, the market price of our common stock could be adversely affected by actual or anticipated sales of a significant number of shares of our common stock in the future.

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

Shares of our common stock are equity interests and do not constitute indebtedness. As such, shares of our common stock rank junior to all of our outstanding indebtedness, including our outstanding March 2016 Notes and our June 2016 Notes, and to other non-equity claims against us and our assets available to satisfy claims against us, including in our liquidation. Additionally, 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 also 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. 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. 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.

There Is No Certainty of Return on Investment

No assurance can be given that a holder of shares of our common stock will realize a substantial return on his or her investment, or any return at all. Further, as a result of the uncertainty and risks associated with our operations as described in this “RISK FACTORS” section, it is possible that an investor will lose his or her entire investment.

We Cannot Ensure When or If We Will Pay Dividends

Our ability to pay dividends is highly dependent on the Bank’s ability to pay dividends and may be limited based upon regulatory restrictions and based upon our earnings and capital needs. The Bank is subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us. On November 3, 2016, the Bank entered into an informal agreement with the Reserve Bank and the TDFI in the form of a MOU. Under the terms of the MOU, the Bank agreed, among other things, to seek prior written approval of the Reserve Bank and the TDFI to pay dividends to FFN, which dividends are used primarily for the purpose of servicing FFN’s subordinated debt. As a result, we cannot project or guarantee when dividends will be declared in the future, if at all. Our Board of Directors has also decided to not pay dividends on common stock at this time.

 

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Index to Financial Statements

We May Require Additional Capital

The Board of Directors believes that the current level of capital will be adequate at the present time to sustain the operations and projected growth of FFN and the Bank and to enable FFN to service its debt. If FFN or the Bank fails to achieve sufficient financial performance (including as a result of significant provision expense as a result of deterioration in asset quality) or if the assets of the Bank grow more quickly than projected, management may determine, or government regulators may require, FFN or the Bank to raise additional capital. In the event FFN or the Bank falls below certain regulatory capital adequacy standards, they may become subject to regulatory intervention and restrictions. Although the Bank is currently “well capitalized,” under the terms of the MOU, the Bank agreed, among other things, to enhance its capital and liquidity plans. We can give no assurance that such additional capital is available at prices that will be acceptable to us, if at all. In the event of the issuance of additional shares, then current shareholders will not have the first right to subscribe to new shares (preemptive rights), so their ownership percentage may be diluted in the future. In addition, if FFN is not able to maintain sufficient capital at the holding company and the payment of dividends by the Bank to FFN is not approved by the Reserve Bank and the TDFI, it may be unable to service its debt.

We Face Risks Related to Our Commercial Real Estate Loan Concentrations

Commercial real estate (“CRE”) is cyclical and poses risks of possible loss due to concentration levels and similar risks of the asset class. As of December 31, 2016, approximately 56% of our loan portfolio consisted of CRE loans, including 28% of construction and land development (“CLD”) loans, which present additional risks including underwriting risks, project risks and market risks. The banking regulators give CRE lending greater scrutiny, and in connection with the MOU, has required us to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly requiring a re-assessment of allowances for possible loan losses and capital levels as a result of CRE lending growth and exposures. In addition, while we believe we have appropriate systems in place to underwrite and monitor the risks associated with CLD loans, if these systems do not adequately protect us from these risks, we could incur losses that exceed our reserves for such losses, which could adversely impact our earnings.

If We Are Unable to Decrease Our Use of Out of Market and Brokered Deposits, Our Costs May Be Higher Than Expected

Although we are increasing our effort to decrease our use of non-core funding sources, we can offer no assurance that we will be able to increase our market share of core-deposit funding in our highly competitive service areas. If we are unable to do so, we may be forced to accept increased amounts of out of market or brokered deposits. As of December 31, 2016, we had approximately $466.4 million in out of market brokered deposits, which represented approximately 19.5% of our total deposits. The cost of out of market and brokered deposits typically exceeds the cost of deposits in our local markets which will decrease our net income. In addition, the cost of out of market and brokered deposits can be volatile, and if we are unable to access these types of deposits or if our costs related to out of market and brokered deposits increases, our liquidity and ability to support demand for loans could be adversely affected.

We Are an Emerging Growth Company and We Cannot Be Certain if the Reduced Disclosure Requirements Applicable to Emerging Growth Companies Will Make Our Common Stock Less Attractive to Investors

We are an emerging growth company. For as long as we continue to be an emerging growth company, among other things, we 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 our 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 we comply with the greater obligations of public companies that are not emerging growth companies, we may avail ourselves of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We will remain an emerging growth company for up to five years following the effectiveness of our Registration Statement on Form S-4, which was declared effective by the SEC on May 14, 2014, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million) or if our total annual gross revenues equal or exceed $1 billion in a fiscal year. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

 

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Anti-Takeover Provisions Could Adversely Affect Our Shareholders

Tennessee law and provisions contained in our charter, as amended, and our amended and restated bylaws could make it difficult for a third party to acquire us, even if doing so might be beneficial to our shareholders. For example, our charter, as amended, authorizes our Board of Directors to determine the designation, preferences, limitations and relative rights of unissued preferred stock, without any vote or action by our shareholders. As a result, our Board of Directors could authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock or with other terms that could impede the completion of a merger, tender offer or other takeover attempt. In addition, certain provisions of Tennessee law, including a provision which restricts certain business combinations between a Tennessee corporation and certain interested shareholders, may delay, discourage or prevent an attempted acquisition or change in control of our company that some or all of our shareholders might consider to be desirable. As a result, efforts by our shareholders to change the direction or management of our company may be unsuccessful.

The ability of a third party to acquire us is also limited under applicable banking regulations. With certain limited exceptions, federal regulations prohibit a person, a company or a group of persons deemed to be “acting in concert” from, directly or indirectly, acquiring more than 10% (5% if the acquirer is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise direct our management or policies without prior notice or application to and the approval of the Federal Reserve. Companies investing in banks and bank holding companies receive additional review and may be required to become bank holding companies, subject to regulatory supervision. Accordingly, prospective investors must be aware of and comply with these requirements, if applicable, in connection with any purchase of shares of our common stock. These provisions effectively inhibit certain mergers or other business combinations, which, in turn, could adversely affect the market price of our common stock.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

 

ITEM 2. PROPERTIES.

FFN’s and the Bank’s main office and headquarters operation is located at 722 Columbia Avenue, Franklin, Tennessee 37064. This location is leased by the Bank. The Bank operates branches at the following locations: 3359 Aspen Grove Drive, Suite 100, Franklin, Tennessee 37067; 134 Pewitt Drive, Suite 100, Brentwood, Tennessee 37027; 1015 Westhaven Blvd., Suite 150, Franklin, Tennessee 37064; 40 Moss Lane, Suite 100, Franklin, Tennessee 37064; 2035 Wall Street, Spring Hill, Tennessee 37174; 7177 Nolensville Road, Suite A3, Nolensville, Tennessee 37135; One East College Street, Murfreesboro, Tennessee 37130; 724 President Place, Smyrna, Tennessee 37167; 2415 Memorial Boulevard, Murfreesboro, Tennessee 37129; 2782 South Church Street, Murfreesboro, Tennessee 37127; and 2610 Old Fort Parkway, Murfreesboro, Tennessee 37128. The Bank also operates a mortgage loan office at 123 East College Street, Murfreesboro, Tennessee 37130, and a loan production office at 33 Music Square West, Nashville, Tennessee 37203. Twelve of these locations are leased by the Bank; two are owned. Certain lease agreements for these properties are with entities owned by related parties of FFN and the Bank.

 

ITEM 3. LEGAL PROCEEDINGS.

Neither we nor any subsidiary is aware of any pending or threatened material legal proceeding to which we or any such subsidiary is a party. Similarly, none of the properties of us or any subsidiary is subject to such proceedings.

 

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information and Holders

Our common stock began trading on the New York Stock Exchange (“NYSE”) on March 26, 2015, under the ticker symbol “FSB”. Prior to March 26, 2015, our common stock traded on the OTCQB of the OTC Markets Group. The following table sets forth the range of high and low sale prices of our common stock as reported on the NYSE and OTCQB, as applicable, for the periods indicated since January 1, 2015. The OTCQB prices during the first quarter of 2015 as reflected in the table below reflect sporadic, limited trading of our common stock, without retail mark-up, mark-down or commissions.

 

     High      Low  

2016

     

First Quarter (January 1 to March 31)

   $ 31.62      $ 22.83  

Second Quarter (April 1 to June 30)

   $ 33.53      $ 24.80  

Third Quarter (July 1 to September 30)

   $ 37.79      $ 29.90  

Fourth Quarter (October 1 to December 31)

   $ 42.80      $ 29.85  

2015

     

First Quarter (January 1 to March 31)

   $ 24.00      $ 17.30  

Second Quarter (April 1 to June 30)

   $ 23.10      $ 19.25  

Third Quarter (July 1 to September 30)

   $ 26.40      $ 21.50  

Fourth Quarter (October 1 to December 31)

   $ 33.26      $ 21.79  

As of February 28, 2017, we had 1,653 shareholders of record of our common stock.

Dividend Policy

We have not declared or paid any dividends on our common stock. We currently intend to retain all of our future earnings, if any, for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future; however, our Board of Directors may decide to declare dividends in the future. Payments of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, tax considerations, general economic conditions and any legal or contractual limitations on our ability to pay dividends. We are not obligated to pay dividends on our common stock.

As a bank holding company, our ability to pay dividends is affected by the policies and enforcement powers of the Federal Reserve. In addition, because we are a holding company, we are dependent upon the payment of dividends by the Bank to us as our principal source of funds to pay dividends in the future, if any, and to make other payments. The Bank is also subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us. The Bank currently may not pay dividends without prior written approval from its primary regulatory agencies. See “BUSINESS—Supervision and Regulation.” Under the terms of the MOU, the Bank agreed, among other things, to seek prior written approval of the Reserve Bank and the TDFI to pay dividends to FFN. In addition, in the future we may enter into borrowing or other contractual arrangements that restrict our ability to pay dividends.

 

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Recent Sales of Unregistered Securities

Shares of the Company’s common stock were issued during the fourth 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  

10/03/2016

     750      Warrants Exercised    $ 12.00      $ 9,000.00  

10/13/2016

     125      Warrants Exercised    $ 12.00      $ 1,500.00  

11/01/2016

     375      Warrants Exercised    $ 12.00      $ 4,500.00  

11/16/2016

     500      Warrants Exercised    $ 12.00      $ 6,000.00  

11/25/2016

     16,424      Options Exercised    $ 10.00      $ 164,240.00  
     8,126      Options Exercised    $ 12.00      $ 97,512.00  
     2,161      Options Exercised    $ 13.00      $ 28,093.00  
     1,486      Options Exercised    $ 13.50      $ 20,061.00  
     721      Options Exercised    $ 20.69      $ 14,917.49  

12/05/2016

     379      Options Exercised    $ 13.50      $ 5,116.50  
     432      Options Exercised    $ 20.69      $ 8,938.08  

12/07/2016

     1,500      Options Exercised    $ 10.00      $ 15,000.00  
     600      Options Exercised    $ 12.50      $ 7,500.00  
     89      Options Exercised    $ 13.00      $ 1,157.00  
     2,214      Options Exercised    $ 13.50      $ 29,889.00  
     185      Options Exercised    $ 20.69      $ 3,827.65  

12/08/2016

     500      Options Exercised    $ 10.00      $ 5,000.00  

12/12/2016

     125      Warrants Exercised    $ 12.00      $ 1,500.00  

12/13/2016

     1,500      Options Exercised    $ 10.00      $ 15,000.00  
     4,904      Options Exercised    $ 12.00      $ 58,848.00  

12/14/2016

     3,075      Options Exercised    $ 10.00      $ 30,750.00  
     117      Options Exercised    $ 13.00      $ 1,521.00  
     296      Options Exercised    $ 13.50      $ 3,996.00  
     198      Options Exercised    $ 20.69      $ 4,096.62  

12/15/2016

     1,000      Options Exercised    $ 10.00      $ 10,000.00  

12/16/2016

     862      Options Exercised    $ 10.00      $ 8,620.00  
     200      Options Exercised    $ 13.50      $ 2,700.00  
     79      Options Exercised    $ 20.69      $ 1,634.51  

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.

Equity Compensation Plan Information as of December 31, 2016

 

Plan Category

   Number of Securities to be
Issued upon Exercise of
Outstanding Options,
Warrants and  Rights
     Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights  ($)
     Number of Securities
Remaining Available for
Future Issuance under
Equity Compensation Plans
 

Equity Compensation Plans Approved by stockholders

     1,411,873      $ 16.64        2,014,652  

Equity Compensation Plans not approved by stockholders

     0      $ 0        0  
  

 

 

    

 

 

    

 

 

 

Total

     1,411,873      $ 16.64        2,014,652  
  

 

 

    

 

 

    

 

 

 

 

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Index to Financial Statements

Performance Graph

This performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Franklin Financial Network, Inc. under the Securities Act or the Exchange Act.

The following graph shows a comparison from March 26, 2015 (the date our common stock commenced trading on the NYSE) through December 31, 2016 of the cumulative total return for our common stock, the NYSE Composite Index and the KBW Regional Banks Index. The graph assumes that $100 was invested at the market close on March 26, 2015 in the common stock of Franklin Financial Network, Inc., the NYSE Composite Index and the KBW Regional Banks Index and data assumes reinvestments of dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance.

Comparison of 22 Month Cumulative Total Return

Assumes Initial Investment of $100

December 2016

 

LOGO

 

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Index to Financial Statements
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA.

The following selected historical consolidated financial data as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, is derived from the audited consolidated financial statements of FFN.

(Amounts are in thousands, except ratios, per share data, banking locations and full time equivalent employees.)

 

     Year ended December 31,  
     2016     2015     2014     2013     2012  

SUMMARY OF OPERATIONS:

          

Total interest income

   $ 99,907     $ 68,721     $ 43,432     $ 24,982     $ 20,004  

Total interest expense

     18,323       9,306       5,739       3,937       4,048  

Net interest income

     81,584       59,415       37,693       21,045       15,956  

Provision for loan losses

     5,240       5,030       2,374       907       1,548  

Net interest income after provision for loan losses

     76,344       54,385       35,319       20,138       14,408  

Non-interest income

     15,140       12,830       10,051       6,819       8,645  

Non-interest expense

     51,681       42,114       31,822       19,662       16,857  

Income before income taxes

     39,803       25,101       13,548       7,295       6,196  

Income tax expense

     11,746       9,021       5,134       2,734       2,056  

Net income

     28,057       16,080       8,414       4,561       4,140  

Preferred stock dividend requirement

     (23     (100     (100     (109     (458

Net income available to common shareholders

   $ 28,034     $ 15,980     $ 8,314     $ 4,452     $ 3,682  

PER COMMON SHARE DATA:

          

Basic earnings per share

   $ 2.56     $ 1.62     $ 1.32     $ 1.13     $ 1.03  

Diluted earnings per share

   $ 2.42     $ 1.54     $ 1.27     $ 1.10     $ 1.02  

Common equity per common share outstanding

   $ 20.73     $ 16.92     $ 14.41     $ 11.34     $ 11.42  

Dividends per common share

   $ —       $ —       $ —       $ —       $ —    

Preferred shares outstanding

     —         10       10       10       10  

Actual common shares outstanding

     13,037       10,571       7,756       4,863       3,621  

Weighted average common shares outstanding, including participating securities

     10,933       9,885       6,320       3,934       3,561  

Diluted weighted average common shares outstanding, including participating securities

     11,608       10,390       6,557       4,038       3,624  

BALANCE SHEET DATA:

          

Assets

   $ 2,943,189     $ 2,167,792     $ 1,355,827     $ 796,374     $ 577,762  

Loans held for sale

     23,699       14,079       18,462       10,694       15,355  

Loans, net of unearned income

     1,773,592       1,303,826       787,188       421,304       299,483  

Allowance for loan losses

     16,553       11,587       6,680       4,900       3,983  

Total securities

     983,649       734,038       449,037       325,090       219,933  

Total deposits

     2,391,818       1,814,039       1,172,233       681,300       514,643  

Federal Home Loan Bank advances

     132,000       57,000       19,000       23,000       8,000  

Other borrowed funds

     141,638       101,086       39,078       24,291       1,602  

Preferred shareholders’ equity

     —         10,000       10,000       10,000       10,000  

Common shareholders’ equity

     270,258       178,816       111,799       55,163       41,356  

Total shareholders’ equity

     270,258       188,816       121,799       65,163       51,356  

Noncontrolling interest in consolidated subsidiary

     103       —         —         —         —    

Total equity

     270,361       188,816       121,799       65,163       51,356  

Average total assets

     2,557,268       1,750,697       1,049,689       637,176       517,091  

Average loans(1)

     1,554,482       1,009,130       609,714       354,248       274,816  

Average interest-earning assets

     2,496,361       1,685,073       1,008,156       616,880       503,215  

Average deposits

     2,153,712       1,478,801       896,674       542,716       450,133  

Average interest-bearing deposits

     1,942,932       1,314,517       796,569       488,849       410,387  

Average interest-bearing liabilities

     2,125,986       1,409,753       848,993       525,906       425,786  

Average total shareholders’ equity

     207,763       168,933       97,567       55,355       49,540  

 

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Index to Financial Statements
     Year ended December 31,  
     2016     2015     2014     2013     2012  

SELECTED FINANCIAL RATIOS:

          

Return on average assets

     1.10     0.92     0.80     0.72     0.80

Return on average equity

     13.50     9.52     8.62     8.24     8.36

Average equity to average total assets

     8.12     9.65     9.29     8.69     9.58

Dividend payout

     —       —       —       —       —  

Efficiency ratio(2)

     53.43     58.29     66.65     70.56     68.52

Net interest margin(3)(5)

     3.42     3.62     3.74     3.41     3.17

Net interest spread(4)(5)

     3.29     3.51     3.63     3.30     3.02

CAPITAL RATIOS:(6)

          

Common equity Tier 1 ratio

     11.75     10.08     N/A       N/A       N/A  

Tier 1 leverage ratio

     9.28     8.48     8.57     9.78     9.27

Tier 1 risk-based capital

     11.75     10.51     11.58     13.83     14.29

Total risk-based capital

     15.09     11.21     12.30     14.81     15.45

ASSET QUALITY RATIOS:

          

Net charge-offs to average loans

     0.02     0.01     0.10     0.00     0.37

Allowance to period end loans(7)

     0.93     0.89     0.85     1.16     1.33

Allowance for loan losses to non-performing loans

     267.76     352.62     580.36     188.39     148.79

Non-performing assets to total assets

     0.21     0.16     0.14     0.35     0.82

OTHER DATA:

          

Banking locations

     12       11       11       4       4  

Full-time equivalent employees

     268       225       216       123       98  

 

(1)  Average loans include both loans held in the Bank’s portfolio and mortgage loans held for sale and are net of deferred origination fees and costs.
(2)  Efficiency ratio is non-interest expense divided by the sum of net interest income before the provision for loan losses plus non-interest income.
(3)  Net interest margin is net interest income (annualized for interim periods) divided by total average earning assets.
(4)  Net interest spread is the difference between the average yield on interest-earning assets and the average yield on interest-bearing liabilities.
(5)  Interest income and rates for 2016 and 2015 include the effects of tax-equivalent adjustments, which adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis. Due to immateriality, interest income and rates for 2014 and prior exclude the effects of tax-equivalent adjustments.
(6)  Capital ratios calculated on consolidated financial statements for December 31, 2016, 2015, 2014 and 2013. Prior capital ratios calculated on bank-only data.
(7)  Period end loans exclude loans held for sale and exclude deferred fees and costs.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with Item 8 “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” as well as other information included in this Annual Report on Form 10-K. Unless otherwise noted, all amounts in this discussion are stated in thousands, with the exception of number of shares or per share amounts.

 

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Index to Financial Statements

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 included elsewhere in this report. 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:

Principles of Consolidation

The consolidated financial statements include Franklin Financial Network, Inc. and its wholly owned subsidiaries, Franklin Synergy Bank and Franklin Synergy Risk Management, Inc., together referred to as “the Company.” The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.

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.

 

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Index to Financial Statements

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 potential designation as impaired. 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. 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.

Overview

The Company reported net income of $28,057 for the year ended December 31, 2016, compared to $16,080 for the year ended December 31, 2015, and $8,414 for the year ended December 31, 2014. After the payment of preferred dividends on the senior preferred stock issued to the Treasury pursuant to Small Business Lending Fund (“SBLF”), which shares of preferred stock the Company redeemed on March 25, 2016, the Company’s net earnings available to common shareholders for the years ended December 31, 2016, 2015 and 2014 were $28,034, $15,980, and $8,314, respectively. The primary reason for the increase in net earnings available to common shareholders was increased interest income on loans and investment securities due to significant organic growth in each of these portfolios during 2016 and 2015.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets, less interest expense. Net interest income for the years ended December 31, 2016, 2015 and 2014 totaled $81,584, $59,415, and $37,693, respectively, which are increases of $22,169, or 37.3%, and 21,722, or 57.6%, respectively.

 

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Index to Financial Statements

For the years ended December 31, 2016 and 2015, interest income increased $31,186 and $25,289 due to growth in both the loan and investment securities portfolios. These were offset by increases of $9,017 and $3,567 in interest expense, which totaled $18,323, $9,306 and $5,739, respectively, for the years ended December 31, 2016, 2015 and 2014, as a result of increases in interest-bearing deposits and borrowings, with 2016 borrowing increases in Federal Home Loan Bank advances and subordinated notes.

Interest-earning assets averaged $2,496,361, $1,685,073, and $1,008,156 during the years ended December 31, 2016, 2015 and 2014, which are increases of $843,635, or 50.1%, and $676,917, or 67.1%, respectively. The increases in 2016 and 2015 were primarily due to significant organic growth in loans and investment securities.

For the years ended December 31, 2016 and 2015, average loans increased 54.0% and 65.5%, respectively, and investment securities increased 38.9% and 71.6%, respectively. The yield on average interest-earning assets decreased two basis points to 4.15% during the year ended December 31, 2016, decreased 14 basis points to 4.17% during the year ended December 31, 2015, compared to 4.31% for the year ended December 31, 2014. The yields on average loans decreased 28 basis points during the year ended December 31, 2016 and 19 basis points during the year ended December 31, 2015. These decreases were due to the reduced accretion of discounts on purchased loans and due to lower interest rates on loans added to the loan portfolio.

For the years ended December 31, 2016, 2015 and 2014, the yield on available for sale securities was 2.49%, 2.44% and 2.59%, respectively. The increase in yield in 2016 is due to the increased volume of tax-exempt municipal securities that were purchased in 2016 combined with the slowing of prepayment amortization during 2016.The primary driver for the decrease during 2015 was the decline in coupon rate on the Company’s securities. During 2015, the yield related to coupon rate declined from 4.45% in 2014 to 4.14% in 2015.

For the years ended December 31, 2016, 2015 and 2014, the yield on held to maturity securities was 3.90%, 3.57% and 2.74%, respectively. The increase in yields in 2016 and in 2015 was attributable to the increased volume of tax-exempt municipal securities that have been purchased over the past two years, which increased the tax equivalent yield of the held to maturity portion of the securities portfolio, combined with the slowing of prepayment amortization during 2016.

Interest-bearing liabilities averaged $2,125,986, $1,409,753, and $848,993, respectively, during the years ended December 31, 2016, 2015 and 2014, which are increases of $716,233, or 50.8%, during 2016 and $560,760, or 66.1%, during 2015. The increase for 2016 was primarily due to growth of average interest-bearing deposits and due to growth in Federal Home Loan Bank advances and subordinated notes. The increase during 2015 was primarily attributed to growth of average interest-bearing deposits.

During 2016, total average interest-bearing deposits grew $628,415, which included increases in average interest checking of $63,540, average money market accounts of $152,448, and average time deposits outstanding of $398,681. During 2015, total average interest-bearing deposits grew $517,948, which included increases in average interest checking of $69,913, average money market accounts of $163,945, and average time deposits outstanding of $272,399.

Rapid growth in the loan portfolio also resulted in an increase in average Federal Home Loan Bank advances of $48,490 and $17,937, respectively in 2016 and 2015. The Company’s 2016 average borrowings increased by $39,276 due to two subordinated note issuances during 2016, and average Federal funds purchased and other borrowings, including securities sold under agreement to repurchased, increased by $24,875 during 2015.

The cost of average interest-bearing liabilities increased by 20 basis points to 0.86% during 2016 and decreased two basis points to 0.66% during 2015. The increase in 2016 cost of interest-bearing liabilities was due to increases in rates on interest checking, money market accounts, Federal Home Loan Bank advances and the subordinated notes that were added during 2016. The favorable decline in 2015 was attributable to decreases in rates paid on money market accounts, time deposits, Federal Home Loan Bank advances and Federal funds purchase and other borrowings.

 

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Index to Financial Statements

The tables below summarize average balances, yields, cost of funds, and the analysis of changes in interest income and interest expense for the years ended December 31, 2016, 2015, and 2014:

Average Balances(7)—Yields & Rates

(Dollars in thousands)

 

     Year Ended December 31,  
     2016     2015     2014  
     Average
Balance
    Interest
Inc/Exp
     Average
Yield/Rate
    Average
Balance
    Interest
Inc/Exp
     Average
Yield/Rate
    Average
Balance
    Interest
Inc/Exp
     Average
Yield/Rate
 

ASSETS:

                     

INTEREST-EARNING ASSETS

                     

Loans(1)(6)

   $ 1,554,482     $ 78,329        5.04   $ 1,009,130     $ 53,647        5.32   $ 609,714     $ 33,585        5.51

Securities available for sale(6)

     666,745       16,593        2.49     545,878       13,314        2.44     307,723       7,961        2.59

Securities held to maturity(6)

     203,884       7,943        3.90     80,932       2,887        3.57     57,576       1,579        2.74

Restricted equity securities

     9,904       500        5.05     6,940       350        5.04     4,368       227        5.20

Certificates of deposit at other financial institutions

     827       15        1.81     250       6        2.40     126       3        2.38

Federal funds sold and other(2)

     60,519       241        0.40     41,943       99        0.24     28,649       77        0.27
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 2,496,361     $ 103,621        4.15   $ 1,685,073     $ 70,303        4.17   $ 1,008,156     $ 43,432        4.31

Allowance for loan losses

     (13,923          (8,398          (5,655     

All other assets

     74,830            74,022            47,188       
  

 

 

        

 

 

        

 

 

      

TOTAL ASSETS

   $ 2,557,268          $ 1,750,697          $ 1,049,689       

LIABILITIES & EQUITY:

                     

INTEREST-BEARING LIABILITIES

                     

Deposits:

                     

Interest checking

   $ 332,285     $ 1,411        0.42   $ 268,745     $ 806        0.30   $ 198,832     $ 510        0.26

Money market

     617,036       3,853        0.62     464,588       2,616        0.56     300,643       2,037        0.68

Savings

     49,525       162        0.33     35,779       164        0.46     24,088       117        0.49

Time deposits

     944,086       8,808        0.93     545,405       5,102        0.94     273,006       2,637        0.97

Federal funds purchased and other(3)

     48,841       303        0.62     48,789       306        0.63     23,914       176        0.74

Federal Home Loan Bank advances

     94,937       884        0.93     46,447       312        0.67     28,510       262        0.92

Subordinated notes and other borrowings

     39,276       2,902        7.39     —         —          —       —         —          —  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 2,125,986     $ 18,323        0.86   $ 1,409,753     $ 9,306        0.66   $ 848,993     $ 5,739        0.68

Demand deposits

     210,780            164,284            100,105       

Other liabilities

     12,739            7,727            3,024       

Total equity

     207,763            168,933            97,567       
  

 

 

        

 

 

        

 

 

      

TOTAL LIABILITIES AND EQUITY

   $ 2,557,268          $ 1,750,697          $ 1,049,689       

NET INTEREST SPREAD(4)

          3.29          3.51          3.63

NET INTEREST INCOME

     $ 85,298          $ 60,997          $ 37,693     

NET INTEREST MARGIN(5)

          3.42          3.62          3.74

 

(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 and interest-bearing deposits at the Federal Reserve Bank, the Federal Home Loan Bank and other financial institutions.
(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 divided by total average earning assets.
(6)  Interest income and rates for 2016 and 2015 include the effects of tax-equivalent adjustments to adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis. Due to immateriality, interest income and rates for years prior to 2015 exclude the effects of tax-equivalent adjustments to adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis.
(7)  Average balances are average daily balances.

 

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The tables below detail the components of the changes in net interest income for the periods indicated. For each major category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category. The changes noted in the table below include tax equivalent adjustments, and as a result, will not agree to the amounts reflected on the Company’s consolidated statements of income for the categories that have been adjusted to reflect tax equivalent income.

Analysis of Changes in Interest Income and Expenses

 

     Net change year ended
December 31, 2016 versus
December 31, 2015
    Net change year ended
December 31, 2015 versus
December 31, 2014
 
     Volume      Rate     Net Change     Volume      Rate     Net Change  

INTEREST INCOME

              

Loans

   $ 29,035      $ (4,353   $ 24,682     $ 22,001      $ (1,939   $ 20,062  

Securities available for sale

     2,946        333       3,279       6,161        (808     5,353  

Securities held to maturity

     4,383        673       5,056       641        667       1,308  

Restricted equity securities

     149        1       150       134        (11     123  

Certificates of deposit at other financial institutions

     14        (5     9       3        —         3  

Federal funds sold and other

     45        97       142       36        (14     22  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

TOTAL INTEREST INCOME

   $ 36,572      $ (3,254   $ 33,318     $ 28,976      $ (2,105   $ 26,871  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

INTEREST EXPENSE

              

Deposits

              

Interest checking

   $ 206      $ 399     $ 605     $ 179      $ 117     $ 296  

Money market accounts

     867        370       1,237       1,111        (532     579  

Savings

     62        (64     (2     57        (10     47  

Time deposits

     3,800        (94     3,706       2,631        (166     2,465  

Federal funds purchased and other

     2        (5     (3     183        (53     130  

Federal Home Loan Bank advances

     325        247       572       165        (115     50  

Subordinated notes and other borrowings

     2,902        —         2,902       —          —         —    
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

TOTAL INTEREST EXPENSE

   $ 8,164      $ 853     $ 9,017     $ 4,326      $ (759   $ 3,567  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

NET INTEREST INCOME

   $ 28,408      $ (4,107   $ 24,301     $ 24,650      $ (1,346   $ 23,304  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

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 $5,240, $5,030 and $2,374 for the years ended December 31, 2016, 2015 and 2014, respectively. The increase in provision amounts for 2016 and 2015 are due primarily to loan growth during 2016 and 2015. Nonperforming loans at December 31, 2016, 2015 and 2014 totaled $6,182, $3,286, and $1,151, representing 0.3%, 0.3% and 0.1% of total loans, respectively.

 

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Non-Interest Income

Non-interest income for the years ended December 31, 2016, 2015 and 2014 was $15,140 $12,856 and $9,955, respectively. The following is a summary of the components of non-interest income (in thousands):

 

    

Years Ended

December 31,

    

2016-2015

Percent

Increase

   

Year Ended

December 31,

   

2015-2014

Percent

Increase

 
     2016      2015      (Decrease)     2014     (Decrease)  

Service charges on deposit accounts

   $ 185      $ 113        63.7   $ 53       113.2

Other service charges and fees

     3,041        2,644        15.0     1,777       48.8

Net gains on sale of loans

     7,183        6,959        3.2     5,814       19.7

Wealth management

     1,894        1,283        47.6     639       100.8

Loan servicing fees, net

     22        227        (90.3 %)      254       (10.6 %) 

Gain on sales and calls of securities

     2,172        833        160.7     259       221.6

Net (gain) loss on foreclosed assets

     40        26        53.8     (96     (127.1 %) 

Other

     603        771        (21.8 %)      1,255       (38.6 %) 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total non-interest income

   $ 15,140      $ 12,856        17.8   $ 9,955       29.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Service charges on deposit accounts increased 63.7% in 2016 and 113.2% in 2015 due to changes made to the Company’s schedule of service charges and to the reduction of the amount of service charges waived.

Other service charges and fees for the year ended December 31, 2016 increased 15.0% from 2015, primarily due to increases in unused commitment fees, other loan-related fees and ATM surcharge income. Other service charges and fees for the year ended December 31, 2015 increased 48.8% from 2014, due to increased ATM surcharge income and increased nonsufficient funds charges collected during the year.

Net gains on the sale of loans include net gains realized from the sales of mortgage loans and SBA loans. Net gains on the sale of mortgage loans are based, in part, on differences between the carrying value of loans being sold to third-party investors and the selling price. Also included are changes in the fair value of mortgage banking derivatives entered into by the Company to hedge the change in interest rates on loan commitments prior to their sale in the secondary market. Fluctuations in mortgage interest rates, changes in the demand for certain loans by investors, and whether servicing rights associated with the loans being sold are retained or released all affect the net gains on mortgage loan sales. Net gains for the year ended December 31, 2016 were $7,183, an increase of $224, or 3.2%, when compared to the year ended December 31, 2015. Net gains for the year ended December 31, 2015 were $6,959, an increase of $1,145, or 19.7%, from the year ended December 31, 2014, primarily attributed to the volume of mortgage loans sold during 2015. The increase was primarily due to improved pricing spread on mortgage loans sold. The Company recognized $5,636 in pricing adjustment gains during 2015, compared to $3,455 during 2014, an increase of $2,181 or 63.1%.

Wealth management income is the commission earned based on the investment brokerage activities and volume related to the Company’s wealth management clients. These commissions are also impacted by market conditions and will fluctuate from time to time due to rises and declines in the investment markets. Wealth management income for 2016 was $1,894, an increase of 47.6% when compared with 2015. Wealth management income for 2015 was $1,283, an increase of 100.8% when compared with 2014. The increases in wealth management income for 2016 and 2015 are attributable to the growth in assets under management and the growth in the investment markets during 2016 and 2015.

Loan servicing fees are fees earned for servicing residential mortgages and SBA loans offset by the amortization of the related servicing rights. These servicing rights are initially recorded at fair value and then amortized in proportion to, and over the period of, the estimated life of the underlying loans. In addition, impairment to the mortgage servicing rights may be recognized through a valuation allowance, and adjustments to the allowance can affect the net loan servicing fees. For the year ended December 31, 2016, net loan servicing fees were $22 compared to $227 for the year ended December 31, 2015. For the year ended December 31, 2015, net loan servicing fees were $227 compared to $254 for the year ended December 31, 2014. The decrease in servicing fees in 2016 and 2015 is attributable to the increase in amortization during both years.

Gains on sales and calls of securities for the year ended December 31, 2016 amounted to $2,172, an increase of $1,339, or 160.7%, when compared with the same period in 2015. For the year ended December 31, 2015, gains on sales and calls of securities increased $259, or 221.6%, when compared with the year ended December 31, 2014. The increases for 2016 and 2015 are attributed to the repositioning of the Company’s investment portfolio over the past two years, during which time management has increased investments in tax-exempt municipal securities in a strategic initiative related to the Company’s tax position.

 

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Other non-interest income decreased $168, or 21.8%, when comparing the years ended December 31, 2016 and 2015, and it decreased $484, or 38.6%, when comparing the years ended December 31, 2015 and 2014. The decrease in other non-interest income for 2016 is attributable to the $98 loss on the sale of two properties of the Bank on College Street in downtown Murfreesboro, Tennessee, and to the reduction of investment services income due to the Company no longer offering that service to other banks. The decrease in other non-interest income for 2015 is primarily attributed to the decrease in compliance fee income due to the Company’s 2014 sale of its subsidiary that provided compliance services.

Non-interest Expense

Non-interest expense for the years ended December 31, 2016, 2015 and 2014 was $51,681, $42,140 and $31,726, respectively. This increase was the result of the following components listed in the table below (in thousands):

 

    

Years Ended

December 31,

    

2016-2015

Percent

Increase

   

Year Ended

December 31,

    

2015-2014

Percent

Increase

 
     2016      2015      (Decrease)     2014      (Decrease)  

Salaries and employee benefits

   $ 30,029      $ 24,040        24.9   $ 19,160        25.5

Occupancy and equipment

     7,627        6,589        15.8     4,729        39.3

FDIC assessment expense

     2,068        1,167        77.2     600        94.5

Marketing

     762        956        (20.3 %)      728        31.3

Professional fees

     3,546        2,425        46.2     2,040        18.9

Other

     7,649        6,963        9.9     4,469        55.8
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total non-interest expense

   $ 51,681      $ 42,140        22.6   $ 31,726        32.8
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

The increase in non-interest expense noted in the table above is relative to the Company’s overall current growth. One of the major increases was in salaries and employee benefits. When comparing 2016, 2015 and 2014, salaries and employee benefits increased as a result of the increasing the Company’s full-time equivalent employees from 218 as of December 31, 2014 to 225 as of December 31, 2015, and then significantly to 268 as of December 31, 2016. The increase in 2016 is attributable to the Company’s building infrastructure to support the Company’s growth and to support the Company’s ongoing compliance initiatives.

During 2016, salaries and employee benefits expense increased 24.9%, with increases in salary expense and mortgage commissions being the largest attributes of the increase. Salary expense increased due to the addition of a variety of personnel, i.e., experienced lenders, compliance and operational personnel, etc. During 2015, salaries and employee benefits expense increased 25.5%, with increases in salary expense and mortgage commissions being the largest attributes of the increase. Salary expense increased due to the addition of experienced lenders and their related support personnel, including a lending team that specialized in healthcare and other types of commercial lending. Mortgage commissions increased in 2016 and 2015 due to increased volume of mortgage loans originated during those two years.

The increase in occupancy and equipment expense during 2016 is attributable to the addition of a new branch location in Nolensville, Tennessee, the addition of the loan production office in Nashville, Tennessee and the addition of the mortgage loan operations facility on the campus of the Company’s headquarters in Franklin, Tennessee. The increase in occupancy and equipment expense during 2015 is attributable to increases in building rent expense from the expansion of the Company’s headquarters in Franklin, Tennessee and the Rutherford County properties sold and leased back during 2015; and increased depreciation expenses related to the furniture, equipment and leasehold improvements that have been added as a result of the Company’s facilities growth.

The Company’s FDIC assessment increased in 2016 due to the Company’s growth in assets during the year coupled with the new assessment calculation model instituted by the FDIC during 2016 which, due to the Company’s asset growth, loan mix and use of brokered deposits, increased the Company’s FDIC assessment expenses beginning in the third quarter of 2016. The Company’s FDIC assessement increased in 2015 due to the Company’s growth in assets during the year.

The decrease in marketing expenses during 2016 is attributed to the Company’s scaling back of some of its marketing initiatives while assessing the benefits and uses for various media sources. The increase in marketing expenses during 2015 is attributed to increased marketing and public relations efforts to further the growth of the Company.

The 46.2% increase in professional fees during 2016 is related to increases in several types of expenses, as follows: other professional fees ($703) regulatory compliance expense ($211), merger expenses ($188), and brokerage settlement expenses ($137). The following types of expenses are included in other professional fees: consulting engagements that include design and implementation of subsidiary companies and lending process optimization initiatives, asset/liability management services, human resources services, talent recruitment services, information technology security, trust operations outsourcing, and corporate

 

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communications. The 18.9% increase in professional fees during 2015 is attributed to increases in legal fees ($255), audit/accounting fees ($283) and brokerage settlement expenses ($188). These increases were offset by a decrease of $429 in other professional fees due to the volume of expenses incurred in 2014 related to an acquisition.

Other noninterest expense increased $686, or 9.9%, during 2016 and $2,494, or 55.8%, during 2015 due to a number of different types of expenses. During 2016, the larger increases included the following: insurance expense ($256); franchise taxes ($194); regulatory compliance expense ($119); electronic banking expense ($118); and ATM-related expenses ($112). These were offset by a decrease in deposit account losses of $124. During 2015, the larger increases included the following: loan-related expenses ($434); insurance expense ($366); indirect costs associated with the Company’s initial public offering ($326); amortization of core deposit intangible ($293); ATM-related expenses ($196); franchise taxes ($177); and telecommunications ($122).

Income Tax Expense

The Company recognized an income tax expense for the years ended December 31, 2016, 2015, and 2014 of $11,746, $9,021, and $5,134, respectively. The Company’s year-to-date income tax expense for the years ended December 31, 2016, 2015, and 2014 reflects effective income tax rates 29.5%, 35.9%, and 37.9%, respectively. The decrease in the effective tax rate for 2016 is attributed to adoption of Accounting Standard Update 2016-09, which decreased the Company’s income tax expense for 2016 by just over $1 million. In addition, the increase in the Company’s tax-exempt investment securities played a part in decreasing the Company’s effect tax rate for 2016. The decrease in the effective tax rate for 2015 is attributed to the increase in the Company’s tax-exempt investment securities, and the increase in the effective tax rate in 2014 resulted from unfavorable permanent differences arising from expenses associated with the MidSouth acquisition and from stock-based compensation expense incurred from the vesting of incentive stock options as a result of employee retirement.

Return on Equity and Assets

The following schedule details selected key ratios for the years ended December 31, 2016, 2015 and 2014:

 

     2016     2015     2014  

Return on assets
(net income divided by average total assets)

     1.10     0.92     0.80

Return on equity
(Net income divided by average equity)

     13.50     9.52     8.62

Dividend payout ratio
(Dividends declared per share divided by net income per share)

     —       —       —  

Equity to asset ratio
(Average equity divided by average total assets)

     8.12     9.65     9.29

Leverage capital ratio
(Equity divided by fourth quarter average total assets, excluding accumulated other comprehensive income)

     9.28     8.48     8.57

The minimum leverage capital ratio required by the regulatory agencies is 4.00%.

 

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Under guidelines developed by regulatory agencies a “risk weight” is assigned to various categories of assets and commitments ranging from 0% to 300% based on the risk associated with the asset. The following schedule details the Bank’s risk-based capital at December 31, 2016 excluding the net unrealized gain on available-for-sale securities which is shown as an addition in stockholders’ equity in the consolidated financial statements:

 

     In Thousands,
Except
Percentages
 

Common Equity Tier 1 capital:

  

Stockholders’ equity, excluding accumulated other comprehensive income, disallowed goodwill, other disallowed intangible assets and disallowed servicing assets

   $ 263,693  
  

 

 

 

Tier 1 capital:

  

Common Equity Tier 1 capital plus additional tier 1 capital instruments and related surplus, less additional tier 1 capital deductions

   $ 263,693  

Tier 2 capital:

  

Tier 2 capital instruments plus related surplus

     58,337  

Total capital minority interest that is not included in tier 1 capital

     92  

Allowable allowance for loan losses (limited to 1.25% of gross risk-weighted assets)

     16,553  
  

 

 

 

Total risk-based capital

   $ 338,675  
  

 

 

 

Risk-weighted assets, gross

   $ 2,244,932  

Less: Excess allowance for loan and lease losses

     —    
  

 

 

 

Risk-weighted assets, net

   $ 2,244,932  
  

 

 

 

Risk-based capital ratios:

  

Common Equity Tier 1 risk-based capital ratio

     11.75
  

 

 

 

Tier 1 risk-based capital ratio

     11.75
  

 

 

 

Total risk-based capital ratio

     15.09
  

 

 

 

The minimum Common Equity Tier 1 risk-based capital ratio required by the regulatory agencies is 4.50%. Tier 1 risk-based capital ratio required by the regulatory agencies is 6.00%, and the minimum total risk-based capital ratio required is 8.00%. At December 31, 2016, the Company was in compliance with these requirements.

COMPARISON OF BALANCE SHEETS AT DECEMBER 31, 2016 and DECEMBER 31, 2015

Overview

The Company’s total assets increased by $775,397, or 35.8%, from December 31, 2015 to December 31, 2016. The increase in total assets was funded by the Company’s subordinated debt offerings in the first and second quarters of 2016 and its secondary public offering that was completed in the fourth quarter of 2016, which allowed for organic growth in both the loan portfolio and the investment portfolio.

The following table presents the growth experienced by the Company when comparing selected balance sheet totals from December 31, 2016 and 2015:

 

In Thousands

   Dec 31, 2016      Dec 31, 2015      Growth      Growth
Percentage
 

Total Loans

   $ 1,773,592      $ 1,303,826      $ 469,766        36.0

Total Securities

     983,649        734,038        249,611        34.0

Total Assets

     2,943,189        2,167,792        775,397        35.8

Total Deposits

     2,391,818        1,814,039        577,779        31.9

Total Liabilities

     2,672,828        1,978,976        693,852        35.1

Total Equity

     270,361        188,816        81,545        43.2

 

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Loans Held For Sale

At December 31, 2016, the Company had $23,699 in mortgage loans held for sale, compared to $14,079 as of December 31, 2015, an increase of 68.3%. The increase is attributable to the volume of loans closed and in the process of being sold to investors at December 31, 2016 as compared to December 31, 2015. For the years ended December 31, 2016, 2015 and 2014, the Company recorded gains from sales of mortgage loans totaling $7,183, $6,959, and $5,814, respectively.

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 it therefore generates the largest portion of revenues. 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 December 31, 2016 and 2015 were $1,773,592 and $1,303,826, respectively, an increase of $469,766, or 36.0%. This growth in the loan portfolio is due to increased market penetration and a healthy local economy, as well as the addition of several experienced lending officers.

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

 

     As of December 31,  
Types of Loans    2016     2015     2014     2013     2012  

Total loans, excluding PCI loans

          

Real estate:

          

Construction and land development

   $ 489,562     $ 372,767     $ 239,225     $ 113,710     $ 83,767  

Commercial

     497,140       364,223       246,352       125,202       77,682  

Residential

     404,989       274,934       213,760       138,466       106,589  

Commercial and industrial

     376,476       283,888       76,570       36,397       20,280  

Consumer and other

     3,359       6,577       8,025       8,250       11,758  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans—gross, excluding PCI loans

     1,771,526       1,302,389       783,932       422,025       300,076  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total PCI loans(1)

     2,859       3,913       4,315       —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total gross loans

     1,774,385       1,306,302       788,247       422,025       300,076  

Less: deferred loan fees, net

     (793     (2,476     (1,059     (721     (593

Allowance for loan losses

     (16,553     (11,587     (6,680     (4,900     (3,983
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net allowance for loan losses

   $ 1,757,039     $ 1,292,239     $ 780,508     $ 416,404     $ 295,500  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) PCI accounted for pursuant to ASC Topic 310-30.

As presented in the above table, gross loans increased $468,083, or 35.8%, during 2016. During 2016, the Company experienced growth in real estate loans of 37.3%, with the growth occurring in the construction and land development (31.3%), commercial real estate (36.1%) and residential real estate (47.2%) segments. The Company also experienced solid growth of 32.5% in the commercial and industrial segment during 2016.

Real estate loans comprised 78.5% of the loan portfolio at December 31, 2016. The largest portion of the real estate segments of the portfolio as of December 31, 2016, was commercial real estate loans, which totaled $497,534 at December 31, 2016, comprising 35.7% of real estate loans and 28.0% 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.

Construction and land development loans totaled, $489,562, or 36.8%, of real estate loans and comprised 27.6% of the total loan portfolio at December 31, 2016. 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.

The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages or junior lien mortgages, not including loans held-for-sale in the secondary market. Residential real estate loans totaled $405,485 and comprised 29.1% of real estate loans and 22.9% of total loans at December 31, 2016.

 

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Commercial and industrial loans consist of commercial loans, including healthcare loans, to various sizes of businesses that are primarily secured by commercial assets, such as inventories, business equipment, receivables and other commercial assets. At December 31, 2016, commercial and industrial loans made up 21.3% of the total loan portfolio, and healthcare loans comprised 41.0% of the Company’s commercial and industrial loans at December 31, 2016.

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 December 31, 2016, excluding unearned net fees and costs.

Loan Maturity Schedule

 

     December 31, 2016  
     One year
or less
     Over one
year to five
years
     Over five
years
     Total  

Real estate:

           

Construction and land development

   $ 254,953      $ 161,590      $ 73,019      $ 489,562  

Commercial

     31,247        125,384        340,903        497,534  

Residential

     26,788        108,780        269,917        405,485  

Commercial and industrial

     53,573        271,253        53,619        378,445  

Consumer and other

     1,624        1,581        154        3,359  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 368,185      $ 668,588      $ 737,612      $ 1,774,385  
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed interest rate

   $ 216,469      $ 341,690      $ 284,482      $ 842,641  

Variable interest rate

     151,716        326,898        453,130        931,744  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 368,185      $ 668,588      $ 737,612      $ 1,774,385  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 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 a peer group. 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.

 

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

 

     December 31, 2016     December 31, 2015     Increase (Decrease)  
     Loan
Balance
     ALLL
Balance
     %     Loan
Balance
     ALLL
Balance
     %     Loan
Balance
    ALLL
Balance
       

Non impaired loans

   $ 1,687,244      $ 15,506        0.92   $ 1,198,891      $ 11,465        0.96   $ 488,353     $ 4,041       -4 bps  

Non-PCI acquired loans(1)

     74,373        23        0.03     99,328        —          —       (24,955     23       3 bps  

Impaired loans

     9,909        1,024        10.33     4,170        113        2.71     5,739       911       762 bps  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Non-PCI loans

     1,771,526        16,553        0.93     1,302,389        11,578        0.89     469,137       4,975       4 bps  

PCI loans

     2,859        —          —       3,913        9        0.23     (1,054     (9     -23 bps  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 1,774,385      $ 16,553        0.93   $ 1,306,302      $ 11,587        0.89   $ 468,083     $ 4,966       4 bps  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Loans acquired pursuant to the July 1, 2014 acquisition of MidSouth that are not PCI loans. These are performing loans recorded at estimated fair value at the acquisition date. This fair value discount established at acquisition is accreted into interest income over the remaining lives of the related loans on a level yield basis. The remaining fair value discount balance at December 31, 2016 related to the non-PCI acquired loans was $2,006, or 2.7% of the outstanding aggregate loan balances. At December 31, 2015, one of the PCI loans was identified as impaired beyond the extent of its recorded discount, and an allowance for loan loss of $9 was recorded related to the acquired loans.

At December 31, 2016, the allowance for loan losses was $16,553, compared to $11,587 at December 31, 2015. The allowance for loan losses as a percentage of total loans was 0.93% and 0.89% at December 31, 2016 and 2015, respectively. Loan growth in addition to an increase in impaired loans during the period is the primary reason for the increase in the allowance for loan losses.

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

 

     2016     2015     2014     2013     2012  

Beginning balance

   $ 11,587     $ 6,680     $ 4,900     $ 3,983     $ 3,413  

Loans charged-off:

          

Construction & land development

     (11     —         —         —         (25

Commercial real estate

     —         —         (540     —         (575

Residential real estate

     (40     (32     (61     (107     (443

Commercial & industrial

     (255     (48     (58     (19     —    

Consumer

     (42     (135     —         —         (7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     (348     (215     (659     (126     (1,050

Recoveries on loans previously charged-off:

          

Construction & land development

     —         —         —         —         58  

Commercial real estate

     —         —         —         —         —    

Residential real estate

     66       26       65       136       14  

Commercial & industrial

     1       1       —         —         —    

Consumer

     7       65       —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loan recoveries

     74       92       65       136       72  

Net recoveries (charge-offs)

     (274     (123     (594     10       (978

Provision for loan losses charged to expense

     5,240       5,030       2,374       907       1,548  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance at end of period

   $ 16,553     $ 11,587     $ 6,680     $ 4,900     $ 3,983  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, gross, at end of period(1)

   $ 1,774,385     $ 1,306,302     $ 788,247     $ 422,025     $ 300,076  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average gross loans(1)

   $ 1,574,387     $ 997,873     $ 594,974     $ 343,697     $ 266,326  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance to total loans

     0.93     0.89     0.85     1.16     1.33
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs to average loans

     0.02     0.01     0.10     0.00     0.37
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Loan balances exclude loans held for sale

 

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Index to Financial Statements

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.

 

     2016      2015      2014      2013      2012  

Real estate loans:

              

Construction and land development

   $ 3,776      $ 3,186      $ 2,690      $ 1,552      $ 1,342  

Commercial

     4,266        3,146        1,494        1,511        1,267  

Residential

     2,398        1,861        1,791        1,402        893  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate

     10,440        8,193        5,975        4,465        3,502  

Commercial and industrial

     6,068        3,358        650        337        275  

Consumer and other

     45        36        55        98        206  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,553      $ 11,587      $ 6,680      $ 4,900      $ 3,983  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fluctuations in the allocations during the periods presented are due, in part, to changes in the specific reserve factors assigned to each category of loans. The Corporation has relied heavily on the loss history of peer groups due to the lack of its own history of losses; therefore, reserve factors have been adjusted in accordance with the loss performance experienced by a select group of local peer banks. Allocations between categories of loans have also been affected by the change in the mix of loans among the categories.

As of December 31, 2016, the largest component of the allowance for loan losses was associated with commercial and industrial loans, followed by commercial real estate loans and construction and land development loans. The increase on these reserves as a percentage of the total allowance in these categories was primarily due to significant loan growth in these portfolio segments and, in the commercial and industrial loans, the specific allowance related to impaired loans. Commercial and industrial loans grew 32.5% from $285,700, or 21.9% of total loans at the end of 2015, to $378,445, or 21.3% of total loans at year-end 2016. During 2016, construction and land development loans increased from $372,845 at December 31, 2015 to $489,562 at December 31, 2016, an increase of 31.3%. During the same period, commercial real estate loans increased 36.1%, from $365,683 at December 31, 2015 to $497,534 at December 31, 2016.

Nonperforming Assets

Nonperforming loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest. Nonperforming assets consist of nonperforming 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 nonperforming loans is non-accrual loans, which as of December 31, 2016 totaled $3,630. The other component of nonperforming 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 $2,552 that were past due 90 days or more and still accruing interest at December 31, 2016.

 

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Index to Financial Statements

The table below summarizes nonperforming loans and assets for the periods presented.

 

     December 31,  
     2016     2015     2014     2013     2012  

Non-accrual loans

   $ 3,630     $ 908     $ 835     $ 2,601     $ 2,677  

Past due loans 90 days or more and still accruing interest

     2,552       2,378       316       —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     6,182       3,286       1,151       2,601       2,677  

Foreclosed real estate (“OREO”)

     —         200       715       181       2,089  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 6,182     $ 3,486     $ 1,866     $ 2,782     $ 4,766  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans as a percentage of total loans

     0.3     0.3     0.1     0.6     0.9

Total nonperforming assets as a percentage of total assets

     0.2     0.2     0.1     0.3     0.8

Allowance for loan losses as a percentage of nonperforming loans

     268     353     580     188     149

As of December 31, 2016, there were five 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        23.0     1  

Residential real estate

     121        3.3     1  

Commercial & industrial

     2,674        73.7     3  

Consumer

     —          —         —    
  

 

 

    

 

 

   

 

 

 

Total non-accrual loans

   $ 3,630        100.0     5  
  

 

 

    

 

 

   

 

 

 

Troubled debt restructurings (TDRs) are modified loans in which a concession is provided to a borrower experiencing financial difficulties. Loan modifications are considered TDRs when the concession provided is not available to the borrower through either normal channels or other sources; however, not all loan modifications are TDRs. Our standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations; however, each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. TDRs can be classified as either accrual or non-accrual loans. Non-accrual TDRs are included in non-accrual loans whereas accruing TDRs are excluded because the borrower remains contractually current. The Company had one loan for $698 classified as an accrual TDR as of December 31, 2016, and Company had no TDRs as of December 31, 2015.

Generally, loans that are current as to principal and interest are not included in our nonperforming assets categories; however, a loan that is current may be classified as a potential problem loan if doubts arise about the borrower’s future performance under the terms of the loan contract. Loans are assigned 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. Loans are analyzed individually when classifying the loans as to credit risk.

The following definitions are used for assigning risk ratings to loans:

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.

 

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Index to Financial Statements

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.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. All loans in all loan categories are assigned risk ratings. As of December 31, 2016, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

     (Dollars in Thousands)  
     Pass      Special
Mention
     Substandard      Doubtful      Total  

Real estate loans:

              

Construction and land development

   $ 488,287      $ —        $ 1,275      $ —        $ 489,562  

Commercial

     487,944        1,847        7,743        —          497,534  

Residential

     401,423        —          4,062        —          405,485  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate

     1,377,654        1,847        13,080        —          1,392,581  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commercial and industrial

     373,243        —          5,202        —          378,445  

Consumer and other

     3,359        —          —          —          3,359  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,754,256      $ 1,847      $ 18,282      $ —        $ 1,774,385  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Investment Securities

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 structured with the goal of minimizing 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. Securities available-for-sale, consisting primarily of U.S. government sponsored enterprises and mortgage-backed securities, were $754,755 at December 31, 2016, compared to $575,838 at December 31, 2015, an increase of $178,917, or 31.1%. The increase in available-for-sale securities was primarily attributed to the Company’s leverage program, which was used to invest funds received in the Company’s subordinated debt offerings in the first and second quarters of 2016 and its secondary public offering in November 2016. The growth in available for sale securities was also used as a strategy to provide tax-exempt income for the Company and to provide for pledging related to the Company’s public funds deposits.

The Company’s 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 $228,894 at December 31, 2016, compared to $158,200 at December 31, 2015, an increase of $70,694, or 44.7%, also as a part of the Company’s leverage program and to provide for pledging related to the Company’s public funds deposits.

The combined portfolios represented 33.4% and 33.9% of total assets at December 31, 2016, and December 31, 2015, respectively. At December 31, 2016, the Company had no securities that were classified as having other than temporary impairment.

 

49


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Index to Financial Statements

The following table summarizes the fair value of the available for sale securities portfolio at December 31, 2016, 2015 and 2014:

 

     December 31,
2016
     December 31,
2015
     December 31,
2014
 

U.S. government sponsored entities and agencies

   $ —        $ 6,817      $ 30,173  

U.S. Treasury securities

     —          —          20,000  

Mortgage-backed securities: residential

     607,085        500,955        339,067  

Mortgage-backed securities: commercial

     19,334        19,835        6,465  

State and political subdivisions

     128,336        48,231        —    
  

 

 

    

 

 

    

 

 

 

Total

   $ 754,755      $ 575,838      $ 395,705  
  

 

 

    

 

 

    

 

 

 

The following table summarizes the amortized cost of the held to maturity securities portfolio at December 31, 2016, 2015 and 2014:

 

     December 31,
2016
     December 31,
2015
     December 31,
2014
 

U.S. government sponsored entities and agencies

   $ 203      $ 3,300      $ 5,550  

Mortgage-backed securities: residential

     106,170        30,398        38,587  

State and political subdivisions

     122,522        124,502        9,195  
  

 

 

    

 

 

    

 

 

 

Total

   $ 228,894      $ 158,200      $ 53,332  
  

 

 

    

 

 

    

 

 

 

The table below presents the maturities and yield characteristics of the Company’s available-for-sale securities as of December 31, 2016. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     (Dollars in Thousands)  
     One Year
or Less
    Over
One Year
Through
Five Years
    Over
Five Years
Through
Ten Years
    Over
Ten Years
    Total
Maturities
    Fair
Value
 

Mortgage-backed securities: residential(1)

   $ —       $ 343,546     $ 270,798     $ —       $ 614,344     $ 607,085  

Mortgage-backed securities: commercial(1)

     —         19,439       —         —         19,439       19,334  

State and political subdivisions

     17,600       —         88,227       27,453       133,280       128,336  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

   $ 17,600     $ 362,985     $ 359,058     $ 27,453     $ 767,063     $ 754,755  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     2.29     47.32     46.81     3.58     100.00  

Weighted average yield(2)

     1.15     2.25     3.26     4.59     2.78  

 

(1)  Mortgage-backed securities are grouped into average lives based on December 2016 prepayment projections.
(2)  The weighted average yields are based on amortized cost, and municipal securities are calculated on a fully tax-equivalent basis.

 

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Index to Financial Statements

The table below presents the maturities and yield characteristics of the Company’s held-to-maturity securities as of December 31, 2016. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     (Dollars in Thousands)  
     One Year
or Less
    Over
One Year
Through
Five Years
    Over
Five Years
Through
Ten Years
    Over
Ten Years
    Total
Maturities
    Fair
Value
 

U.S. government sponsored entities and agencies

   $ 203     $ —       $ —       $ —       $ 203     $ 209  

Mortgage-backed securities: residential(1)

     564       72,729       19,082       13,794       106,169       104,154  

State and political subdivisions

     —         6,263       89,061       27,198       122,522       123,529  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total held-to-maturity securities

   $ 767     $ 78,992     $ 108,143     $ 40,992     $ 228,894     $ 227,892  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     0.33     34.51     47.25     17.91     100.0  

Weighted average yield(2)

     2.68     2.46     5.34     4.94     4.27  

 

(1)  Mortgage-backed securities are grouped into average lives based on December 2016 prepayment projections.
(2)  The weighted average yields are based on amortized cost and municipal securities are calculated on a fully tax-equivalent basis.

Securities pledged at December 31, 2016 and 2015 had a carrying amount of $808,224 and $595,523, respectively, and were pledged to secure public deposits and repurchase agreements.

At December 31, 2016 and 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.

Restricted Equity Securities

The Company also had other investments of $11,843 and $7,998 at December 31, 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 $9,551 at December 31, 2016 compared to $7,640 at December 31, 2015, an increase of $1,911, or 25.0%. This increase was primarily due to the addition of a new branch location in Nolensville, Tennessee and a new mortgage loan operations facility on the campus of the Company headquarters in downtown Franklin, Tennessee.

Bank Owned Life Insurance

As of December 31, 2016, the Company had $23,267 in bank owned life insurance (“BOLI”), compared to $22,619 at December 31, 2015. The increase in BOLI is primarily attributed to increase in value due to earnings on the BOLI during 2016.

Goodwill and Intangible Assets

As of December 31, 2016 and 2015, the Company had $9,124 in goodwill. The goodwill is related to the acquisition of MidSouth Bank that occurred in 2014. At December 31, 2016, there were no circumstances or significant changes that have occurred related to that acquisition that, in management’s assessment, would necessitate recording impairment of goodwill.

As of December 31, 2016 and 2015, the Company had net core deposit intangible of $1,480 and $2,043, respectively, all of which is attributed to the acquisition of MidSouth Bank. At the time of the acquisition, the Company recorded a core deposit intangible of $3,060, and that intangible is being amortized over 8.2 years. Through December 31, 2016, the Company has recognized amortization of $1,580 related to the core deposit intangible.

 

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The following table represents acquired intangible assets at December 31, 2016 and 2015:

 

     2016      2015  
     Gross Carrying
Amount
     Accumulated
Amortization
     Gross Carrying
Amount
     Accumulated
Amortization
 

Acquired intangible assets:

           

Core deposit intangibles

   $ 3,060      $ (1,580    $ 3,060      $ (1,017

Aggregate amortization expense was $563, $655 and $362 for 2016, 2015 and 2014, respectively.

The following table presents estimated amortization expense for each of the next five years:

 

2017

   $ 473  

2018

     382  

2019

     291  

2020

     201  

2021

     110  

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 December 31, 2016, total deposits were $2,391,818, an increase of $577,779, or 31.9%, compared to $1,814,039 at December 31, 2015. Included in the Company’s funding strategy are brokered deposits and public funds deposits. Total brokered deposits decreased by 1.2%, to $472,515, at December 31, 2016 when compared with $478,257 at December 31, 2015. Public funds deposits increased 99.4% from $327,766 at December 31, 2015 to $653,572 at December 31, 2015, due to Company’s focus on providing banking services to the municipalities in the counties in our primary service areas, Williamson County and Rutherford County, Tennessee.

Time deposits, excluding brokered deposits, as of December 31, 2016, amounted to $555,732, as compared to $470,284 as of December 31, 2015.

The average amounts for deposits for 2016, 2015 and 2014 are detailed in the following schedule.

 

     2016     2015     2014  
In thousands, except percentages    Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Non-interest-bearing deposits

   $ 210,780        —     $ 164,284        —     $ 100,105        —  

Interest-bearing checking accounts

     332,285        0.42       268,745        0.30       198,832        0.26  

Money market deposit accounts

     617,036        0.62       464,588        0.56       300,643        0.68  

Other savings

     49,525        0.33       35,779        0.46       24,088        0.49  

Time deposits

     944,086        0.93       545,405        0.94       273,006        0.97  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 2,153,712        0.66   $ 1,478,801        0.59   $ 896,674        0.59
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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The following table shows time deposits, excluding brokered deposits, of $100 or more by category based on time remaining until maturity.

 

     December 31, 2016  

Three months or less

   $ 148,737  

Over three months through six months

     43,684  

Over six months through 12 months

     54,048  

Over one year through three years

     69,657  

Over three years through five years

     78,248  

Over five years

     —    
  

 

 

 

Total

   $ 394,374  
  

 

 

 

Liquidity, Other Borrowings, and Capital Resources

Federal Funds Purchased and Repurchase Agreements

As of December 31, 2016, the Company had Federal funds purchased from correspondent banks totaling $46,805 compared to $39,825 outstanding as of December 31, 2015. The weighted average Federal funds rate at December 31, 2016 was 1.06%.

Securities sold under agreements to repurchase had an outstanding balance of $36,496 as of December 31, 2016, compared to $61,261 as of December 31, 2015. Securities sold under agreements to repurchase are financing arrangements that typically mature daily. At maturity, the securities underlying the agreements are returned to the Company. The Company’s repurchase agreements at December 31, 2016 were composed of customer repurchase agreements, compared with the Company’s repurchase agreements at December 31, 2015, which were composed of two types of agreements: customer repurchase agreements and a correspondent bank repurchase agreement, the latter of which served as a short-term funding instrument for the Company. The weighted average rate for repurchase agreements was 0.56% as of December 31, 2016.

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 December 31, 2016, advances totaled $132,000 compared to $57,000 as of December 31, 2015.

At December 31, 2016, the scheduled maturities of these and advances and interest rates were as follows:

 

Scheduled Maturities

   Amount      Weighted
Average Rates
 

2017

   $ 10,000        1.27

2018

     87,000        1.12

2019

     35,000        1.30
  

 

 

    

 

 

 

Total

   $ 132,000        1.18
  

 

 

    

 

 

 

Subordinated Notes

The Company completed the issuance of $60,000 in principal amount of subordinated notes in two separate issuances. In March 2016, $40,000 of 6.875% fixed-to-floating rate subordinated notes were issued in a public offering to accredited institutional investors, and in June 2016, $20,000 of 7.00% fixed-to-floating rate subordinated notes were issued to certain accredited institutional investors in a private offering. At December 31, 2016, the Company’s subordinated notes, net of issuance costs, totaled $58,337. The Company had no subordinated notes outstanding at December 31, 2015. For regulatory capital purposes, the subordinated 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 15 of the consolidated financial statements.

The subordinated 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 subordinated 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 Company’s bank subsidiary, its depositors, and any preferred equity holders of our subsidiaries. The holders of the Subordinated 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.

 

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The following table summarizes the terms of each subordinated note offering:

 

     March 2016
Subordinated

Notes
  June 2016
Subordinated

Notes

Principal amount issued

   $40,000   $20,000

Maturity date

   March 30, 2026   July 1, 2026

Initial fixed interest rate

   6.875%   7.00%

Initial interest rate period

   5 years   5 years

First interest rate change date

   March 30, 2021   July 1, 2021

Interest repricing index and margin

   3-month LIBOR
plus 5.636%
  3-month LIBOR
plus 6.04%

Repricing frequency

   Quarterly   Quarterly

For more detail related to the subordinated notes, please see Note 10 of the consolidated financial statements.

Capital

Shareholders’ equity was $270,258 at December 31, 2016, an increase of $81,442, or 43.1%, from $188,816 at December 31, 2015. No common dividends were paid during 2016.

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 the 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. Under the Basel III rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of Common Equity Tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to RWA. Phase-in of the capital conservation buffer requirements began on January 1, 2016 and the requirements will be fully phased in on January 1, 2019. The capital conservation buffer threshold for 2016 is 0.625%. A banking organization with a buffer greater than 2.5% once the capital conservation buffer is fully phased in would not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. Effectively, the Basel III framework will require us to meet minimum capital ratios of (i) 7% for Common Equity Tier 1 capital, (ii) 8.5% Tier 1 capital, and (iii) 10.5% Total Capital. The eligible retained income of a banking organization is defined as its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income. When the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer will exceed the prompt corrective action (“PCA”) well-capitalized thresholds.

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 December 31, 2016, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.

 

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Management believes as of December 31, 2016, the Company and Bank meet all capital adequacy requirements to which they are subject. Actual and required capital amounts and ratios are presented below as of December 31, 2016 and 2015 for the Company and Bank.

 

     Actual     Required
For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Regulations
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

December 31, 2016

               

Company common equity Tier 1 capital to risk-weighted assets

   $ 263,693        11.75   $ 101,022        4.50     N/A        N/A  

Company Total Capital to risk weighted assets

   $ 338,675        15.09   $ 179,595        8.00     N/A        N/A  

Company Tier 1 (Core) Capital to risk weighted assets

   $ 263,693        11.75   $ 134,696        6.00     N/A        N/A  

Company Tier 1 (Core) Capital to average assets

   $ 263,693        9.28   $ 113,697        4.00     N/A        N/A  

Bank common equity Tier 1 capital to risk-weighted assets

   $ 319,005        14.18   $ 101,216        4.50   $ 146,201        6.50

Bank Total Capital to risk weighted assets

   $ 335,650        14.92   $ 179,939        8.00   $ 224,924        10.00

Bank Tier 1 (Core) Capital to risk weighted assets

   $ 319,005        14.18   $ 134,954        6.00   $ 179,939        8.00

Bank Tier 1 (Core) Capital to average assets

   $ 319,005        11.22   $ 113,697        4.00   $ 142,122        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   $ 99,696        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

Note: Minimum ratios presented exclude the capital conservation buffer.

Contractual Obligations

The following table summarizes our contractual obligations and other commitments to make future payments as of December 31, 2016:

 

     (Dollars in Thousands)  
     One Year or
Less
     More Than
One Year but
Less Than
Three years
     More Than
Three Years
but Less
Than Five
Years
     Five Years
or More
     Total  

As of December 31, 2016

              

Time deposits

   $ 516,233      $ 234,604      $ 89,485      $ 35      $ 840,357  

Federal funds purchased and repurchase agreements

     83,301        —          —          —          83,301  

FHLB advances

     10,000        122,000        —          —          132,000  

Subordinated notes

     —          —          —          60,000        60,000  

Lease commitments

     3,636        8,068        8,109        39,074        58,887  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 613,170      $ 364,672      $ 97,594      $ 99,109      $ 1,174,545  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

FHLB advances include arrangements under various FHLB credit programs. Long-term FHLB debt is more fully described under the caption “Federal Home Loan Bank Advances” in Note 9 of our Consolidated Financial Statements. Subordinated notes include two issuances that occurred in the first and second quarters of 2016. The subordinated notes are more fully described in Note 10, “Subordinated Notes” of our Consolidated Financial Statements. Lease commitments include the leases in place for certain branch sites.

 

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Interest Rate Sensitivity

The following schedule details the Company’s interest rate sensitivity at December 31, 2016:

 

            Repricing Within  

(In Thousands, Except Percentages)

   Total      1-90 Days     3 months
to 12
months
    1 to 5 years     Over 5
years
 

Earning assets:

           

Loans, net of unearned income

   $ 1,770,755      $ 471,996     $ 208,400     $ 514,863     $ 575,496  

Available for sale securities

     754,755        —         17,537       44,160       693,058  

Held to maturity securities

     228,894        —         —         705       228,189  

Loans held for sale

     23,699        —         —         —         23,699  

Interest-bearing deposits at other financial institutions

     61,421        61,421       —         —         —    

Certificates of deposit at other financial institutions

     1,055        —         165       640       250  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

     2,840,579        533,417       226,102       560,368       1,520,692  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

           

Deposits:

           

Interest-bearing checking accounts

     634,805        634,805       —         —         —    

Money market deposit accounts

     631,242        631,242       —         —         —    

Other savings

     51,634        51,634       —         —         —    

IRA’s and certificates of deposit, $250,000 and over

     370,009        37,063       199,694       133,217       35  

IRA’s and certificates of deposit, under $250,000

     470,348        164,793       114,682       190,873       —    

Federal funds purchased

     46,805        46,805       —         —         —    

Securities sold under agreement to repurchase

     36,496        36,496       —         —         —    

FHLB borrowings

     132,000        5,000       5,000       122,000       —    

Subordinated notes

     58,337        —         —         58,337       —    
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total interest- bearing liabilities

     2,431,676        1,607,838       319,376       504,427       35  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
  

 

 

          

Interest-sensitivity gap

      $ (1,074,421   $ (93,274   $ 55,941     $ 1,520,657  
     

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative gap

      $ (1,074,421   $ (1,167,695   $ (1,111,754   $ 408,903  
     

 

 

   

 

 

   

 

 

   

 

 

 

Interest-sensitivity gap as % of total average assets

        (42.01 )%      (3.65 )%      2.19     59.46
     

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative gap as % of total average assets

        (42.01 )%      (45.66 )%      (43.47 )%      15.99
     

 

 

   

 

 

   

 

 

   

 

 

 

 

  Loans, net of unearned income excludes non-accrual loans.

 

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Liquidity

Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis.

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. Our source of funds to pay interest on our March 2016 Notes and June 2016 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,” 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 December 31, 2016, $754,755 of the investment securities portfolio was classified as available-for-sale and is reported at fair value on the consolidated balance sheet. Another $228,894 of the portfolio was classified as held-to-maturity and is reported at amortized cost. Approximately $808,224 of the total $983,649 investment securities portfolio on hand at December 31, 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.

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 December 31, 2016, the Company had unfunded loan commitments outstanding of $42,689, unused lines of credit of $515,987, and outstanding standby letters of credit of $24,994.

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;

 

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    “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; and

 

    “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:

 

(Amounts in thousands, except share/per share data and percentages)    As of or for the Years Ended  
   December 31,
2016
    December 31,
2015
    December 31,
2014
 

Total shareholders’ equity

   $ 270,258     $ 188,816     $ 121,799  

Less: Preferred stock

     —         10,000       10,000  
  

 

 

   

 

 

   

 

 

 

Total common shareholders’ equity

     270,258       178,816       111,799  

Less: Goodwill and other intangible assets

     10,633       11,231       11,886  
  

 

 

   

 

 

   

 

 

 

Tangible common shareholders’ equity

   $ 259,625     $ 167,585     $ 99,913  

Common shares outstanding

     13,036,954       10,571,377       7,756,411  
  

 

 

   

 

 

   

 

 

 

Tangible book value per common share

   $ 19.91     $ 15.85     $ 12.88  
  

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 28,034     $ 15,980     $ 8,314  

Average tangible common equity

     194,529       147,374       82,504  
  

 

 

   

 

 

   

 

 

 

Return on average tangible common equity

     14.41     10.84     10.08
  

 

 

   

 

 

   

 

 

 

Efficiency Ratio:

      

Net interest income

   $ 81,584     $ 59,415     $ 37,693  

Noninterest income

     15,140       12,830       10,051  
  

 

 

   

 

 

   

 

 

 

Operating revenue

     96,724       72,245       47,744  

Expense

      

Total noninterest expense

     51,681       42,114       31,822  
  

 

 

   

 

 

   

 

 

 

Efficiency ratio

     53.43     58.29     66.65
  

 

 

   

 

 

   

 

 

 

Reported yield on loans(1)

     4.94     5.32     5.51

Effect of accretion income on acquired loans

     (0.07 %)      (0.27 %)      (0.24 %) 
  

 

 

   

 

 

   

 

 

 

Adjusted yield on loans

     4.87     5.05     5.27
  

 

 

   

 

 

   

 

 

 

Reported net interest margin(1)

     3.42     3.62     3.74

Effect of accretion income on acquired loans

     (0.05 %)      (0.16 %)      (0.15 %) 

Effect of premium amortization of acquired deposits

     (0.00 %)      (0.00 %)      (0.01 %) 
  

 

 

   

 

 

   

 

 

 

Adjusted net interest margin

     3.37     3.46     3.58
  

 

 

   

 

 

   

 

 

 

 

(1)  Calculation of this item for 2014 does not include tax-equivalent adjustments due to immateriality.

 

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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 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 and 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.

Impact of Recent Accounting Guidance

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606): Revenue from Contracts with Customers. ASU 2014-09 created a new topic in the FASB Accounting Standards Codification® (“ASC”), Topic 606. In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASU 2014-09 established a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, ASU 2014-09 added a new Subtopic to the ASC, Other Assets and Deferred Costs: Contracts with Customers (“ASC 340-40”), to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling a contract with a customer that are not in the scope of another ASC Topic. The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product or service warranties, and non-monetary exchanges between entities in the same line of business to facilitate sales to customers. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. Since most of the Company’s revenues come from financial instruments which are not included in the scope of this ASU, adoption of this guidance is not expected to have a material impact on the Company’s financial statements.

In January 2016, FASB issued ASU 2016-01, Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends prior guidance to require an entity to measure its equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of same issuer. The new guidance simplifies the impairment assessment of equity investments without readily determinable fair values, requires public entities to use the exit price notion when measuring fair value of financial instruments for disclosure purposes, requires an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from changes in the instrument-specific credit risk when the entity has selected fair value option for financial

 

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instruments and requires separate presentation of financial assets and liabilities by measurement category and form of financial asset. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. Management has not yet determined the impact that adoption of this guidance will have on the Company’s financial statements.

On February 25, 2016, FASB issued ASU 2016-02 which creates Topic 842, Leases and supersedes Topic 840, Leases. ASU 2016-02 is intended to improve financial reporting about leasing transactions, by increasing transparency and comparability among organizations. Under the new guidance, a lessee will be required to record all leases with lease terms of more than 12 months on their balance sheet as lease liabilities with a corresponding right-of-use asset. ASU 2016-02 maintains the dual model for lease accounting, requiring leases to be classified as either operating or finance, with lease classification determined in a manner similar to existing lease guidance. The new guidance will be effective for public companies for fiscal years beginning on or after December 15, 2018, and for private companies for fiscal years beginning on or after December 15, 2019. Early adoption is permitted for all entities. At the time this ASU is adopted, the Company will recognize a right-of-use asset and a lease liability for all leases, which will initially be measured at the present value of lease payments, and a single lease cost calculated so that the costs of the leases are allocated over the terms of the Company’s leases on a generally straight-line basis. Since an asset will be recognized at the time of adoption, the Company’s regulatory capital ratios will likely be impacted. Management is evaluating the impact ASU 2016-02 will have on the Company’s 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. The Company elected to adopt this ASU in the fourth quarter of 2016 effective as of January 1, 2016. The adoption of this ASU decreased income tax expense for the year by $1,013. The adoption of this ASU also impacted previously reported quarterly earnings and/or earnings per share in 2016, as follows: (1) first quarter 2016 – decreased diluted earnings per share by $0.01; (2) second quarter 2016 – decreased income tax expense by $509 and increased diluted earnings per share by $0.04; and (3) third quarter 2016 – decreased income tax expense by $107 and increased diluted earnings per share by $0.01.

In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU is effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities). Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently gathering information, reviewing possible vendors and has formed a committee to formulate the methodology to be used. Most importantly, the Company is gathering as much data as possible to enable review scenarios and to determine which calculations will produce the most reliable results. The impact of adopting ASU 2016-13 is not currently known.

In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This Accounting Standards Update addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. The amendments in this Update are effective for the Company 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. This ASU is not expected to have a material impact on the Company’s financial statements.

 

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Other Events

On November 3, 2016, the Bank entered into an informal agreement with the Reserve Bank and the 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. In addition, the Company currently may not make interest payments on its subordinated debt without prior written approval from its primary regulatory agencies.

The Company has also executed 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 includes 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Our 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 our 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 our operations, we are 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. Our rate sensitivity position has an important impact on earnings. Senior management monitors our rate sensitivity position throughout each month, and 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 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 ending December 31, 2016, net interest income was estimated to decrease 0.87% and 2.18% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to decrease 2.02% and 14.70% 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 December 31, 2016.

 

Projected Interest Rate
Change

    Net Interest
Income
    Net Interest Income $
Change from Base
    % Change from Base  
  -200       66,487       (11,461     (14.70
  -100       76,377       (1,571     (2.02
  Base       77,948       —       0.00  
  +100       77,266       (682     (0.87
  +200       76,249       (1,699     (2.18
  +300       76,024       (1,924     (2.47
  +400       74,730       (3,218     (4.13

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

 

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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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements required by this Item are included as a separate section of this report commencing on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

 

ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, has concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) were effective as of December 31, 2016, based on the evaluation of these controls and procedures required by Rule 13a-15(b) or 15d-15(b) of the Exchange Act.

Management’s Report on Internal Control Over Financial Reporting

The management of Franklin Financial Network, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Franklin Financial Network, Inc.’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Franklin Financial Network, Inc.’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).

Based on our assessment we believe that, as of December 31, 2016, the Company’s internal control over financial reporting was effective based on those criteria.

This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the SEC for an emerging growth company.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the fourth quarter of 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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ITEM 9B. OTHER INFORMATION.

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information called for by this item is incorporated herein by reference to the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 25, 2017, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

 

ITEM 11. EXECUTIVE COMPENSATION.

The information called for by this item is incorporated herein by reference to the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 25, 2017, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The information called for by this item is incorporated herein by reference to the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 25, 2017, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

The information called for by this item is incorporated herein by reference to the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 25, 2017, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information called for by this item is incorporated herein by reference to the definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 25, 2017, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act.

 

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PART IV

 

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

Financial Statements

The list of financial statements contained herein is set forth on page F-1 hereof.

Financial Statement Schedules

None

Exhibits

Exhibits required by Item 601 of Regulation S-K are incorporated herein by reference and are listed on the Exhibit Index below.

EXHIBIT INDEX

 

Exhibit

No.

  

Description of Exhibit

    2.1    Agreement and Plan of Reorganization and Bank Merger, dated as of November 21, 2013, between Franklin Financial Network, Inc., Franklin Synergy Bank and MidSouth Bank (incorporated herein by reference to Appendix A to Form S-4 (File No. 333-193951) filed with the Securities and Exchange Commission on February 14, 2014) (schedules and exhibits to which have been omitted pursuant to Item 601(b)(2) of Regulations S-K).
    2.2    Agreement and Plan of Reorganization and Bank Merger, dated as of December 14, 2015 among Franklin Financial Network, Inc., Franklin Synergy Bank and Civic Bank & Trust (incorporated herein by reference to Exhibit 2.1 to Form 8-K (File No. 001-36895) filed with the Securities and Exchange Commission on December 14, 2015) (schedules and exhibits to which have been omitted pursuant to Item 601(b)(2) of Regulations S-K).
    2.3    Amendment No. 1 to the Agreement and Plan of Reorganization and Bank Merger, dated May 9, 2016 among Civic Bank & Trust, Franklin Financial Network, Inc. and Franklin Synergy Bank (incorporated herein by reference to Exhibit 2.1 to Form 10-Q (File No. 001-36895) filed with the Securities and Exchange Commission on May 10, 2016).
    3.1    Charter of Franklin Financial Network, Inc. (incorporated herein by reference to Exhibit 3.1 to Form S-4 (File No. 333-193951) filed with the Securities and Exchange Commission on February 14, 2014).
    3.2    Articles of Amendment to the Charter of Franklin Financial Network, Inc., dated November 15, 2007 (incorporated herein by reference to Exhibit 3.2 to Form S-4 (File No. 333-193951) filed with the Securities and Exchange Commission on February 14, 2014).
    3.3    Articles of Amendment to the Charter of Franklin Financial Network, Inc., dated June 17, 2010 (incorporated herein by reference to Exhibit 3.3 to Form S-4 (File No. 333-193951) filed with the Securities and Exchange Commission on February 14, 2014).
    3.4    A