Franklin Financial Network Inc. - FORM 10-Q

Franklin Financial Network Inc. - FORM 10-Q - November 9, 2017

Attached files

Attached files

Franklin Financial Network Inc. Reports

file	filename
EX-32 - EX-32 - Franklin Financial Network Inc.	d451666dex32.htm
EX-31.2 - EX-31.2 - Franklin Financial Network Inc.	d451666dex312.htm
EX-31.1 - EX-31.1 - Franklin Financial Network Inc.	d451666dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2017

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

For the transition period from to

Commission file number 001-36895

FRANKLIN FINANCIAL NETWORK, INC.

(Exact name of registrant as specified in its charter)


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

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

615-236-2265

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

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

The number of shares outstanding of the registrant’s common stock, no par value per share, as of November 7, 2017, was 13,215,564.

TABLE OF CONTENTS


PART I FINANCIAL INFORMATION

Cautionary Note Regarding Forward-Looking Statements			1
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets			2
Consolidated Statements of Income			3
Consolidated Statements of Comprehensive Income			4
Consolidated Statement of Changes in Shareholders’ Equity			5
Consolidated Statements of Cash Flows			6
Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			27
Item 3. Quantitative and Qualitative Disclosures About Market Risk			47
Item 4. Controls and Procedures			48

PART II OTHER INFORMATION

Item 1. Legal Proceedings			48
Item 1A. Risk Factors			48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			49
Item 3. Defaults Upon Senior Securities			49
Item 4. Mine Safety Disclosures			49
Item 5. Other Information			49
Item 6. Exhibits			50

SIGNATURES

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

Risks and uncertainties that could cause our actual results to differ materially from those described in forward-looking statements include those discussed in our filings with the Securities and Exchange Commission (“SEC”), including those described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.

PART I FINANCIAL INFORMATION

ITEM 1.

CONSOLIDATED FINANCIAL STATEMENTS

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED BALANCE SHEETS

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


	September 30, 2017			December 31, 2016
	(Unaudited)
ASSETS
Cash and due from financial institutions	$	155,842		$	90,927
Certificates of deposit at other financial institutions		2,365			1,055
Securities available for sale		980,737			754,755
Securities held to maturity (fair value 2017—$220,089 and 2016—$227,892)		217,312			228,894
Loans held for sale, at fair value		11,823			23,699
Loans		2,115,930			1,773,592
Allowance for loan losses		(19,944	)		(16,553	)

Net loans		2,095,986			1,757,039

Restricted equity securities, at cost		18,472			11,843
Premises and equipment, net		11,217			9,551
Accrued interest receivable		11,156			9,931
Bank owned life insurance		23,732			23,267
Deferred tax asset		13,592			15,013
Foreclosed assets		1,503			—
Servicing rights, net		3,639			3,621
Goodwill		9,124			9,124
Core deposit intangible, net		1,117			1,480
Other assets		7,663			2,990

Total assets	$	3,565,278		$	2,943,189

LIABILITIES AND EQUITY
Deposits
Non-interest bearing	$	257,177		$	233,781
Interest bearing		2,567,648			2,158,037

Total deposits		2,824,825			2,391,818
Federal Home Loan Bank advances		337,000			132,000
Federal funds purchased and repurchase agreements		32,862			83,301
Subordinated notes, net		58,470			58,337
Accrued interest payable		2,597			1,924
Other liabilities		5,827			5,448

Total liabilities		3,261,581			2,672,828
Equity
Preferred stock, no par value: 1,000,000 shares authorized; no shares outstanding at September 30, 2017 and December 31, 2016		—			—
Common stock, no par value: 30,000,000 and 20,000,000 shares authorized at September 30, 2017 and December 31, 2016, respectively; 13,209,055 and 13,036,954 issued at September 30, 2017 and December 31, 2016, respectively		221,642			218,354
Retained earnings		85,075			59,386
Accumulated other comprehensive loss		(3,123	)		(7,482	)

Total shareholders’ equity		303,594			270,258
Noncontrolling interest in consolidated subsidiary		103			103

Total equity	$	303,697		$	270,361

Total liabilities and equity	$	3,565,278		$	2,943,189

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF INCOME

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

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Interest income and dividends
Loans, including fees	$	25,973		$	20,192		$	73,195		$	56,864
Securities:
Taxable		5,041			3,889			16,358			11,402
Tax-Exempt		2,217			1,457			6,449			3,776
Dividends on restricted equity securities		269			133			663			354
Federal funds sold and other		280			53			667			175

Total interest income		33,780			25,724			97,332			72,571

Interest expense
Deposits		7,311			3,683			19,118			10,118
Federal funds purchased and repurchase agreements		92			69			309			237
Federal Home Loan Bank advances		968			215			2,228			511
Subordinated notes and other borrowings		1,083			1,082			3,239			1,820

Total interest expense		9,454			5,049			24,894			12,686

Net interest income		24,326			20,675			72,438			59,885
Provision for loan losses		590			1,392			3,018			4,095

Net interest income after provision for loan losses		23,736			19,283			69,420			55,790

Noninterest income
Service charges on deposit accounts		39			44			114			139
Other service charges and fees		787			845			2,297			2,245
Net gains on sale of loans		1,517			2,942			5,918			6,859
Wealth management		643			446			1,884			1,343
Loan servicing fees, net		70			(40	)		230			(2	)
Gain on sale or call of securities		350			430			470			1,535
Net (loss) gain on sale of foreclosed assets		(16	)		30			(10	)		36
Other		179			179			554			432

Total noninterest income		3,569			4,876			11,457			12,587

Noninterest expense
Salaries and employee benefits		9,011			7,979			26,172			22,099
Occupancy and equipment		2,399			2,001			6,689			5,563
FDIC assessment expense		900			570			2,675			1,388
Marketing		192			206			744			611
Professional fees		821			935			2,558			3,006
Amortization of core deposit intangible		115			138			363			431
Other		1,840			1,879			5,636			5,354

Total noninterest expense		15,278			13,708			44,837			38,542

Income before income tax expense		12,027			10,451			36,040			29,925
Income tax expense		3,138			3,314			10,343			9,047

Net income		8,889			7,137			25,697			20,878
Earnings attributable to noncontrolling interest		—			—			(8	)		—
Dividends paid on Series A preferred stock		—			—			—			(23	)

Net income available to common shareholders	$	8,889		$	7,137		$	25,689		$	20,855

Earnings per share:
Basic	$	0.67		$	0.67		$	1.96		$	1.96
Diluted		0.65			0.63			1.86			1.84

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

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

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Net income	$	8,889		$	7,137		$	25,697		$	20,878
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gain (loss) arising during the period		1,610			(3,664	)		7,641			13,910
Reclassification adjustment for gains included in net income		(350	)		(430	)		(470	)		(1,535	)

Net unrealized gains (losses)		1,260			(4,094	)		7,171			12,375
Tax effect		(494	)		1,606			(2,812	)		(4,854	)

Total other comprehensive income (loss)		766			(2,488	)		4,359			7,521

Comprehensive income	$	9,655		$	4,649		$	30,056		$	28,399

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Nine Months Ended September 30, 2017 and 2016

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

(Unaudited)


													Accumulated Other
	Preferred			Common Stock						Retained			Comprehensive			Noncontrolling		Total
	Stock			Shares			Amount			Earnings			Income (Loss)			Interest		Equity
Balance at December 31, 2015	$	10,000			10,571,377		$	147,784		$	31,352		$	(320	)	$	—	$	188,816
Exercise of common stock options, net		—			152,003			1,357									—		1,357
Exercise of common stock warrants		—			6,575			79									—		79
Redemption of Series A preferred stock		(10,000	)		—			—			—			—			—		(10,000	)
Dividends paid on Series A preferred stock		—			—			—			(23	)		—			—		(23	)
Stock based compensation expense, net of restricted share forfeitures		—			34,480			1,201			—			—			—		1,201
Stock issued (divestment) in conjunction with 401(k) employer match, net of distributions		—			(6,952	)		(185	)		—			—			—		(185	)
Net income		—			—			—			20,878			—			—		20,878
Other comprehensive income		—			—			—			—			7,521			—		7,521

Balance at September 30, 2016	$	—			10,757,483		$	150,236		$	52,207		$	7,201			—	$	209,644

Balance at December 31, 2016	$	—			13,036,954		$	218,354		$	59,386		$	(7,482	)		103	$	270,361
Exercise of common stock options, net		—			138,007			1,361			—			—			—		1,361
Exercise of common stock warrants		—			12,461			150			—			—			—		150
Stock based compensation expense, net of restricted share forfeitures		—			26,718			1,970			—			—			—		1,970
Stock issued (divestment) in conjunction with 401(k) employer match, net of distributions		—			(5,085	)		(193	)		—			—			—		(193	)
Earnings attributable to noncontrolling interest		—			—			—			(8	)		—			—		(8	)
Net income		—			—			—			25,697			—			—		25,697
Other comprehensive income		—			—			—			—			4,359			—		4,359

Balance at September 30, 2017	$	—			13,209,055		$	221,642		$	85,075		$	(3,123	)	$	103	$	303,697

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

(Unaudited)


	Nine Months Ended September 30,
	2017			2016
Cash flows from operating activities
Net income	$	25,697		$	20,878
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization on premises and equipment		1,118			986
Accretion of purchase accounting adjustments		(873	)		(488	)
Net amortization of securities		7,654			5,428
Amortization of loan servicing right asset		721			905
Amortization of core deposit intangible		363			431
Amortization of debt issuance costs		133			79
Provision for loan losses		3,018			4,095
Deferred income tax benefit		(1,394	)		(1,015	)
Origination of loans held for sale		(270,876	)		(260,598	)
Proceeds from sale of loans held for sale		290,669			253,701
Net gain on sale of loans		(5,918	)		(6,859	)
Gain on sale of available for sale securities		(470	)		(1,535	)
Income from bank owned life insurance		(465	)		(486	)
Net loss/(gain) on foreclosed assets		10			(36	)
Loss on sale of assets held for sale		—			98
Stock-based compensation		1,970			1,201
Compensation expense related to common stock issued to 401(k) plan		—			404
Deferred gain on sale of loans		(58	)		(46	)
Net change in:
Accrued interest receivable and other assets		(5,949	)		(1,033	)
Accrued interest payable and other liabilities		1,120			2,261

Net cash from operating activities		46,470			18,371
Cash flows from investing activities
Securities available for sale :
Sales		122,837			74,203
Purchases		(455,700	)		(223,432	)
Maturities, prepayments and calls		108,339			64,502
Securities held to maturity :
Purchases		(1,996	)		(92,646	)
Maturities, prepayments and calls		12,110			14,088
Net change in loans		(346,595	)		(349,944	)
Proceeds from sale of assets held for sale		—			1,542
Purchase of restricted equity securities		(6,629	)		(3,831	)
Proceeds from sale of foreclosed assets		1,330			336
Purchases of premises and equipment, net		(2,784	)		(2,142	)
Capitalization of foreclosed assets		(35	)		—
Increase in certificates of deposits at other financial institutions		(1,310	)		(805	)

Net cash from investing activities		(570,433	)		(518,129	)
Cash flows from financing activities
Increase in deposits		433,007			403,915
Decrease in federal funds purchased and repurchase agreements		(50,439	)		(55,243	)
Proceeds from Federal Home Loan Bank advances		370,000			305,000
Repayment of Federal Home Loan Bank advances		(165,000	)		(200,000	)
Proceeds from other borrowings		—			10,000
Repayment of other borrowings		—			(10,000	)
Proceeds from issuance of subordinated notes, net of issuance costs		—			58,213
Proceeds from exercise of common stock warrants		150			79
Proceeds from exercise of common stock options		1,361			1,357
Divestment of common stock issued to 401(k) plan		(193	)		(185	)
Redemption of Series A preferred stock		—			(10,000	)
Dividends paid on preferred stock		—			(23	)
Earnings attributable to noncontrolling interest		(8	)		—

Net cash from financing activities		588,878			503,113

Net change in cash and cash equivalents		64,915			3,355
Cash and cash equivalents at beginning of period		90,927			52,394

Cash and cash equivalents at end of period	$	155,842		$	55,749

Supplemental information:
Interest paid	$	24,221		$	11,931
Income taxes paid		12,380			9,650
Non-cash supplemental information:
Transfers from loans to foreclosed assets	$	2,818		$	—
Transfers from loans to loans held for sale		2,685			—

See accompanying notes to consolidated financial statements.

FRANKLIN FINANCIAL NETWORK, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles (U.S. GAAP). All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included as required by Regulation S-X, Rule 10-01. All such adjustments are of a normal recurring nature. It is suggested that these interim consolidated financial statements and notes be read in conjunction with the financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2017.

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

NOTE 2—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available for sale portfolio at September 30, 2017 and December 31, 2016 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income.


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2017
U.S. government sponsored entities and agencies	$	20,147	$	—	$	(65	)	$	20,082
Mortgage-backed securities: residential		729,014		1,113		(5,460	)		724,667
Mortgage-backed securities: commercial		15,675		—		(65	)		15,610
State and political subdivisions		161,223		2,197		(2,855	)		160,565
U.S Treasury bills		59,816		1		(4	)		59,813

Total	$	985,875	$	3,311	$	(8,449	)	$	980,737


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2016
Mortgage-backed securities: residential	$	614,344	$	949	$	(8,208	)	$	607,085
Mortgage-backed securities: commercial		19,439		27		(132	)		19,334
State and political subdivisions		133,280		238		(5,182	)		128,336

Total	$	767,063	$	1,214	$	(13,522	)	$	754,755

The amortized cost and fair value of the securities held to maturity portfolio at September 30, 2017 and December 31, 2016 and the corresponding amounts of gross unrecognized gains and losses were as follows:


	Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses			Fair Value
September 30, 2017
Mortgage backed securities: residential	$	95,560	$	354	$	(1,502	)	$	94,412
State and political subdivisions		121,752		3,957		(32	)		125,677

Total	$	217,312	$	4,311	$	(1,534	)	$	220,089


	Gross Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses			Fair Value
December 31, 2016
U.S. government sponsored entities and agencies	$	203	$	6	$	—		$	209
Mortgage backed securities: residential		106,169		328		(2,343	)		104,154
State and political subdivisions		122,522		1,214		(207	)		123,529

Total	$	228,894	$	1,548	$	(2,550	)	$	227,892

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


	Three Months Ended September 30,					Nine Months Ended September 30,
	2017			2016		2017			2016
Proceeds	$	61,647		$	11,939	$	122,837		$	74,203
Gross gains		414			430		659			1,920
Gross losses		(64	)		—		(189	)		(385	)

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


	September 30, 2017
	Amortized Cost		Fair Value
Available for sale
One year or less	$	74,815	$	74,800
Over one year through five years		20,147		20,082
Over five years through ten years		4,681		4,811
Over ten years		141,543		140,767
Mortgage-backed securities: residential		729,014		724,667
Mortgage-backed securities: commercial		15,675		15,610

Total	$	985,875	$	980,737

Held to maturity
Over one year through five years	$	1,607	$	1,665
Over five years through ten years		6,322		6,496
Over ten years		113,823		117,516
Mortgage-backed securities: residential		95,560		94,412

Total	$	217,312	$	220,089

Securities pledged at September 30, 2017 and December 31, 2016 had a carrying amount of $944,463 and $808,224, respectively, and were pledged to secure public deposits and repurchase agreements.

At September 30, 2017 and December 31, 2016, there were no holdings of securities of any one issuer, other than the U.S. government-sponsored entities and agencies, in an amount greater than 10% of shareholders’ equity.

The following table summarizes the securities with unrealized and unrecognized losses at September 30, 2017 and December 31, 2016, aggregated by major security type and length of time in a continuous unrealized loss position:


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
September 30, 2017
Available for sale
U.S. government sponsored entities and agencies	$	20,082	$	(65	)	$	—	$	—		$	20,082	$	(65	)
Mortgage-backed securities: Residential		369,300		(2,279	)		130,043		(3,181	)		499,343		(5,460	)
Mortgage-backed securities: Commercial		15,610		(65	)		—		—			15,610		(65	)
State and political subdivisions		22,134		(82	)		61,297		(2,773	)		83,431		(2,855	)
U.S. Treasury bills		19,827		(4	)		—		—			19,827		(4	)

Total available for sale	$	446,953	$	(2,495	)	$	191,340	$	(5,954	)	$	638,293	$	(8,449	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses
Held to maturity
Mortgage-backed securities: residential	$	25,405	$	(335	)	$	55,224	$	(1,167	)	$	80,629	$	(1,502	)
State and political subdivisions		263		(1	)		1,154		(31	)		1,417		(32	)

Total held to maturity	$	25,668	$	(336	)	$	56,378	$	(1,198	)	$	82,046	$	(1,534	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2016
Available for sale
Mortgage-backed securities: residential	$	465,416	$	(7,833	)	$	9,907	$	(375	)	$	475,323	$	(8,208	)
Mortgage-backed securities: commercial		15,752		(132	)		—		—			15,752		(132	)
State and political subdivisions		100,020		(5,182	)		—		—			100,020		(5,182	)

Total available for sale	$	581,188	$	(13,147	)	$	9,907	$	(375	)	$	591,095	$	(13,522	)


	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses			Fair Value		Unrecognized Losses
Held to maturity
Mortgage-backed securities: residential	$	89,523	$	(2,244	)	$	3,025	$	(99	)	$	92,548	$	(2,343	)
State and political subdivisions		18,907		(207	)		—		—			18,907		(207	)

Total held to maturity	$	108,430	$	(2,451	)	$	3,025	$	(99	)	$	111,455	$	(2,550	)

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

NOTE 3—LOANS

Loans at September 30, 2017 and December 31, 2016 were as follows:


	September 30, 2017			December 31, 2016
Loans that are not PCI loans
Construction and land development	$	514,934		$	489,562
Commercial real estate:
Nonfarm, nonresidential		565,536			458,569
Other		33,310			38,571
Residential real estate:
Closed-end 1-4 family		373,536			254,474
Other		158,577			150,515
Commercial and industrial		464,747			376,476
Consumer and other		3,933			3,359

Loans before net deferred loan fees		2,114,573			1,771,526
Deferred loan fees, net		(1,201	)		(793	)

Total loans that are not PCI loans		2,113,372			1,770,733
Total PCI loans		2,558			2,859
Allowance for loan losses		(19,944	)		(16,553	)

Total loans, net of allowance for loan losses	$	2,095,986		$	1,757,039

The following table presents the activity in the allowance for loan losses by portfolio segment for the three month periods ended September 30, 2017 and 2016:


	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Three Months Ended September 30, 2017
Allowance for loan losses:
Beginning balance	$	3,796		$	5,011	$	2,939		$	6,894		$	49		$	18,689
Provision for loan losses		(507	)		212		169			707			9			590
Loans charged-off		—			—		—			(9	)		(11	)		(20	)
Recoveries		668			—		14			—			3			685

Total ending allowance balance	$	3,957		$	5,223	$	3,122		$	7,592		$	50		$	19,944

Three Months Ended September 30, 2016
Allowance for loan losses:
Beginning balance	$	3,624		$	3,865	$	2,060		$	4,655		$	49		$	14,253
Provision for loan losses		427			43		451			455			16			1,392
Loans charged-off		(11	)		—		(40	)		—			(19	)		(70	)
Recoveries		—			—		13			—			2			15

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

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine-month periods ended September 30, 2017 and 2016:


	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Nine Months Ended September 30, 2017
Allowance for loan losses:
Beginning balance	$	3,776		$	4,266	$	2,398		$	6,068		$	45		$	16,553
Provision for loan losses		(487	)		957		687			1,833			28			3,018
Loans charged-off		—			—		(1	)		(309	)		(36	)		(346	)
Recoveries		668			—		38			—			13			719

Total ending allowance balance	$	3,957		$	5,223	$	3,122		$	7,592		$	50		$	19,944


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

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

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2017 and December 31, 2016. For purposes of this disclosure, recorded investment in loans excludes accrued interest receivable and deferred loan fees, net due to immateriality.


	Construction and Land Development		Commercial Real Estate		Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
September 30, 2017
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	1,011	$	—	$	1,011
Collectively evaluated for impairment		3,957		5,223		3,122		6,581		50		18,933
Purchased credit-impaired loans		—		—		—		—		—		—

Total ending allowance balance	$	3,957	$	5,223	$	3,122	$	7,592	$	50	$	19,944

Loans:
Individually evaluated for impairment	$	—	$	—	$	116	$	3,090	$	—	$	3,206
Collectively evaluated for impairment		514,934		598,846		531,997		461,657		3,933		2,111,367
Purchased credit-impaired loans		—		387		182		1,989		—		2,558

Total ending loans balance	$	514,934	$	599,233	$	532,295	$	466,736	$	3,933	$	2,117,131

December 31, 2016
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	1,024	$	—	$	1,024
Collectively evaluated for impairment		3,776		4,266		2,398		5,044		45		15,529
Purchased credit-impaired loans		—		—		—		—		—		—

Total ending allowance balance	$	3,776	$	4,266	$	2,398	$	6,068	$	45	$	16,553

Loans:
Individually evaluated for impairment	$	1,275	$	2,836	$	2,190	$	3,608	$	—	$	9,909
Collectively evaluated for impairment		488,287		494,304		402,799		372,868		3,359		1,761,617
Purchased credit-impaired loans		—		394		496		1,969		—		2,859

Total ending loans balance	$	489,562	$	497,534	$	405,485	$	378,445	$	3,359	$	1,774,385

Loans collectively evaluated for impairment reported at September 30, 2017 include certain acquired loans. At September 30, 2017, these non-PCI loans had a carrying value of $57,663, comprised of contractually unpaid principal totaling $59,227 and discounts totaling $1,564. Management evaluated these loans for credit deterioration since acquisition and determined that $11 in allowance for loan losses was necessary at September 30, 2017. As of December 31, 2016, these non-PCI loans had a carrying value of $72,367, comprised of contractually unpaid principal totaling $74,373 and discounts totaling $2,006. Management evaluated these loans for credit deterioration since acquisition and determined that a $23 allowance for loan losses was necessary at December 31, 2016.

The following table presents information related to impaired loans by class of loans as of September 30, 2017 and December 31, 2016:


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
September 30, 2017
With no allowance recorded:
Construction and land development	$	—	$	—	$	—
Commercial real estate:
Nonfarm, nonresidential		—		—		—
Residential real estate:
Closed-end 1-4 family		—		—		—
Other		116		116		—
Commercial and industrial		92		92		—
Consumer and other		—		—		—

Subtotal		208		208		—
With an allowance recorded:
Commercial and industrial		2,998		2,998		1,011

Subtotal		2,998		2,998		1,011

Total	$	3,206	$	3,206	$	1,011

December 31, 2016
With no allowance recorded:
Construction and land development	$	1,275	$	1,275	$	—
Commercial real estate:
Nonfarm, nonresidential		4,423		2,836		—
Residential real estate:
Closed-end 1-4 family		2,069		2,069		—
Other		121		121		—
Commercial and industrial		934		934		—

Subtotal		8,822		7,235		—

With an allowance recorded:
Commercial and industrial		2,864		2,674		1,024

Subtotal		2,864		2,674		1,024

Total	$	11,686	$	9,909	$	1,024

The following table presents the average recorded investment of impaired loans by class of loans for the three and nine months ended September 30, 2017 and 2016:


	Three Months Ended September 30,				Nine Months Ended September 30,
Average Recorded Investment	2017		2016		2017		2016
With no allowance recorded:
Construction and land development	$	1,348	$	—	$	1,199	$	340
Commercial real estate:
Nonfarm, nonresidential		812		1,427		2,394		1,307
Residential real estate:
Closed-end 1-4 family		112		451		863		533
Other		199		837		245		768
Commercial and industrial		499		46		657		110
Consumer and other		—		—		1		10

Subtotal		2,970		2,761		5,359		3,068

With an allowance recorded:
Commercial and industrial	$	2,998	$	490	$	2,820	$	247
Residential real estate:
Closed-end 1-4 family		—		70		—		23

Subtotal		2,998		560		2,820		270

Total	$	5,968	$	3,321	$	8,179	$	3,338

The impact on net interest income for these loans was not material to the Company’s results of operations for the three and nine months ended September 30, 2017 and 2016.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2017 and December 31, 2016:


	Nonaccrual		Loans Past Due Over 90 Days
September 30, 2017
Residential real estate:
Closed-end 1-4 family	$	—	$	262
Other		116		—
Commercial and industrial		2,466		16

Total	$	2,582	$	278

December 31, 2016
Construction and land development	$	—	$	1,950
Commercial real estate:
Nonfarm, nonresidential		835		—
Residential real estate:
Closed-end 1-4 family		—		452
Other		121		—
Commercial and industrial		2,674		150

Total	$	3,630	$	2,552

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

The following table presents the aging of the recorded investment in past due loans as of September 30, 2017 and December 31, 2016 by class of loans:


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 89 Days Past Due		Nonaccrual		Total Past Due and Nonaccrual		Loans Not Past Due		PCI Loans		Total
September 30, 2017
Construction and land development	$	1,370	$	—	$	—	$	—	$	1,370	$	513,564	$	—	$	514,934
Commercial real estate:
Nonfarm, nonresidential		—		—		—		—		—		565,536		387		565,923
Other		—		—		—		—		—		33,310		—		33,310
Residential real estate:
Closed-end 1-4 family		939		1,007		262		—		2,208		371,328		182		373,718
Other		150		—		—		116		266		158,311		—		158,577
Commercial and industrial		511		301		16		2,466		3,294		461,453		1,989		466,736
Consumer and other		5		—		—		—		5		3,928		—		3,933

	$	2,975	$	1,308	$	278	$	2,582	$	7,143	$	2,107,430	$	2,558	$	2,117,131

December 31, 2016
Construction and land development	$	380	$	—	$	1,950	$	—	$	2,330	$	487,232	$	—	$	489,562
Commercial real estate:
Nonfarm, nonresidential		664		—		—		835		1,499		457,070		394		458,963
Other		—		—		—		—		—		38,571		—		38,571
Residential real estate:
Closed-end 1-4 family		428		10		452		—		890		253,584		496		254,970
Other		231		—		—		121		352		150,163		—		150,515
Commercial and industrial		155		39		150		2,674		3,018		373,458		1,969		378,445
Consumer and other		—		—		—				—		3,359		—		3,359

	$	1,858	$	49	$	2,552	$	3,630	$	8,089	$	1,763,437	$	2,859	$	1,774,385

Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans as well as non-homogeneous residential real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

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

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

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. The following table includes PCI loans, which are included in the “Substandard” column. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of September 30, 2017 and December 31, 2016:


	Pass		Special Mention		Substandard		Total
September 30, 2017
Construction and land development	$	512,912	$	—	$	2,022	$	514,934
Commercial real estate:
Nonfarm, nonresidential		548,792		12,322		4,809		565,923
Other		32,927		—		383		33,310
Residential real estate:
Closed-end 1-4 family		371,149		—		2,569		373,718
Other		156,820		—		1,757		158,577
Commercial and industrial		445,736		12,649		8,351		466,736
Consumer and other		3,928		5		—		3,933

	$	2,072,264	$	24,976	$	19,891	$	2,117,131


	Pass		Special Mention		Substandard		Total
December 31, 2016
Construction and land development	$	488,287	$	—	$	1,275	$	489,562
Commercial real estate:
Nonfarm, nonresidential		449,373		1,847		7,743		458,963
Other		38,571		—		—		38,571
Residential real estate:
1-4 family		251,919		—		3,051		254,970
Other		149,504		—		1,011		150,515
Commercial and industrial		373,243		—		5,202		378,445
Consumer and other		3,359		—		—		3,359

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

Troubled Debt Restructurings

As of both September 30, 2017 and December 31, 2016, the Company’s loan portfolio contains one loan that has been modified in a troubled debt restructuring with a balance of $608 and $698, respectively.

NOTE 4—LOAN SERVICING

Loans serviced for others are not reported as assets. The principal balances of these loans at September 30, 2017 and December 31, 2016 are as follows:


	September 30, 2017		December 31, 2016
Loan portfolios serviced for:
Federal Home Loan Mortgage Corporation	$	506,345	$	499,385
Other		4,662		2,954

The components of net loan servicing fees for the three and nine months ended September 30, 2017 and 2016 were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Loan servicing fees, net:
Loan servicing fees	$	312		$	309		$	951		$	903
Amortization of loan servicing fees		(242	)		(349	)		(721	)		(905	)
Change in impairment		—			—			—			—

Total	$	70		$	(40	)	$	230		$	(2	)

The fair value of servicing rights was estimated by management to be approximately $4,916 at September 30, 2017. Fair value for September 30, 2017 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 10.2%. At December 31, 2016, the fair value of servicing rights was estimated by management to be approximately $5,015. Fair value for December 31, 2016 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 9.9%.

NOTE 5—SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

Our subsidiary bank enters into borrowing arrangements with our retail business customers and correspondent banks through agreements to repurchase (“securities sold under agreements to repurchase”) under which the bank pledges investment securities owned and under its control as collateral against these short-term borrowing arrangements. At maturity the securities underlying the agreements are returned to the Company. At September 30, 2017 and December 31, 2016, these short-term borrowings totaled $32,862 and $36,496, respectively, and were secured by securities with carrying amounts of $41,279 and $41,136, respectively. At September 30, 2017, all of the Company’s repurchase agreements had one-day maturities.

The following table provides additional details as of September 30, 2017:


As of September 30, 2017	Mortgage- Backed Securities: Residential			State and Political Subdivisions			Total
Market value of securities pledged	$	651		$	41,921		$	42,572
Borrowings related to pledged amounts	$	—		$	32,862		$	32,862
Market value pledged as a % of borrowings		—	%		128	%		130	%

The following table provides additional details as of December 31, 2016:


As of December 31, 2016	U.S. Government Sponsored Entities and Agencies Securities			Mortgage- Backed Securities: Residential			State and Political Subdivisions			Total
Market value of securities pledged	$	209		$	117		$	41,330		$	41,656
Borrowings related to pledged amounts	$	—		$	—		$	36,496		$	36,496
Market value pledged as a % of borrowings		—	%		—	%		113	%		114	%

NOTE 6—SHARE-BASED PAYMENTS

In connection with the Company’s 2010 private offering, 32,425 warrants were issued to shareholders, one warrant for every twenty shares of common stock purchased. Each warrant allowed the shareholders to purchase an additional share of common stock at $12.00 per share. The warrants were issued with an effective date of March 30, 2010 and were exercisable in whole or in part up to seven years following the date of issuance, and they expired on March 30, 2017. The warrants were detachable from the common stock. There were 12,461 and 6,575 warrants exercised during the nine months ended September 30, 2017 and 2016, respectively. A summary of the stock warrant activity for the nine months ended September 30, 2017 and 2016 follows:


	September 30, 2017		September 30, 2016
Stock warrants exercised:
Intrinsic value of warrants exercised	$	329	$	136
Cash received from warrants exercised		150		79

The warrants expired on March 30, 2017; therefore at September 30, 2017, there were no outstanding warrants associated with the 2010 offering.

The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $735 and $406 and $1,970 and $1,201 for the three and nine months ended September 30, 2017 and 2016, respectively. The total income tax benefit, which is shown on the Consolidated Statements of Income as a reduction of income tax expense, was $261 and $711 for the three and nine months ended September 30, 2017. The total income tax benefit for the three and nine months ended September 30, 2016 was $107 and $616, respectively.

Stock Options: The Company’s 2007 Omnibus Equity Incentive Plan (the “2007 Plan”), as amended and shareholder-approved, provides for authorized shares up to 4,000,000. At September 30, 2017, there were 1,960,041 authorized shares available for issuance under the 2007 Plan, although the Company has ceased issuing awards under the 2007 Plan.

The 2007 Plan provides that no options intended to be ISOs may be granted after April 9, 2017. As a result, the Company’s board of directors approved, and recommended to its shareholders for approval, a new equity incentive plan, the 2017 Omnibus Equity Incentive Plan. The Company’s shareholders approved the 2017 Omnibus Equity Incentive Plan at the 2017 annual meeting of shareholders. The terms of the 2017 Omnibus Equity Incentive Plan are substantially similar to the terms of the 2007 Omnibus Equity Incentive Plan it was intended to replace. The 2017 Omnibus Equity Incentive Plan provides for authorized shares up to 5,000,000. At September 30, 2017, there were 4,762,750 authorized shares available for issuance under the 2017 Omnibus Equity Incentive Plan.

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

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

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

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


	September 30, 2017			September 30, 2016
Risk-free interest rate		2.16	%		1.60	%
Expected term		6.8 years			7.5 years
Expected stock price volatility		32.32	%		30.09	%
Dividend yield		0.03	%		0.24	%

The weighted average fair value of options granted for the nine months ended September 30, 2017 and 2016 were $14.51 and $9.78, respectively.

A summary of the activity in the plans for the nine months ended September 30, 2017 follows:


	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		1,395,016		$	16.70		6.39	$	35,090
Granted		267,195			38.04
Exercised		(146,944	)		11.73
Forfeited, expired, or cancelled		(3,113	)		25.37

Outstanding at period end		1,512,154		$	20.93		6.65	$	22,256

Vested or expected to vest		1,436,546		$	20.93		6.65	$	21,143
Exercisable at period end		787,451		$	13.43		4.96	$	17,498


	For the nine months ended September 30,
	2017		2016
Stock options exercised:
Intrinsic value of options exercised	$	4,141	$	3,463
Cash received from options exercised		1,361		1,357
Tax benefit realized from option exercises		406		522

As of September 30, 2017, there was $6,054 of total unrecognized compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted-average period of 1.8 years.

Restricted Stock: Additionally, the 2007 Omnibus Equity Incentive Plan and the 2017 Omnibus Equity Incentive Plan each provides for the granting of restricted share awards and other performance related incentives. When the restricted shares are awarded, a participant receives voting and dividend rights with respect to the shares, but is not able to transfer the shares until the restrictions have lapsed. These awards have a vesting period of three to five years and vest in equal annual installments on the anniversary date of the grant.

A summary of activity for non-vested restricted share awards for the nine months ended September 30, 2017 is as follows:


Non-vested Shares	Shares			Weighted- Average Grant- Date Fair Value
Non-vested at December 31, 2016		106,458		$	19.81
Granted		27,282			37.35
Vested		(36,767	)		18.22
Forfeited		(564	)		28.66

Non-vested at September 30, 2017		96,409		$	25.32

Compensation expense associated with the restricted share awards is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of September 30, 2017, there was $2,080 of total unrecognized compensation cost related to non-vested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 3.6 years. The total fair value of shares vested during the nine months ended September 30, 2017 and 2016 was $1,457 and $974, respectively.

The total income tax benefit realized from the vesting of restricted stock was $215 and $4 and $305 and $170 for the three and nine months ended September 30, 2017 and 2016, respectively.

NOTE 7—REGULATORY CAPITAL MATTERS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company on January 1, 2016 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019.

The Basel III rules additionally provide for countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Under the Basel III rules, banks must maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital equal to 2.5% of risk-weighted assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying certain discretionary bonuses. This new capital conservation buffer requirement was phased in beginning January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented at 2.5% in January 2019. The capital conservation buffer in effect for 2017 is 1.25%.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At September 30, 2017, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Management believes that, as of September 30, 2017, the Company and Bank met all capital adequacy requirements to which they are subject. There are no conditions or events since that notification that management believes have changed the institution’s category.

Actual and required capital amounts and ratios are presented below as of September 30, 2017 and December 31, 2016 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
September 30, 2017
Company common equity Tier 1 capital to risk-weighted assets	$	293,004		11.58	%	$	113,908		4.50	%		N/A		N/A
Company Total Capital to risk weighted assets	$	371,510		14.68	%	$	202,502		8.00	%		N/A		N/A
Company Tier 1 (Core) Capital to risk weighted assets	$	293,004		11.58	%	$	151,877		6.00	%		N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	293,004		8.58	%	$	136,609		4.00	%		N/A		N/A
Bank common equity Tier 1 capital to risk-weighted assets	$	347,043		13.71	%	$	113,901		4.50	%	$	164,523		6.50	%
Bank Total Capital to risk weighted assets	$	367,079		14.50	%	$	202,490		8.00	%	$	253,112		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	347,043		13.71	%	$	151,867		6.00	%	$	202,490		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	347,043		10.17	%	$	136,511		4.00	%	$	170,639		5.00	%
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	%

Note: Minimum ratios presented exclude the capital conservation buffer

Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. Neither the Company nor the Bank may currently pay dividends without prior written approval from its primary regulatory agencies.

NOTE 8—FAIR VALUE

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

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

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

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

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

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

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

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

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

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

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


	Fair Value Measurements at September 30, 2017 Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Financial Assets
Securities available for sale
U.S. government sponsored entities and agencies	$	—	$	20,082		$	—
Mortgage-backed securities-residential		—		724,667			—
Mortgage-backed securities-commercial		—		15,610			—
State and political subdivisions		—		160,565			—
U.S. Treasury bills		—		59,813			—

Total securities available for sale	$	—	$	980,737		$	—

Loans held for sale	$	—	$	11,823		$	—

Mortgage banking derivatives	$	—	$	501		$	—

Financial Liabilities
Mortgage banking derivatives	$	—	$	(88	)	$	—


	Fair Value Measurements at December 31, 2016 Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Financial Assets
Securities available for sale
Mortgage-backed securities-residential	$	—	$	607,085		$	—
Mortgage-backed securities-commercial		—		19,334			—
State and political subdivisions		—		128,336			—

Total securities available for sale	$	—	$	754,755		$	—

Loans held for sale	$	—	$	23,699		$	—

Mortgage banking derivatives	$	—	$	229		$	—

Financial Liabilities
Mortgage banking derivatives	$	—	$	(66	)	$	—

As of September 30, 2017, the unpaid principal balance of loans held for sale was $11,524 resulting in an unrealized gain of $299 included in gains on sale of loans. As of December 31, 2016, the unpaid principal balance of loans held for sale was $23,457, resulting in an unrealized gain of $242 included in gains on sale of loans. For the three months ended September 30, 2017 and 2016, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $(48) and $326, respectively. For the nine months ended September 30, 2017 and 2016, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $57 and $558, respectively. None of these loans were 90 days or more past due or on nonaccrual as of September 30, 2017 and December 31, 2016.

There were no transfers between level 1 and 2 during 2017 or 2016.

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

There were two collateral-dependent commercial and industrial impaired loans carried at fair value of $1,987 as of September 30, 2017 and one collateral-dependent commercial and industrial impaired loan carried at fair value of $1,650 as of December 31, 2016. For the three and nine months ended September 30, 2017, there was no additional provision for loan losses recorded related to impaired loans recorded at fair value of collateral. For the three and nine months ended September 30, 2016, $115 additional provision for loan losses was recorded related to impaired loans recorded at fair value of collateral.

Foreclosed assets measured at fair value less costs to sell, had a net carrying amount of $1,503 as of September 30, 2017 and $0 as of December 31, 2016. The foreclosed property was previously collateral for a commercial real estate loan. There were no properties at September 30, 2017 or 2016 that had required write-downs to fair value resulting in no write downs for the three and nine months ended September 30, 2017 and 2016, respectively.

The carrying amounts and estimated fair values of financial instruments at September 30, 2017 and December 31, 2016 are as follows:


	Carrying Amount			Fair Value Measurements at September 30, 2017 Using:
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and cash equivalents	$	155,842		$	155,842		$	—		$	—	$	155,842
Certificates of deposit held at other financial institutions		2,365			—			2,365			—		2,365
Securities available for sale		980,737			—			980,737			—		980,737
Securities held to maturity		217,312			—			220,089			—		220,089
Loans held for sale		11,823			—			11,823			—		11,823
Net loans		2,115,930			—			—			2,074,102		2,074,102
Restricted equity securities		18,472			n/a			n/a			n/a		n/a
Servicing rights, net		3,639			—			—			4,916		4,916
Mortgage banking derivative assets		501			—			501			—		—
Accrued interest receivable		11,156			(13	)		5,603			5,566		11,156
Financial liabilities
Deposits	$	2,824,825		$	1,438,459		$	1,352,945		$	—	$	2,791,404
Repurchase agreements		32,862			—			32,862			—		32,862
Federal Home Loan Bank advances		337,000			—			355,910			—		355,910
Subordinated notes, net		58,470			—			—			61,576		61,576
Mortgage banking derivative liabilities		(88	)		—			(88	)		—		—
Accrued interest payable		2,597			35			2,212			350		2,597

	Carrying Amount			Fair Value Measurements at December 31, 2016 Using:
	Carrying Amount			Level 1			Level 2			Level 3		Total
Financial assets
Cash and cash equivalents	$	90,927		$	90,927		$	—		$	—	$	90,927
Certificates of deposit held at other financial institutions		1,055			—			1,055			—		1,055
Securities available for sale		754,755			—			754,755			—		754,755
Securities held to maturity		228,894			—			227,892			—		227,892
Loans held for sale		23,699			—			23,699			—		23,699
Net loans		1,757,039			—			—			1,727,188		1,727,188
Restricted equity securities		11,843			n/a			n/a			n/a		n/a
Servicing rights, net		3,621			—			—			5,015		5,015
Mortgage banking derivative assets		229			—			229			—		—
Accrued interest receivable		9,931			—			5,172			4,759		9,931
Financial liabilities
Deposits	$	2,391,818		$	1,551,461		$	836,444		$	—	$	2,387,905
Federal funds purchased and repurchase agreements		83,301			—			83,301			—		83,301
Federal Home Loan Bank advances		132,000			—			131,098			—		131,098
Subordinated notes, net		58,337			—			—			61,762		61,762
Mortgage banking derivative liabilities		(66	)		—			(66	)		—		—
Accrued interest payable		1,924			154			1,075			695		1,924

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

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

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

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

(d) Mortgage Servicing Rights: Fair value of mortgage servicing rights is based on valuation models that calculate the present value of estimated net cash flows based on industry market data. The valuation model incorporates assumptions that market participants would use in estimating future net cash flows resulting in a Level 3 classification.

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

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

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

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

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

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

NOTE 9—EARNINGS PER SHARE

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


	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Basic
Net income available to common shareholders	$	8,889		$	7,137		$	25,689		$	20,855
Less: earnings allocated to participating securities		(66	)		(70	)		(206	)		(219	)

Net income allocated to common shareholders	$	8,823		$	7,067		$	25,483		$	20,636

Weighted average common shares outstanding including participating securities		13,188,761			10,721,253			13,119,170			10,652,223
Less: Participating securities		(97,842	)		(105,343	)		(105,350	)		(111,937	)

Average shares		13,090,919			10,615,910			13,013,820			10,540,286

Basic earnings per common share	$	0.67		$	0.67		$	1.96		$	1.96

Diluted
Net income allocated to common shareholders	$	8,823		$	7,067		$	25,483		$	20,636
Weighted average common shares outstanding for basic earnings per common share		13,090,919			10,615,910			13,013,820			10,540,286
Add: Dilutive effects of assumed exercises of stock options		584,778			668,674			662,890			652,272
Add: Dilutive effects of assumed exercises of stock warrants		—			13,370			2,104			12,937

Average shares and dilutive potential common shares		13,675,697			11,297,954			13,678,814			11,205,495

Diluted earnings per common share	$	0.65		$	0.63		$	1.86		$	1.84

For the three months ended September 30, 2017 and 2016, stock options for 352,042 and 272,087 shares of common stock were not considered in computing diluted earnings per common share because they were antidilutive. Stock options for 254,204 and 151,544 shares of common stock were not considered in computing diluted earnings per common share for the nine months ended September 30, 2017 and 2016 because they were antidilutive.

NOTE 10—SUBORDINATED DEBT ISSUANCE

The Company’s subordinated notes, net of issuance costs, totaled $58,470 and $58,337 at September 30, 2017 and at December 31, 2016, respectively. 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 7 of these consolidated financial statements.

The Company completed the issuance of $60,000 in principal amount of subordinated notes in two separate offerings. In March 2016, $40,000 of 6.875% fixed-to-floating rate subordinated notes (the “March 2016 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 (the “June 2016 Subordinated Notes”) were issued to certain accredited institutional investors in a private offering. 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.

The issuance costs related to the March 2016 Subordinated Notes amounted to $1,382 and are being amortized as interest expense over the ten-year term of the March 2016 Subordinated Notes. The issuance costs related to the June 2016 Subordinated Notes were $404 and are being amortized as interest expense over the ten-year term of the June 2016 Subordinated Notes. For the three months ended September 30, 2017 and 2016, amortization of issuance costs has amounted to $45 for both periods. For the nine months ended September 30, 2017 and 2016, amortization of issuance costs has amounted to $133 and $79, respectively.

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 payment frequency through year five*	Semiannually	Semiannually
Interest payment frequency after five years*	Quarterly	Quarterly
Interest repricing index and margin	3-month LIBOR plus 5.636%	3-month LIBOR plus 6.04%
Repricing frequency after five years	Quarterly	Quarterly

*	The Company currently may not make interest payments on either series of subordinated notes without prior written approval from its primary regulatory agencies. Through September 30, 2017 all interest payments have been made in accordance with the terms of the agreements.

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

The following discussion is intended to assist in the understanding and assessment of significant changes and trends related to the Company’s results of operations and financial condition. This discussion and analysis should be read in conjunction with the accompanying unaudited financial statements, the audited financial statements and accompanying notes included in the Company’s Form 10-K filed with the SEC on March 16, 2017, which includes additional information about critical accounting policies and practices and risk factors. Historical results and trends that might appear in the consolidated financial statements should not be interpreted as being indicative of future operations. All amounts are in thousands, except per share data or unless otherwise indicated.

Company Overview

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

Critical Accounting Policies

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

The Company’s accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the notes to the consolidated financial statements in the Company’s Form 10-K that was filed with the SEC on March 16, 2017. 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.

Allowance for Loan Losses

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

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

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

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

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

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

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

Recently Adopted Accounting Pronouncements

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 are to 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 excludes the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits are classified along with other income tax cash flows as an operating activity rather than as 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 changed 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 nine months ended September 30, 2016 by $616 and increased diluted earnings per share by $0.04. The adoption of this ASU also impacted previously reported quarterly earnings and earnings per share in the third quarter of 2016 by decreasing income tax expense by $107 and increasing diluted earnings per share by $0.01.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 creates a new topic in the FASB 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 establishes 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. Most of the Company’s revenues come from financial instruments, like loans, investment securities and other financial instruments which are not included in the scope of this ASU. The Company’s revenue recognition pattern for revenue streams within the scope of ASU 2014-09, including but not limited to service charges on deposit accounts, gains/losses on the sale of OREO and wealth management income, is not expected to change significantly from current practice. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company is currently planning to use the modified retrospective transition method which requires application of ASU 2014-09 to uncompleted contracts at the date of adoption. Periods prior to the date of adoption are not retrospectively revised, but a cumulative effect of adoption is recognized for the impact of the ASU on uncompleted contracts at the date of adoption. Adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2016, the 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 the 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 the fair value option for financial 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.

In February 2016, the 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 the Company for fiscal years beginning on or after December 15, 2018. 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 be impacted. Management is evaluating the impact ASU 2016-02 will have on the Company’s consolidated financial statements.

In June 2016, the 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 data 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, the 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.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. ASU 2017-04 is effective for interim and annual reporting periods beginning after December 15, 2019, applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. Adoption of ASU 2017-04 is not expected to have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This Update shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. The new guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the provisions of ASU 2017-08 to determine the potential impact the new standard will have on the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Subtopic 718): Scope of Modification Accounting. ASU 2017-09 clarifies when changes to terms or conditions of a share-based payment award must be accounted for as a modification. Under the new guidance, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the fair value of the award, (ii) the vesting conditions of the award, and (iii) the classification of the award as either an equity or liability instrument. ASU 2017-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The guidance requires companies to apply the requirements prospectively to awards modified on or after the adoption date. ASU 2017-09 is not expected to have a significant impact on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. The objective of this ASU is to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition to that main objective, the amendments in this Update make certain targeted improvements to simplify the application of the hedge accounting guidance in current GAAP. This Update is effective for public business entities for fiscal years beginning after December 15, 2018, and early application is permitted in any interim period after issuance of the Update. The Company currently does not have any hedging activities that would be subject to this Update; however, management may consider hedging activities in the future. Adoption of this Update is not expected to have a material impact on the Company’s consolidated financial statements.

COMPARISON OF RESULTS OF OPERATIONS FOR

THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $8,889 and $25,697 for the three and nine months ended September 30, 2017, respectively, compared to $7,137 and $20,878 for the three and nine months ended September 30, 2016, respectively. After earnings attributable to noncontrolling interest and after the payment of preferred dividends on the shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) issued to the United States Department of the Treasury (“Treasury”) pursuant to the Small Business Lending Fund (“SBLF”), the Company’s net earnings available to common shareholders for the three and nine months ended September 30, 2017 was $8,889 and $25,689, respectively, compared to $7,137 and $20,855 for the three and nine months ended September 30, 2016, respectively. The primary reason for the increase in net earnings available to common shareholders for the three and nine months ended September 30, 2017 was increased interest income on loans and investment securities compared with the same periods in 2016. The increase in loans was due to significant organic growth. The growth in the securities portfolio is primarily attributable to the Company’s leverage program to utilize proceeds received from capital raised during the fourth quarter of 2016.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets less interest expense paid on interest-bearing liabilities and is the most significant component of our revenues. Net interest income for the three and nine months ended September 30, 2017, totaled $24,326 and $72,438, respectively, compared to $20,675 and $59,885 for the same periods in 2016, an increase of $3,651 and $12,553, or 17.7% and 21.0%, between the respective periods. For the three and nine months ended September 30, 2017, interest income increased $8,056 and $24,761, or 31.3% and 34.1%, respectively, compared with the same periods in 2016, due to growth in both the loan and investment securities portfolios. For the three and nine months ended September 30, 2017, interest expense increased $4,405 and $12,208, or 87.2% and 96.2%, respectively, compared with the same periods in 2016, as a result of increases in interest-bearing deposits, Federal Home Loan Bank (“FHLB”) advances and subordinated notes.

Interest-earning assets averaged $3,351,421 and $2,576,294 during the three months ended September 30, 2017 and 2016, respectively, an increase of $775,127, or 30.1%. This increase was due to growth in all types of interest-earning assets, but the largest growth occurred in loans and investment securities. Average loans increased 26.5%, and investment securities increased 31.8%, when comparing the three months ended September 30, 2017 with the same period in 2016. When comparing the three months ended September 30, 2017 and 2016, the yield on average interest earning assets, adjusted for tax equivalent yield, increased five basis points in 2017 to 4.17% compared to 4.12% for the same period during 2016. For the three months ended September 30, 2017, the tax equivalent yield on available for sale securities was 2.61%, and for the three months ended September 30, 2016, the tax equivalent yield on available for sale securities was 2.42%. For the three months ended September 30, 2017, the tax equivalent yield on held to maturity securities was 4.11%, and for the three months ended September 30, 2016, the tax equivalent yield on held to maturity securities was 3.75%. The primary driver for the increase in yields on securities for the three-month period ended September 30, 2017 was the volume of tax-exempt municipal securities purchased during the past 12 months, which increased tax equivalent yields when comparing the three-month period in 2017 with the same period in 2016.

Interest-bearing liabilities averaged $2,856,337 during the three months ended September 30, 2017, compared to $2,201,206 for the same period in 2016, an increase of $655,131, or 29.8%. Total average interest-bearing deposits grew $460,127, or 22.9%, including increases in average interest checking of $291,152 and average time deposits of $178,786 for the three-month period ended September 30, 2017, as compared to the same period during 2016. Rapid growth in the loan portfolio also resulted in an increase in average FHLB advances of $202,445 when comparing the three months ended September 30, 2017 with the same period in 2016.

For the three-month periods ended September 30, 2017 and 2016, the cost of average interest-bearing liabilities increased 40 basis points to 1.31% from 0.91%. The increase was due to rate increases in the cost of funds for interest-bearing deposits, FHLB advances and Federal funds purchased.

Interest-earning assets averaged $3,304,558 and $2,427,824 during the nine months ended September 30, 2017 and 2016, respectively, an increase of $876,734, or 36.1%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 28.6%, and investment securities increased 46.8%, when comparing the nine months ended September 30, 2017 with the same period in 2016. When comparing the nine months ended September 30, 2017 and 2016, the yield on average interest earning assets, adjusted for tax equivalent yield decreased 2 basis points to 4.11% in 2017 compared to 4.13% for the same period during 2016.

For the nine months ended September 30, 2017 and 2016, the tax equivalent yield on loans was 4.96% and 4.95% respectively. For the three months ended September 30, 2017 and 2016, the tax equivalent yield on loans was 5.03% and 4.96%, respectively. The primary driver for the increase in yields on loans for the three- and nine-month periods ended September 30, 2017 was an increase in loan interest rates when compared with the same periods in 2016.

For the nine months ended September 30, 2017, the tax equivalent yield on available for sale securities was 2.66%, and for the nine months ended September 30, 2016, the tax equivalent yield on available for sale securities was 2.48%. For the nine months ended September 30, 2017, the tax equivalent yield on held to maturity securities was 4.18%, and for the nine months ended September 30, 2016, the tax equivalent yield on held to maturity securities was 3.92%. The primary driver for the increase in yields on securities for the nine-month period ended September 30, 2017 was the volume of tax-exempt municipal securities purchased during the past 12 months, which increased tax equivalent yields when comparing the nine-month period in 2017 with the same period in 2016.

Interest-bearing liabilities averaged $2,839,188 during the nine months ended September 30, 2017, compared to $2,044,661 for the same period in 2016, an increase of $794,527, or 38.9%. Total average interest-bearing deposits grew $606,229, including increases in interest-bearing checking of $339,569 and average time deposits of $259,409 for the nine-month period ended September 30, 2017, as compared to the same period during 2016. Rapid growth in the loan portfolio also resulted in an increase in average FHLB advances of $167,137, and subordinated notes and other borrowings increased $25,516, when comparing the nine months ended September 30, 2017 with the same period in 2016.

For the nine-month periods ended September 30, 2017 and 2016, the cost of average interest-bearing liabilities increased 34 basis points from 0.83% to 1.17%. The increase was due to increases in the cost of funds from interest-bearing deposits, FHLB advances, Federal funds purchased and repurchase agreements.

The tables below summarize average balances, annualized yields and rates, cost of funds, and the analysis of changes in interest income and interest expense for the three and nine months ended September 30, 2017 and 2016:

Average Balances—Yields & Rates⁽⁷⁾

(Dollars are in thousands)


	Three Months Ended September 30,
	2017								2016
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans⁽¹⁾⁽⁶⁾	$	2,049,575		$	26,006		5.03	%	$	1,620,347		$	20,219		4.96	%
Securities available for sale⁽⁶⁾		972,988			6,405		2.61	%		671,725			4,084		2.42	%
Securities held to maturity⁽⁶⁾		220,313			2,283		4.11	%		233,986			2,203		3.75	%
Restricted equity securities		17,396			269		6.13	%		10,372			133		5.10	%
Certificates of deposit at other financial institutions		2,412			9		1.48	%		941			4		1.69	%
Federal funds sold and other⁽²⁾		88,737			271		1.21	%		38,923			49		0.50	%

TOTAL INTEREST EARNING ASSETS	$	3,351,421		$	35,243		4.17	%	$	2,576,294		$	26,692		4.12	%
Allowance for loan losses		(18,891	)							(14,508	)
All other assets		94,334								86,466

TOTAL ASSETS	$	3,426,864							$	2,648,252
LIABILITIES & EQUITY
Deposits:
Interest checking	$	552,502		$	1,285		0.92	%	$	261,350		$	256		0.39	%
Money market		604,416			1,703		1.12	%		617,913			957		0.62	%
Savings		54,921			42		0.30	%		51,235			40		0.31	%
Time deposits		1,259,452			4,281		1.35	%		1,080,666			2,430		0.89	%
Federal Home Loan Bank advances		289,228			968		1.33	%		86,783			215		0.99	%
Federal funds purchased and other⁽³⁾		37,374			92		0.98	%		44,974			69		0.61	%
Subordinated notes and other borrowings		58,444			1,083		7.35	%		58,285			1,082		7.39	%

TOTAL INTEREST BEARING LIABILITIES	$	2,856,337		$	9,454		1.31	%	$	2,201,206		$	5,049		0.91	%
Demand deposits		261,127								224,387
Other liabilities		11,312								16,650
Total equity		298,088								206,009

TOTAL LIABILITIES AND EQUITY	$	3,426,864							$	2,648,252
NET INTEREST SPREAD⁽⁴⁾							2.86	%							3.21	%
NET INTEREST INCOME				$	25,789							$	21,643
NET INTEREST MARGIN⁽⁵⁾							3.05	%							3.34	%


	Nine Months Ended September 30,
	2017								2016
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans⁽¹⁾⁽⁶⁾	$	1,975,592		$	73,274		4.96	%	$	1,535,894		$	56,933		4.95	%
Securities available for sale(⁶⁾		1,002,118			19,958		2.66	%		641,270			11,917		2.48	%
Securities held to maturity⁽⁶⁾		224,174			7,012		4.18	%		194,326			5,698		3.92	%
Restricted equity securities		15,830			663		5.60	%		9,256			354		5.11	%
Certificates of deposit at other financial institutions		2,178			24		1.47	%		751			11		1.96	%
Federal funds sold and other⁽²⁾		84,666			643		1.02	%		46,327			164		0.47	%

TOTAL INTEREST EARNING ASSETS	$	3,304,558		$	101,574		4.11	%	$	2,427,824		$	75,077		4.13	%
Allowance for loan losses		(18,182	)							(13,179	)
All other assets		92,425								41,988

TOTAL ASSETS	$	3,378,801							$	2,456,633
LIABILITIES & EQUITY
Deposits:
Interest checking	$	631,582		$	3,586		0.76	%	$	292,013		$	853		0.39	%
Money market		608,670			4,412		0.97	%		608,341			2,767		0.61	%
Savings		55,569			127		0.31	%		48,647			121		0.33	%
Time deposits		1,196,675			10,993		1.23	%		937,266			6,377		0.91	%
Federal Home Loan Bank advances		242,549			2,228		1.23	%		75,412			511		0.91	%
Federal funds purchased and other⁽³⁾		45,745			309		0.90	%		50,100			237		0.63	%
Subordinated notes and other borrowings		58,398			3,239		7.42	%		32,882			1,820		7.39	%

TOTAL INTEREST BEARING LIABILITIES	$	2,839,188		$	24,894		1.17	%	$	2,044,661		$	12,686		0.83	%
Demand deposits		246,675								200,981
Other liabilities		7,358								12,707
Total equity		285,580								198,284

TOTAL LIABILITIES AND EQUITY	$	3,378,801							$	2,456,633
NET INTEREST SPREAD⁽⁴⁾							2.94	%							3.30	%
NET INTEREST INCOME				$	76,680							$	62,391
NET INTEREST MARGIN⁽⁵⁾							3.10	%							3.43	%

⁽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 and the Federal Home Loan Bank.

⁽³⁾	Includes repurchase agreements.

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

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

⁽⁶⁾	Interest income and rates include the effects of 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.

Analysis of Changes in Interest Income and Expenses


	Net change three months ended September 30, 2017 versus September 30, 2016
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	5,425		$	362		$	5,787
Securities available for sale		1,855			466			2,321
Securities held to maturity		(120	)		200			80
Restricted equity securities		91			45			136
Certificates of deposit at other financial institutions		6			(1	)		5
Federal funds sold and other		63			159			222

TOTAL INTEREST INCOME	$	7,320		$	1,231		$	8,551

INTEREST EXPENSE
Deposits
Interest checking	$	291		$	738		$	1,029
Money market accounts		(16	)		762			746
Savings		3			(1	)		2
Time deposits		391			1,460			1,851
Federal Home Loan Bank advances		505			248			753
Fed funds purchased and other borrowed funds		(12	)		35			23
Subordinated Notes and other borrowings		7			(6	)		1

TOTAL INTEREST EXPENSE	$	1,169		$	3,236		$	4,405

NET INTEREST INCOME	$	6,151		$	(2,005	)	$	4,146


	Net change nine months ended September 30, 2017 versus September 30, 2016
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	16,193		$	148		$	16,341
Securities available for sale		6,692			1,349			8,041
Securities held to maturity		878			436			1,314
Restricted equity securities		251			58			309
Certificates of deposit at other financial institutions		21			(8	)		13
Federal funds sold and other		131			348			479

TOTAL INTEREST INCOME	$	24,166		$	2,331		$	26,497

INTEREST EXPENSE
Deposits
Interest checking	$	985		$	1,748		$	2,733
Money market accounts		6			1,639			1,645
Savings		14			(8	)		6
Time deposits		1,752			2,864			4,616
Federal Home Loan Bank advances		1,136			581			1,717
Fed funds purchased and other borrowed funds		(20	)		92			72
Subordinated notes and other borrowings		1,406			13			1,419

TOTAL INTEREST EXPENSE	$	5,279		$	6,929		$	12,208

NET INTEREST INCOME	$	18,887		$	(4,598	)	$	14,289

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 $590 and $1,392 for the three months ended September 30, 2017 and 2016, respectively, and $3,018 and $4,095 for the nine months ended September 30, 2017 and 2016, respectively. The lower provision for the three and nine months ended September 30, 2017 compared to the same periods in 2016 is based on the Company’s analysis of its allowance for loan losses which, based on the loan portfolio’s risk profile and comparatively less loan growth, required less provision be recorded. Nonperforming loans at September 30, 2017 totaled $2,860 compared to $6,182 at December 31, 2016, representing 0.1% and 0.3% of total loans, respectively.

Non-Interest Income

Non-interest income for the three and nine months ended September 30, 2017 was $3,569 and $11,457, respectively, compared to $4,876 and $12,587 for the same periods in 2016, respectively. The following is a summary of the components of non-interest income (in thousands):


	Three Months Ended September 30,						$ Increase (Decrease)			% Increase (Decrease)
	2017			2016			$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	39		$	44		$	(5	)		(11.4	%)
Other service charges and fees		787			845			(58	)		(6.9	%)
Net gains on sale of loans		1,517			2,942			(1,425	)		(48.4	%)
Wealth management		643			446			197			44.2	%
Loan servicing fees, net		70			(40	)		110			275.0	%
Gain on sales of investment securities, net		350			430			(80	)		(18.6	%)
Net gain on foreclosed assets		(16	)		30			(46	)		(153.3	%)
Other		179			179			—			—	%

Total non-interest income	$	3,569		$	4,876		$	(1,307	)		(26.8	%)


	Nine Months Ended September 30,						$ Increase (Decrease)			% Increase (Decrease)
	2017			2016			$ Increase (Decrease)			% Increase (Decrease)
Service charges on deposit accounts	$	114		$	139		$	(25	)		(18.0	%)
Other service charges and fees		2,297			2,245			52			2.3	%
Net gains on sale of loans		5,918			6,859			(941	)		(13.7	%)
Wealth management		1,884			1,343			541			40.3	%
Loan servicing fees, net		230			(2	)		232			11,600.0	%
Gain on sales of investment securities, net		470			1,535			(1,065	)		(69.4	%)
Net gain on foreclosed assets		(10	)		36			(46	)		(127.8	%)
Other		554			432			122			28.2	%

Total non-interest income	$	11,457		$	12,587		$	(1,130	)		(9.0	%)

Service charges on deposit accounts for the three and nine months ended September 30, 2017 decreased $5 and $25, or 11.4% and 18.0%, respectively, from the same periods in 2016. The decrease for the nine months ended September 30, 2017 was due to the Company’s waiving service charges on deposit accounts during March 2017 while the Company was going through a core system conversion.

Other service charges and fees for the three and nine months ended September 30, 2017 decreased $58 and increased $52, or 6.9% and 2.3%, respectively, from the same periods in 2016. The fluctuation for the nine months ended September 30, 2017 was due to a combination of increases and decreases, with the following types of fees having the largest fluctuation in the comparative periods: unused commitment fees ($108), ATM foreign surcharge fees ($42), and underwriting fees ($32).

Net gain on sale of loans decreased $1,425, or 48.4% and $941, or 13.7%, when comparing the three and nine months ended September 30, 2017 to the same period in 2016, respectively. The changes in both periods were due to the volume of loans sold and the margins related to the loans sold.

Wealth management income for the three and nine months ended September 30, 2017 increased $197 and $541, or 44.2% and 40.3%, respectively, in comparison with the same periods in 2016. The increase was attributed to the growth in the client base and assets under management in the wealth management division, as well as improvement in the stock markets. As a comparison, the Company had assets under management at September 30, 2017 and 2016 of $351,932 and $262,879, respectively.

Net loan servicing fees for the three and nine months ended September 30, 2017 increased $110 and $232, or 275.0% and 11,600.0%, respectively, in comparison with the same periods in 2016. The increase was attributed to the growth in the mortgage loans serviced and the related valuation increase of the mortgage servicing rights.

Net gain on sale of investment securities decreased $80 and $1,065, or 18.6% and 69.4%, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods in 2016. The decreases were primarily due to the gains on securities that were recognized in the third quarter of 2016, which were related to management selling a number of smaller securities to consolidate the number of securities carried in the portfolio, and selling securities of two municipalities whose credit rating had fallen below management’s credit score limit.

Other non-interest income remained consistent when comparing the three months ended September 30, 2017 with the same period in 2016 and increased by $122, or 28.2%, when comparing the nine months ended September 30, 2017 with the same period in 2016. The increase for the nine months ended September 30, 2017 is primarily attributed to the loss of $98 recorded on the sale of the Company’s real estate in downtown Murfreesboro, Tennessee during first quarter 2016.

Non-Interest Expense

Non-interest expense for the three and nine months ended September 30, 2017 was $15,278 and $44,837, respectively, compared to $13,708 and $38,452 for the same periods in 2016, respectively. The increases were the result of the following components listed in the table below (in thousands):


	Three Months Ended September 30,				$ Increase (Decrease)			% Increase (Decrease)
	2017		2016		$ Increase (Decrease)			% Increase (Decrease)
Salaries and employee benefits	$	9,011	$	7,979	$	1,032			12.9	%
Occupancy and equipment		2,399		2,001		398			19.9	%
FDIC assessment expense		900		570		330			57.9	%
Marketing		192		206		(14	)		(6.8	%)
Professional fees		821		935		(114	)		(12.2	%)
Amortization of core deposit intangible		115		138		(23	)		(16.7	%)
Other		1,840		1,879		(39	)		(2.1	%)

Total non-interest expense	$	15,278	$	13,708	$	1,570			11.5	%


	Nine Months Ended September 30,				$ Increase (Decrease)			% Increase (Decrease)
	2017		2016		$ Increase (Decrease)			% Increase (Decrease)
Salaries and employee benefits	$	26,172	$	22,099	$	4,073			18.4	%
Occupancy and equipment		6,689		5,563		1,126			20.2	%
FDIC assessment expense		2,675		1,388		1,287			92.7	%
Marketing		744		611		133			21.8	%
Professional fees		2,558		3,006		(448	)		(14.9	%)
Amortization of core deposit intangible		363		431		(68	)		(15.8	%)
Other		5,636		5,354		282			5.3	%

Total non-interest expense	$	44,837	$	38,452	$	6,385			16.3	%

The increase in non-interest expense noted in the table above is related to the Company’s overall growth. The Company’s largest increases for the three and nine months ended September 30, 2017, in comparison with the same periods of 2016, were in salaries and employee benefits, occupancy and equipment, FDIC assessment expense, and other non-interest expense.

Salaries and employee benefits increased $1,032 and $4,073, or 12.9% and 18.4%, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods in 2016. The increases in both periods are primarily due to the Company’s staffing growth, during which the Company went from 261 full-time equivalent employees as of September 30, 2016, to 279 as of September 30, 2017, many of which were officer level positions as the Company has worked to enhance its management team to properly oversee the Company’s growth and to grow its team of lenders to further grow the loan portfolio. In addition to salaries, incentive expenses increased $405 and $309, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods of 2016 due to the Company’s financial performance during the three and nine months ended September 30, 2017. Stock-based compensation expense also increased $266 and $657, respectively, for the three and nine months ended September 30, 2017 in comparison with the same periods in 2016.

Occupancy and equipment expense increased $398 and $1,126, or 19.9% and 20.2%, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods in 2016. The variance for the three months ended September 30, 2017 versus the three months ended September 30, 2016 is primarily attributable to increases in building rent expense ($222), software maintenance fees ($114), and software depreciation ($21). The variance when comparing the nine months ended September 30, 2017 with the nine months ended September 30, 2016 is attributable to increases in building rent expense ($634), software maintenance fees ($281) and leasehold improvement depreciation ($69).

The Company’s FDIC assessment expense increased $330 and $1,287, or 57.9% and 92.7%, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods in 2016. The increases are due to the year-over-year asset growth of the Company, on which FDIC assessments are calculated, and are also related to the change in the FDIC insurance assessment calculation in the third quarter of 2016, which caused an increase in the Company’s insurance assessments based on the calculation’s components.

Professional fees decreased $114 and $448, or 12.2% and 14.9%, respectively, when comparing the three and nine months ended September 30, 2017 with the same periods in 2016. The decrease when comparing the three months ended September 30, 2017 with the same period in 2016 is due to decreases in other professional fees ($85) and compliance fees ($152). The decrease, when comparing the nine months ended September 30, 2017 and 2016, is due to decreases in merger-related expenses ($316), legal fees ($79) and SEC filing expense ($67). The decreases in other professional fees are related to the following 2016 expenses: (1) the design and implementation of subsidiaries (Franklin Synergy Risk Management, Inc., Franklin Synergy Investments of Tennessee, Inc., Franklin Synergy Investments of Nevada, Inc., and Franklin Synergy Preferred Capital, Inc.); (2) a consulting engagement related to the Company’s core systems and related processes; and (3) professional placement service fees for the hiring of several key lending and management professionals.

For the three months ended September 30, 2017, other non-interest expenses decreased $39, or 2.1%, and for the nine months ended September 30, 2017, other noninterest expenses increased $282, or 5.3%, from the same comparative periods during 2016. The increase in other non-interest expense for the nine months ended September 30, 2017 versus September 30, 2016 is attributed to increases in several types of expenses, but the following expense types represent the largest variances: insurance expense ($78); franchise taxes ($162); travel expenses ($74); management fees ($200); and loan servicing expense ($219). These variances were offset by decreases in various expense types, with the following account having the largest decrease: loan-related expenses ($283).

Income Tax Expense

The Company recognized income tax expense for the three and nine months ended September 30, 2017, of $3,138 and $10,343, respectively, compared to $3,314 and $9,047, respectively, for the three and nine months ended September 30, 2016. The Company’s year-to-date income tax expense for the period ended September 30, 2017 reflects an effective income tax rate of 28.7%, a decrease compared to 30.2% for the same period in 2016.

COMPARISON OF BALANCE SHEETS AT SEPTEMBER 30, 2017 AND DECEMBER 31, 2016

Overview

The Company’s total assets increased by $622,089, or 21.1%, from December 31, 2016 to September 30, 2017. The increase in total assets has primarily been the result of organic growth in the loan portfolio and from purchases of additional investment securities.

Loans

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

The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, at September 30, 2017 and December 31, 2016 were $2,115,930 and $1,773,592, respectively, an increase of $342,338, or 19.3%. As a percentage of total assets, total loans, net of deferred fees, at September 30, 2017 and December 31, 2016 were 59.3% and 60.3%, respectively. Growth in the loan portfolio is primarily due to increased market penetration and a healthy local economy. The Company has also attracted a number of experienced commercial and mortgage lenders to help increase penetration in its primary markets in Middle Tennessee, Williamson County, Rutherford County and Davidson County.

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


	September 30, 2017						December 31, 2016
Types of Loans	Amount			% of Total Loans			Amount			% of Total Loans
Total loans, excluding purchased credit impaired (“PCI”) loans
Real estate:
Construction and land development	$	514,934			24.3	%	$	489,562			27.6	%
Commercial		598,846			28.3	%		497,140			28.0	%
Residential		532,113			25.1	%		404,989			22.8	%
Commercial and industrial		464,747			22.0	%		376,476			21.2	%
Consumer and other		3,933			0.2	%		3,359			0.2	%

Total loans—gross, excluding PCI loans		2,114,573			99.9	%		1,771,526			99.8	%

Total PCI loans		2,558			0.1	%		2,859			0.2	%

Total gross loans		2,117,131			100.0	%		1,774,385			100.0	%

Less: deferred loan fees, net		(1,201	)					(793	)
Allowance for loan losses		(19,944	)					(16,553	)

Total loans, net allowance for loan losses	$	2,095,986					$	1,757,039

The discussion in the following paragraphs includes the PCI loans in the breakdown of the various categories of loans.

Total gross loans increased 19.3% during the first nine months of 2017, due to organic growth as a result of continued market penetration and the strength of the local economy. During this period, the Company experienced growth in real estate loans of 18.2% with growth occurring in the residential real estate (31.3%), commercial real estate (20.4%) and construction and land development (5.2%) segments. The Company also experienced growth of 23.3% in the commercial and industrial segment during the first nine months of 2017.

Real estate loans comprised 77.7% of the loan portfolio at September 30, 2017. The largest portion of the real estate segments as of September 30, 2017, was commercial real estate loans, which totaled 36.4% of real estate loans. Commercial real estate loans totaled $599,233 at September 30, 2017, and comprised 28.3% 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 $514,934 at September 30, 2017, and comprised 31.3% of total real estate loans and 24.3% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development.

The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit and other junior lien mortgage loans. Residential real estate loans totaled $532,295 and comprised 32.3% of real estate loans and 25.1% of total loans at September 30, 2017.

Commercial and industrial loans totaled $466,736 at September 30, 2017 and grew 23.3% during the first nine months of 2017. Loans in this classification comprised 22.0% of total loans at September 30, 2017. The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and healthcare loans.

The repayment of loans is a source of additional liquidity for the Company. The following table sets forth the loans maturing within specific intervals at September 30, 2017, excluding unearned net fees and costs.

Loan Maturity Schedule


	September 30, 2017
	One year or less		Over one year to five years		Over five years		Total
Real estate:
Construction and land development	$	276,021	$	165,429	$	73,484	$	514,934
Commercial		28,239		154,309		416,685		599,233
Residential		37,849		116,899		377,547		532,295
Commercial and industrial		75,035		308,537		83,164		466,736
Consumer and other		2,249		1,281		403		3,933

Total	$	419,393	$	746,455	$	951,283	$	2,117,131

Fixed interest rate	$	205,808	$	306,701	$	433,595	$	946,104
Variable interest rate		213,585		439,754		517,688		1,171,027

Total	$	419,393	$	746,455	$	951,283	$	2,117,131

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

Allowance for Loan Losses

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

•

past loan experience;

•

the nature and volume of the portfolio;

•

risks known about specific borrowers;

•

underlying estimated values of collateral securing loans;

•

current and anticipated economic conditions; and

•

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

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

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

In the table below, the components, as discussed above, of the allowance for loan losses are shown as of September 30, 2017 and December 31, 2016.


	September 30, 2017							December 31, 2016							Increase (Decrease)
	Loan Balance		ALLL Balance		%			Loan Balance		ALLL Balance		%			Loan Balance			ALLL Balance
Non impaired loans	$	2,053,704	$	18,922		0.92	%	$	1,687,244	$	15,506		0.92	%	$	366,460		$	3,416		—
Non-PCI acquired loans (Note 1)		57,663		11		0.02	%		74,373		23		0.03	%		(16,710	)		(12	)	-1	bps
Impaired loans		3,206		1,011		31.53	%		9,909		1,024		10.33	%		(6,703	)		(13	)	2,120	bps

Non-PCI loans		2,114,573		19,944		0.94	%		1,771,526		16,553		0.93	%		343,047			3,391		1	bps
PCI loans		2,558		—		—	%		2,859		—		—	%		(301	)		—		—

Total loans	$	2,117,131	$	19,944		0.94	%	$	1,774,385	$	16,553		0.93	%	$	342,746		$	3,391		1	bps

Note 1: Loans acquired pursuant to the July 1, 2014 acquisition of MidSouth Bank (“MidSouth”) that are not PCI loans. These are performing loans recorded at estimated fair value at the acquisition date. The fair value adjustment at the acquisition date was approximately $5,014 of the outstanding non-PCI loan balances acquired. This amount is accreted into interest income over the remaining lives of the related loans on a level yield basis. Based on the analysis performed by management as of September 30, 2017, $11 in allowance for loan loss was recorded at September 30, 2017 related to the loans acquired from MidSouth.

At September 30, 2017, the allowance for loan losses was $19,944, compared to $16,553 at December 31, 2016. The allowance for loan losses as a percentage of total loans was 0.94% at September 30, 2017 compared to 0.94% at December 31, 2016. Loan growth during the first nine months of 2017 is the primary reason for the increase in the allowance amount.

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


	Nine Months Ended September 30, 2017			Nine Months Ended September 30, 2016
Beginning balance	$	16,553		$	11,587
Loans charged-off:
Construction & land development		—			11
Commercial real estate		—			—
Residential real estate		1			39
Commercial & industrial		309			65
Consumer & other		36			35

Total loans charged-off		346			150
Recoveries on loans previously charged-off:
Construction & land development		668			—
Commercial real estate		—			—
Residential real estate		38			53
Commercial & industrial		—			—
Consumer & other		13			5

Total loan recoveries		719			58
Net recoveries (charge-offs)		373			(92	)
Provision for loan losses charged to expense		3,018			4,095

Total allowance at end of period	$	19,944		$	15,590

Total loans, gross, at end of period⁽¹⁾	$	2,117,131		$	1,654,878

Average gross loans⁽¹⁾	$	1,966,635		$	1,525,359

Allowance to total loans		0.94	%		0.94	%

Net charge-offs (recoveries) to average loans, annualized		(0.03	%)		0.01	%

⁽¹⁾	Loan balances exclude loans held for sale

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


	September 30, 2017					December 31, 2016
	Amount		% of Loans to Total			Amount		% of Loans to Total
Real estate loans:
Construction and land development	$	3,957		24.3	%	$	3,776		27.6	%
Commercial		5,223		28.3	%		4,266		28.0	%
Residential		3,122		25.1	%		2,398		22.9	%

Total real estate		12,302		77.7	%		10,440		78.5	%

Commercial and industrial		7,592		22.1	%		6,068		21.3	%
Consumer and other		50		0.2	%		45		0.2	%

	$	19,944		100.0	%	$	16,553		100.0	%

Nonperforming Assets

Non-performing loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest. Non-performing assets consist of non-performing loans plus OREO (i.e., real estate acquired through foreclosure or deed in lieu of foreclosure). Loans that become past due 90 days are reviewed to determine if they should be placed on non-accrual status. Loans where, after giving consideration to economic conditions, collateral value, and collection efforts, the full collection of principal and interest is in doubt, or a portion of principal has been charged off, will be placed on non-accrual. When a loan is placed on non-accrual status, interest accruals cease and uncollected interest is reversed and charged against current income. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The primary component of non-performing loans is non-accrual loans, which as of September 30, 2017 totaled $2,582. The other component of non-performing loans are loans past due greater than 90 days and still accruing interest. Loans past due greater than 90 days are placed on non-accrual status, unless they are both well-secured and in the process of collection. There were outstanding loans totaling $278 that were past due 90 days or more and still accruing interest at September 30, 2017.

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


	September 30, 2017			December 31, 2016
Non-accrual loans	$	2,582		$	3,630
Past due loans 90 days or more and still accruing interest		278			2,552

Total non-performing loans		2,860			6,182
Foreclosed real estate (“OREO”)		1,503			—

Total non-performing assets		4,363			6,182
Total non-performing loans as a percentage of total loans		0.1	%		0.3	%
Total non-performing assets as a percentage of total assets		0.1	%		0.2	%
Allowance for loan losses as a percentage of non-performing loans		697	%		268	%

As of September 30, 2017, there were three loans on non-accrual status. The amount and number are further delineated by collateral category and number of loans in the table below.


	Total Amount		Percentage of Total Non-Accrual Loans			Number of Non-Accrual Loans
Construction & land development	$	—		—	%		—
Commercial real estate		116		4.5	%		1
Residential real estate		—		—	%		—
Commercial & industrial		2,466		95.5	%		2
Consumer		—		—	%		—

Total non-accrual loans	$	2,582		100.0	%		3

Investment Securities and Other Earning Assets

The investment securities portfolio is intended to provide the Company with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is structured with minimal credit exposure to the Company and consists of both securities classified as available-for-sale and securities classified as held-to-maturity. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management deem it to be in the Company’s best interest. Securities available-for-sale, consisting primarily of U.S. government sponsored enterprises and mortgage-backed securities, were $980,737 at September 30, 2017, compared to $754,755 at December 31, 2016, an increase of $225,982, or 29.9%. The increase in available-for-sale securities was primarily attributed to the volume of securities purchased during the first nine months of 2017.

The held-to-maturity securities are carried at amortized cost. This portfolio, consisting of U.S. government sponsored enterprises, mortgage-backed securities and municipal securities, totaled $217,312 at September 30, 2017, compared to $228,894 at December 31, 2016, a decrease of $11,582, or 5.1%. The decrease is attributable to securities that matured or had principal pay downs during the first nine months of 2017.

The combined portfolios represented 33.6% and 33.4% of total assets at September 30, 2017 and December 31, 2016, respectively. At September 30, 2017, the Company had no securities that were classified as having other than temporary impairment.

The Company also had other investments of $18,472 and $11,843 at September 30, 2017 and December 31, 2016, 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 $11,217 at September 30, 2017 compared to $9,551 at December 31, 2016, an increase of $1,666, or 17.4%. This increase was the result of adding leasehold improvements and furniture and equipment as needed in the normal course of business and related to the build-out of a new leased bank office building in Murfreesboro, Tennessee, a new leased office space in Franklin, Tennessee, and a new leased bank building located in Spring Hill, Tennessee.

Deposits

Deposits represent the Company’s largest source of funds. The Company competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives.

At September 30, 2017, total deposits were $2,824,825, an increase of $433,007, or 18.1%, compared to $2,391,818 at December 31, 2016. The growth in deposits is attributable to growth in time deposits and noninterest-bearing deposits.

Included in the Company’s funding strategy are brokered deposits. Total brokered deposits increased from $472,515 at December 31, 2016 to $878,565 at September 30, 2017, due to the increased need for funding for the Bank’s loan growth and due to the fluctuation in certain brokered deposits that are interest-bearing checking and money market accounts that can fluctuate daily.

Public funds deposits in the form of county deposits are a part of the Company’s funding strategy and are cyclical in nature, with the peak of those deposit balances occurring during the middle of the first quarter of each calendar year. Public funds declined $214,866, or 32.9%, from $653,572 at December 31, 2016 to $438,706 at September 30, 2017.

Time deposits excluding brokered deposits as of September 30, 2017, amounted to $736,067, compared to $555,732 as of December 31, 2016, an increase of $180,335, or 32.4%, primarily due to an increase in Local Government Investment Pool (LGIP) deposits of $185,030 during the first nine months of 2017. Non-public funds money market accounts, excluding brokered deposits, increased $90,039, or 33.8%, from December 31, 2016 to September 30, 2017. Noninterest-bearing checking deposits grew $23,396, or 10.0%, and non-public funds interest checking accounts, excluding brokered deposits, grew $12,560, or 11.0%, respectively, when comparing deposit balances from September 30, 2017 with balances at December 31, 2016.

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


	September 30, 2017
Three months or less	$	448,951
Three through six months		92,911
Six through twelve months		76,147
Over twelve months		151,497

Total	$	769,506

Federal Funds Purchased and Repurchase Agreements

As of September 30, 2017, the Company had $0 in federal funds purchased from correspondent banks compared to $46,805 outstanding as of December 31, 2016. Securities sold under agreements to repurchase had an outstanding balance of $32,862 as of September 30, 2017, compared to $36,496 as of December 31, 2016. Securities sold under agreements to repurchase are financing arrangements that mature daily or within a short period of time. At maturity, the securities underlying the agreements are returned to the Company.

Federal Home Loan Bank Advances

The Company has established a line of credit with the Federal Home Bank of Cincinnati which is secured by a blanket pledge of 1-4 family residential mortgages and home equity lines of credit. At September 30, 2017 and at December 31, 2016, advances totaled $337,000 and $132,000, respectively.

At September 30, 2017, the scheduled maturities and interest rates of these advances were as follows:


Scheduled Maturities	Amount		Weighted Average Rates
2017	$	75,000		1.17	%
2018		157,000		1.19	%
2019		50,000		1.41	%
2020		55,000		1.72	%

Total	$	337,000		1.31	%

Subordinated Notes

At September 30, 2017, the Company’s subordinated notes, net of issuance costs, totaled $58,470, compared with $58,337 at December 31, 2016. For more information related to the subordinated notes and the related issuance costs, please see Note 10 of the consolidated financial statements.

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 subordinated notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. Under the terms of the informal agreement with the Federal Reserve Bank of Atlanta (the “Reserve Bank”) and the Tennessee Department of Financial Institutions (“TDFI”), described in “Other Events” below, the Bank is required to receive prior written approval from its regulatory agencies to pay dividends to the Company.

Funds are available from a number of basic banking activity sources including the core deposit base, the repayment and maturity of loans, payments of principal and interest as well as sales of investments classified as available-for-sale, and sales of brokered deposits. As of September 30, 2017, $980,737 of the investment securities portfolio was classified as available-for-sale and is reported at fair value on the consolidated balance sheet. Another $217,312 of the portfolio was classified as held-to-maturity and is reported at amortized cost. Approximately $944,463 of the total $1,198,049 investment securities portfolio on hand at September 30, 2017, 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.

Equity

As of September 30, 2017, the Company’s equity was $303,697, as compared with $270,361 as of December 31, 2016. The increase in equity was primarily due to the Company’s earnings of $25,697 in the first nine months of 2017, the increase in common stock of $3,288 during the first nine months of 2017, and the $4,359 increase in other comprehensive income from the increase in the valuation of available for sale securities.

Effects of Inflation and Changing Prices

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

Off Balance Sheet Arrangements

The Company generally does not have any off-balance sheet arrangements other than approved and unfunded loans and lines and letters of credit to customers in the ordinary course of business. At September 30, 2017, the Company had unfunded loan commitments outstanding of $43,611, unused lines of credit of $563,178, and outstanding standby letters of credit of $41,523.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

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 Three Months Ended
	Sept 30, 2017			Jun 30, 2017			Mar 31, 2017			Dec 31, 2016			Sept 30, 2016
Total shareholders’ equity	$	303,594		$	292,918		$	278,407		$	270,258		$	209,644
Less: Preferred stock		—			—			—			—			—

Total common shareholders’ equity		303,594			292,918			278,407			270,258			209,644
Less: Goodwill and other intangible assets		10,294			10,356			10,477			10,633			10,774

Tangible common shareholders’ equity	$	293,300		$	282,562		$	267,930		$	259,625		$	198,870
Common shares outstanding		13,209,055			13,181,501			13,064,110			13,036,954			10,757,483

Tangible book value per share	$	22.20		$	21.44		$	20.51		$	19.91		$	18.49

Average total common equity		298,088			285,659		$	272,713		$	235,984		$	206,009
Less: Average Goodwill and other intangible assets		10,321			10,427			10,565			10,719			10,855

Average tangible common shareholders’ equity	$	287,767		$	275,232		$	262,148		$	225,265		$	195,154
Net income available to common shareholders		8,889			8,866			7,934			7,179			7,137
Average tangible common equity		287,767			275,232			262,148			225,265			195,154

Return on average tangible common equity		12.26	%		12.92	%		12.27	%		12.68	%		14.55	%

Efficiency Ratio:
Net interest income	$	24,326		$	24,469		$	23,643		$	21,699		$	20,675
Noninterest income		3,569			3,880			4,008			2,553			4,876

Operating revenue		27,895			28,349			27,651			24,252			25,551
Expense
Total noninterest expense		15,278			15,283			14,276			13,229			13,708

Efficiency ratio		54.77	%		53.91	%		51.63	%		54.55	%		53.65	%

FRANKLIN FINANCIAL NETWORK, INC.

SUMMARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)

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


	As of and for the three months ended
	Sept 30, 2017			Jun 30, 2017		Mar 31, 2017		Dec 31, 2016		Sept 30, 2016
Income Statement Data ($):
Interest income		33,780			33,011		30,541		27,336		25,724
Interest expense		9,454			8,542		6,898		5,637		5,049
Net interest income		24,326			24,469		23,643		21,699		20,675
Provision for loan losses		590			573		1,855		1,145		1,392
Noninterest income		3,569			3,880		4,008		2,553		4,876
Noninterest expense		15,278			15,283		14,276		13,229		13,708
Net income before taxes		12,027			12,493		11,520		9,878		10,451
Income tax expense⁽¹⁾		3,138			3,619		3,586		2,699		3,314
Net income⁽¹⁾		8,889			8,874		7,934		7,179		7,137
Earnings before interest and taxes		21,481			21,035		18,418		15,515		15,500
Net income available to common shareholders		8,889			8,866		7,934		7,179		7,137
Weighted average diluted common shares		13,773,539			13,701,762		13,657,357		12,473,725		11,415,422
Earnings per share, basic		0.67			0.68		0.61		0.61		0.67
Earnings per share, diluted		0.65			0.64		0.58		0.58		0.63
Profitability (%)
Return on average assets		1.03			1.03		0.99		1.00		1.07
Return on average equity		11.83			12.46		11.80		12.10		13.78
Return on average tangible common equity⁽³⁾		12.26			12.92		12.27		12.68		14.55
Efficiency ratio⁽³⁾		54.77			53.91		51.63		54.55		53.65
Net interest margin⁽⁴⁾		3.05			3.08		3.18		3.27		3.34
Balance Sheet Data ($):
Loans (including HFS)		2,127,753			2,023,679		1,962,397		1,797,291		1,680,877
Loan loss reserve		19,944			18,689		18,105		16,553		15,590
Cash		155,842			96,741		114,664		90,927		56,804
Securities		1,198,049			1,243,406		1,299,349		983,649		905,806
Goodwill		9,124			9,124		9,124		9,124		9,124
Intangible assets (Sum of core deposit intangible and SBA servicing rights)		1,170			1,232		1,353		1,509		1,650
Assets		3,565,278			3,443,593		3,454,788		2,943,189		2,703,195
Deposits		2,824,825			2,754,425		2,817,212		2,391,818		2,217,954
Liabilities		3,261,581			3,150,572		3,176,278		2,672,828		2,493,551
Total equity		303,697			293,021		278,510		270,361		209,644
Common equity		303,594			292,918		278,407		270,258		209,644
Tangible common equity⁽³⁾		293,300			282,562		267,930		259,625		198,870
Asset Quality (%)
Nonperforming loans/ total loans⁽²⁾		0.14			0.19		0.21		0.35		0.10
Nonperforming assets / (total loans⁽²⁾ + foreclosed assets)		0.21			0.26		0.27		0.35		0.10
Loan loss reserve / total loans⁽²⁾		0.94			0.93		0.93		0.93		0.94
Net charge-offs / average loans		(0.13	)		0.00		0.07		0.04		0.01
Capital (%)
Tangible common equity to tangible assets⁽³⁾		8.25			8.23		7.78		8.85		7.39
Leverage ratio		8.58			8.21		8.36		9.28		7.15
Common Equity Tier 1 ratio		11.58			11.54		11.32		11.75		9.09
Tier 1 risk-based capital ratio		11.58			11.54		11.32		11.75		9.09
Total risk-based capital ratio		14.68			14.69		14.51		15.09		12.66

⁽¹⁾

This item reflects the retrospective adoption of Accounting Standard Update 2016-09 during fourth quarter 2016, which impacted previously reported quarterly earnings and/or earnings per share (“EPS”) in 2016, as follows: third quarter 2016 – decreased income tax expense by $107 and increased diluted EPS by $0.01.

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

⁽³⁾	See Non-GAAP table in the preceding pages.

⁽⁴⁾	Net interest margins shown in the table above include tax-equivalent adjustments to adjust interest income on tax-exempt loans and tax-exempt investment securities to a fully taxable basis.

Emerging Growth Company Status

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the effectiveness of our Registration Statement on Form S-4, which was declared effective by the SEC on May 14, 2014; (2) the last day of the fiscal year in which we have more than $1.07 billion in annual revenues; (3) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act; or (4) the date on which we have, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.

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

Other Events

On October 18, 2017, the Bank received regulatory approval from the Reserve Bank to open a new branch at 1605 Medical Center Parkway, Murfreesboro, Tennessee. The TDFI previously approved this new branch on July 14, 2017. The Bank plans to open this new branch during the fourth quarter of 2017.

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.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

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

Management believes interest rate risk is best measured by earnings simulation modeling. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 and 200 basis points. All rates are increased or decreased parallel to the change in prime rate. As a result of the simulation, over a 12-month time period ended September 30, 2017, net interest income was estimated to decrease 3.02% and 7.13% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to increase 1.26% and decrease 5.25% in a 100 basis points and 200 basis points declining rate assumption, respectively. These results are in line with the Company’s guidelines for rate sensitivity.

The following chart reflects the Company’s sensitivity to changes in interest rates as indicated as of September 30, 2017.


Projected Interest Rate Change	Net Interest Income		Net Interest Income $ Change from Base			% Change from Base
-200		90,629		(5,024	)		(5.25	%)
-100		96,857		1,205			1.26	%
Base		95,652		—			0.00	%
+100		92,762		(2,890	)		(3.02	%)
+200		88,832		(6,820	)		(7.13	%)
+300		84,852		(10,800	)		(11.29	%)
+400		81,364		(14,288	)		(14.94	%)

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

ITEM 4.

CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures. The Company’s chief executive officer and chief financial officer have evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2017, the end of the fiscal quarter covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are effective.

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

PART II OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS.

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

ITEM 1A.

RISK FACTORS

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2017.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4.

MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5.

OTHER INFORMATION.

None.

ITEM 6.

EXHIBITS


Exhibit No.		Description

2.1		Amendment No. 3 to the Agreement and Plan of Reorganization and Bank Merger (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 5, 2017)

10.1		Triple Net Office Lease Agreement, by and between Petra Real Estate Partners II, LLC and Franklin Synergy Bank (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 27, 2017)

10.2		Lease Agreement, by and between SS McEwen, LLC and Franklin Synergy Bank (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 27, 2017)

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

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

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

101*		Interactive Data Files.

*	Filed herewith

SIGNATURES

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

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