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Table of Contents

 

 

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 March 31, 2018

 

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.

 

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

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 April 30, 2018, was 14,373,890.

 

 

 


Table of Contents

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

     41  

Item 4. Controls and Procedures

     42  

PART II OTHER INFORMATION

  

Item 1. Legal Proceedings

     42  

Item 1A. Risk Factors

     42  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     43  

Item 3. Defaults Upon Senior Securities

     43  

Item 4. Mine Safety Disclosures

     43  

Item 5. Other Information

     43  

Item 6. Exhibits

     43  

SIGNATURES

  


Table of Contents

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, 2017, filed with the SEC on March 16, 2018.

 

1


Table of Contents

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)

 

     March 31,
2018
    December 31,
2017
 
     (Unaudited)        

ASSETS

    

Cash and due from financial institutions

   $ 246,164     $ 251,543  

Certificates of deposit at other financial institutions

     2,855       2,855  

Securities available for sale

     1,186,420       999,881  

Securities held to maturity (fair value 2018—$210,888 and 2017—$217,608)

     213,381       214,856  

Loans held for sale, at fair value

     12,871       12,024  

Loans

     2,310,018       2,256,608  

Allowance for loan losses

     (21,738     (21,247
  

 

 

   

 

 

 

Net loans

     2,288,280       2,235,361  
  

 

 

   

 

 

 

Restricted equity securities, at cost

     19,606       18,492  

Premises and equipment, net

     10,941       11,281  

Accrued interest receivable

     12,937       11,947  

Bank owned life insurance

     49,450       49,085  

Deferred tax asset

     13,807       10,007  

Foreclosed assets

     1,503       1,503  

Servicing rights, net

     3,602       3,620  

Goodwill

     9,124       9,124  

Core deposit intangible, net

     903       1,007  

Other assets

     11,819       10,940  
  

 

 

   

 

 

 

Total assets

   $ 4,083,663     $ 3,843,526  
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Deposits

    

Non-interest bearing

   $ 298,503     $ 272,172  

Interest bearing

     3,056,650       2,895,056  
  

 

 

   

 

 

 

Total deposits

     3,355,153       3,167,228  

Federal Home Loan Bank advances

     317,000       272,000  

Federal funds purchased and repurchase agreements

     36,071       31,004  

Subordinated notes, net

     58,559       58,515  

Accrued interest payable

     2,775       2,769  

Other liabilities

     9,240       7,357  
  

 

 

   

 

 

 

Total liabilities

     3,778,798       3,538,873  

Equity

    

Preferred stock, no par value: 1,000,000 shares authorized; no shares outstanding at March 31, 2018 and December 31, 2017

     —         —    

Common stock, no par value: 30,000,000 and 30,000,000 shares authorized at March 31, 2018 and December 31, 2017 , respectively; 13,258,142 and 13,237,128 issued at March 31, 2018 and December 31, 2017 , respectively

     223,594       222,665  

Retained earnings

     98,723       88,671  

Accumulated other comprehensive loss

     (17,555     (6,786
  

 

 

   

 

 

 

Total shareholders’ equity

     304,762       304,550  

Noncontrolling interest in consolidated subsidiary

     103       103  
  

 

 

   

 

 

 

Total equity

     304,865       304,653  
  

 

 

   

 

 

 

Total liabilities and equity

   $ 4,083,663     $ 3,843,526  
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF INCOME

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

(Unaudited)

 

    

Three Months Ended

March 31,

 
     2018      2017  

Interest income and dividends

     

Loans, including fees

   $ 28,793      $ 22,560  

Securities:

     

Taxable

     6,111        5,617  

Tax-Exempt

     1,915        2,020  

Dividends on restricted equity securities

     274        181  

Federal funds sold and other

     954        163  
  

 

 

    

 

 

 

Total interest income

     38,047        30,541  
  

 

 

    

 

 

 

Interest expense

     

Deposits

     10,643        5,246  

Federal Home Loan Bank advances

     1,110        508  

Federal funds purchased and repurchase agreements

     96        70  

Subordinated notes and other borrowings

     1,082        1,074  
  

 

 

    

 

 

 

Total interest expense

     12,931        6,898  
  

 

 

    

 

 

 

Net interest income

     25,116        23,643  

Provision for loan losses

     573        1,855  
  

 

 

    

 

 

 

Net interest income after provision for loan losses

     24,543        21,788  
  

 

 

    

 

 

 

Noninterest income

     

Service charges on deposit accounts

     42        30  

Other service charges and fees

     751        752  

Net gains on sale of loans

     1,439        2,334  

Wealth management

     704        593  

Loan servicing fees, net

     119        107  

Net (loss) gain on sale of foreclosed assets

     3        3  

Other

     398        189  
  

 

 

    

 

 

 

Total noninterest income

     3,456        4,008  
  

 

 

    

 

 

 

Noninterest expense

     

Salaries and employee benefits

     9,188        8,033  

Occupancy and equipment

     2,594        2,095  

FDIC assessment expense

     660        760  

Marketing

     280        267  

Professional fees

     869        1,035  

Amortization of core deposit intangible

     104        127  

Other

     1,793        1,959  
  

 

 

    

 

 

 

Total noninterest expense

     15,488        14,276  
  

 

 

    

 

 

 

Income before income tax expense

     12,511        11,520  

Income tax expense

     2,459        3,586  
  

 

 

    

 

 

 

Net income

     10,052        7,934  
  

 

 

    

 

 

 

Net income available to common shareholders

   $ 10,052      $ 7,934  
  

 

 

    

 

 

 

Earnings per share:

     

Basic

   $ 0.76      $ 0.61  

Diluted

     0.73        0.58  

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

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

(Unaudited)

 

    

Three Months Ended

March 31,

 
     2018     2017  

Net income

   $ 10,052     $ 7,934  

Other comprehensive loss, net of tax:

    

Unrealized gains on securities:

    

Unrealized holding loss arising during the period

     (14,577     (641

Reclassification adjustment for gains included in net income

     —         —    
  

 

 

   

 

 

 

Net unrealized losses

     (14,577     (641

Tax effect

     3,808       251  
  

 

 

   

 

 

 

Total other comprehensive loss

     (10,769     (390
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ (717   $ 7,544  
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Three Months Ended March 31, 2018 and 2017

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

(Unaudited)

 

     Preferred      Common Stock     Retained     

Accumulated

Other

Comprehensive

    Noncontrolling      Total  
   Stock      Shares     Amount     Earnings      Income (Loss)     Interest      Equity  

Balance at December 31, 2016

   $ —          13,036,954     $ 218,354     $ 59,386      $ (7,482     103      $ 270,361  

Exercise of common stock options

     —          20,268       177       —          —         —          177  

Exercise of common stock warrants

     —          11,011       132       —          —         —          132  

Stock based compensation expense, net of restricted share forfeitures

     —          (180     447       —          —         —          447  

Stock issued in conjunction with 401(k) employer match, net of distributions

     —          (3,943     (151     —          —         —          (151

Net income

     —          —         —         7,934        —         —          7,934  

Other comprehensive loss

     —          —         —         —          (390     —          (390
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Balance at March 31, 2017

   $ —          13,064,110     $ 218,959     $ 67,320      $ (7,872     103      $ 278,510  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Balance at December 31, 2017

   $ —          13,237,128     $ 222,665     $ 88,671      $ (6,786     103      $ 304,653  

Exercise of common stock options

     —          21,348       220       —          —         —          220  

Stock based compensation expense, net of restricted share forfeitures

     —          (334     759       —          —         —          759  

Stock issued in conjunction with 401(k) employer match, net of distributions

     —          —         (50     —          —         —          (50

Net income

     —          —         —         10,052        —         —          10,052  

Other comprehensive loss

     —          —         —         —          (10,769     —          (10,769
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Balance at March 31, 2018

   $ —          13,258,142     $ 223,594     $ 98,723      $ (17,555     103      $ 304,865  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

(Unaudited)

 

    

Three Months Ended

March 31,

 
     2018     2017  

Cash flows from operating activities

    

Net income

   $ 10,052     $ 7,934  

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation and amortization on premises and equipment

     403       368  

Accretion of purchase accounting adjustments

     (252     (381

Net amortization of securities

     1,904       2,452  

Amortization of loan servicing right asset

     214       213  

Amortization of core deposit intangible

     104       127  

Amortization of debt issuance costs

     44       44  

Provision for loan losses

     573       1,855  

Deferred income tax benefit

     10       (561

Origination of loans held for sale

     (83,226     (65,213

Proceeds from sale of loans held for sale

     83,622       78,379  

Net gain on sale of loans

     (1,439     (2,334

Income from bank owned life insurance

     (365     (155

Stock-based compensation

     759       447  

Deferred gain on sale of loans

     (4     (58

Deferred gain on sale of foreclosed assets

     (3     (3

Net change in:

    

Accrued interest receivable and other assets

     (1,871     (1,687

Accrued interest payable and other liabilities

     1,896       5,944  
  

 

 

   

 

 

 

Net cash from operating activities

     12,421       27,371  

Cash flows from investing activities

    

Available for sale securities:

    

Purchases

     (224,712     (363,298

Maturities, prepayments and calls

     22,129       42,167  

Held to maturity securities:

    

Purchases

     (1,676     (1,996

Maturities, prepayments and calls

     2,714       4,335  

Net change in loans

     (53,240     (177,360

Purchase of restricted equity securities

     (1,114     (3,135

Purchases of premises and equipment, net

     (63     (1,048

Increase in certificates of deposits at other financial institutions

     —         (980
  

 

 

   

 

 

 

Net cash from investing activities

     (255,962     (501,315

Cash flows from financing activities

    

Increase in deposits

     187,925       425,394  

Increase (Decrease) in federal funds purchased and repurchase agreements

     5,067       (12,871

Proceeds from Federal Home Loan Bank advances

     95,000       230,000  

Repayment of Federal Home Loan Bank advances

     (50,000     (145,000

Proceeds from exercise of common stock warrants

     —         132  

Proceeds from exercise of common stock options

     220       177  

Divestment of common stock issued to 401(k) plan

     (50     (151
  

 

 

   

 

 

 

Net cash from financing activities

     238,162       497,681  
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (5,379     23,737  

Cash and cash equivalents at beginning of period

     251,543       90,927  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 246,164     $ 114,664  
  

 

 

   

 

 

 

Supplemental information:

    

Interest paid

   $ 12,925     $ 6,829  

Income taxes paid

     525       530  

See accompanying notes to consolidated financial statements.

 

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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, 2018.

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.

Recently Adopted Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09,Revenue from Contracts with Customers” (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU replaces most existing revenue recognition guidance in GAAP. The new standard was effective for the Company on January 1, 2018. Adoption of ASU 2014-09 did not have a material impact on the Company’s consolidated financial statements and related disclosures as the Company’s primary sources of revenues are derived from interest earned on loans, investment securities, and other financial instruments that are not within the scope of ASU 2014-09. 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 and gains/losses on the sale of OREO, did not change significantly from current practice. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company elected to use the modified retrospective transition method which requires application of ASU 2014-09 to uncompleted contracts at the date of adoption. The impact on uncompleted contracts at the date of adoption of this Update was not considered material.

The Company has identified the contract with a customer, identified the performance obligations in the contract, determined the transaction price, allocated the transaction price to the performance obligations in the contract, and recognized revenue when (or as) the Company satisfied a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods. The Company’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not impacted by the new standard. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying the new standard that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

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In January 2016, the FASB issued ASU No. 2016-01,Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 was effective for the Company on January 1, 2018 and resulted in the use of an exit price rather than an entrance price to determine the fair value of loans not measured at fair value on a non-recurring basis in the consolidated balance sheets. The Company does not have any equity investments that qualify for consideration under ASU 2016-01. See Note 8, “Fair Value,” for further information regarding the valuation of these loans.

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 became effective for the Company on January 1, 2018. The adoption of this ASU did not have a material impact on the Company’s financial statements.

In January 2017, the FASB issued ASU 2017-01,Business Combinations (Topic 805): Clarifying the Definition of a Business,” (“ASU 2017-01”) to improve such definition and, as a result, assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or as business combinations. The definition of a business impacts many areas of accounting including acquisitions, disposals, goodwill and consolidation. ASU 2017-01 was effective for the Company on January 1, 2018 and is to be applied under a prospective approach. The Company expects the adoption of this new guidance to impact the determination of whether future acquisitions are considered business combinations.

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. The guidance requires companies to apply the requirements prospectively to awards modified on or after the adoption date. The adoption of ASU 2017-09 did not have a significant impact on the Company’s consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

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.

 

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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.

Acquisition of Civic Bank & Trust

Effective April 1, 2018, the Company acquired Civic Bank & Trust, which was located in Nashville, Tennessee. Effective with the acquisition, Dr. Anil Patel, who was the chairman of the Civic Bank & Trust board of directors, was added to the Company’s board of directors for a term expiring at the Company’s 2018 annual meeting of shareholders.

NOTE 2—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available for sale portfolio at March 31, 2018 and December 31, 2017 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
 

March 31, 2018

           

U.S. Treasury securities

   $ 289,086      $ —        $ (515    $ 288,571  

U.S. government sponsored entities and agencies

     20,103        —          (209      19,894  

Mortgage-backed securities: residential

     782,579        45        (19,496      763,128  

Mortgage-backed securities: commercial

     5,123        —          (112      5,011  

State and political subdivisions

     113,295        404        (3,883      109,816  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,210,186      $ 449      $ (24,215    $ 1,186,420  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

December 31, 2017

           

U.S. Treasury securities

   $ 229,119      $ —        $ (210    $ 228,909  

U.S. government sponsored entities and agencies

     20,125        —          (164      19,961  

Mortgage-backed securities: residential

     641,225        102        (8,761      632,566  

Mortgage-backed securities: commercial

     5,133        —          (59      5,074  

State and political subdivisions

     113,468        1,787        (1,884      113,371  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,009,070      $ 1,889      $ (11,078    $ 999,881  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The amortized cost and fair value of the securities held to maturity portfolio at March 31, 2018 and December 31, 2017 and the corresponding amounts of gross unrecognized gains and losses were as follows:

 

     Amortized
Cost
     Gross
Unrecognized
Gains
     Gross
Unrecognized
Losses
     Fair
Value
 

March 31, 2018

           

Mortgage backed securities: residential

   $ 92,152      $ 111      $ (3,495    $ 88,768  

State and political subdivisions

     121,229        1,064        (173      122,120  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 213,381      $ 1,175      $ (3,668    $ 210,888  
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2017

           

Mortgage backed securities: residential

   $ 93,366      $ 207      $ (1,796    $ 91,777  

State and political subdivisions

     121,490        4,379        (38      125,831  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 214,856      $ 4,586      $ (1,834    $ 217,608  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

    

Three Months Ended

March 31,

 
     2018      2017  

Proceeds

   $ —        $ —    

Gross gains

     —          —    

Gross losses

     —          —    

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

 

     March 31, 2018  
     Amortized
Cost
     Fair
Value
 

Available for sale

     

One year or less

   $ 289,086      $ 288,571  

Over one year through five years

     20,103        19,894  

Over five years through ten years

     410        406  

Over ten years

     112,885        109,410  

Mortgage-backed securities: residential

     782,579        763,128  

Mortgage-backed securities: commercial

     5,123        5,011  
  

 

 

    

 

 

 

Total

   $ 1,210,186      $ 1,186,420  
  

 

 

    

 

 

 

Held to maturity

     

One year or less

   $ 501      $ 511  

Over one year through five years

     1,106        1,121  

Over five years through ten years

     11,875        11,907  

Over ten years

     107,747        108,581  

Mortgage-backed securities: residential

     92,152        88,768  
  

 

 

    

 

 

 

Total

   $ 213,381      $ 210,888  
  

 

 

    

 

 

 

Securities pledged at March 31, 2018 and December 31, 2017 had a carrying amount of $1,168,275 and $975,518, respectively, and were pledged to secure public deposits and repurchase agreements.

At March 31, 2018 and December 31, 2017, 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.

 

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The following table summarizes the securities with unrealized and unrecognized losses at March 31, 2018 and December 31, 2017, 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
 

March 31, 2018

               

Available for sale

               

U.S. Treasury securities

   $ 288,571      $ (515   $ —        $ —       $ 288,571      $ (515

U.S. government sponsored entities and agencies

     —          —         19,894        (209     19,894        (209

Mortgage-backed securities: residential

     436,263        (7,882     295,862        (11,614     732,125        (19,496

Mortgage-backed securities: commercial

     5,011        (112     —          —         5,011        (112

State and political subdivisions

     11,409        (164     60,804        (3,719     72,213        (3,883
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available for sale

   $ 741,254      $ (8,673   $ 376,560      $ (15,542   $ 1,117,814      $ (24,215
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     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

   $ 13,636      $ (306   $ 68,768      $ (3,189   $ 82,404      $ (3,495

State and political subdivisions

     22,825        (127     1,137        (46     23,962        (173
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held to maturity

   $ 36,461      $ (433   $ 69,905      $ (3,235   $ 106,366      $ (3,668
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     Less Than 12 Months     12 Months or Longer     Total  
     Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

December 31, 2017

               

Available for sale

               

U.S. Treasury securities

   $ 228,909      $ (210   $ —        $ —       $ 228,909      $ (210

U.S. government sponsored entities and agencies

     19,961        (164     —          —         19,961        (164

Mortgage-backed securities: residential

     301,158        (2,447     311,366        (6,314     612,524        (8,761

Mortgage-backed securities: commercial

     5,074        (59     —          —         5,074        (59

State and political subdivisions

     1,298        (2     62,725        (1,882     64,023        (1,884
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available for sale

   $ 556,400      $ (2,882   $ 374,091      $ (8,196   $ 930,491      $ (11,078
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     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

   $ 11,191      $ (69   $ 72,582      $ (1,727   $ 83,773      $ (1,796

State and political subdivisions

     262        (2     1,148        (36     1,410        (38
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held to maturity

   $ 11,453      $ (71   $ 73,730      $ (1,763   $ 85,183      $ (1,834
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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.

 

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Table of Contents

NOTE 3—LOANS

Loans at March 31, 2018 and December 31, 2017 were as follows:

 

     March 31,
2018
     December 31,
2017
 

Loans that are not PCI loans

     

Construction and land development

   $ 523,660      $ 494,818  

Commercial real estate:

     

Nonfarm, nonresidential

     673,497        628,554  

Other

     43,110        49,684  

Residential real estate:

     

Closed-end 1-4 family

     430,467        407,695  

Other

     172,216        169,640  

Commercial and industrial

     462,954        502,006  

Consumer and other

     3,899        3,781  
  

 

 

    

 

 

 

Loans before net deferred loan fees

     2,309,803        2,256,178  

Deferred loan fees, net

     (2,225      (1,963
  

 

 

    

 

 

 

Total loans that are not PCI loans

     2,307,578        2,254,215  

Total PCI loans

     2,440        2,393  

Allowance for loan losses

     (21,738      (21,247
  

 

 

    

 

 

 

Total loans, net of allowance for loan losses

   $ 2,288,280      $ 2,235,361  
  

 

 

    

 

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three month periods ended March 31, 2018 and 2017:

 

     Construction
and Land
Development
    Commercial
Real
Estate
    Residential
Real
Estate
    Commercial
and
Industrial
    Consumer
and
Other
    Total  

Three Months Ended March 31, 2018

            

Allowance for loan losses:

            

Beginning balance

   $ 3,802     $ 5,981     $ 3,834     $ 7,587     $ 43     $ 21,247  

Provision for loan losses

     582       (106     (241     328       10       573  

Loans charged-off

     (39     —         (7     (49     (11     (106

Recoveries

     —         —         19       —         5       24  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 4,345     $ 5,875     $ 3,605     $ 7,866     $ 47     $ 21,738  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2017

            

Allowance for loan losses:

            

Beginning balance

   $ 3,776     $ 4,266     $ 2,398     $ 6,068     $ 45     $ 16,553  

Provision for loan losses

     61       393       262       1,117       22       1,855  

Loans charged-off

     —         —         —         (300     (23     (323

Recoveries

     —         —         12       —         8       20  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 3,837     $ 4,659     $ 2,672     $ 6,885     $ 52     $ 18,105  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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 March 31, 2018 and December 31, 2017. 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  

March 31, 2018

                 

Allowance for loan losses:

                 

Ending allowance balance attributable to loans:

                 

Individually evaluated for impairment

   $ —        $ —        $ —        $ 543      $ —        $ 543  

Collectively evaluated for impairment

     4,345        5,875        3,605        7,317        47        21,189  

 

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Table of Contents
     Construction
and Land
Development
     Commercial
Real
Estate
     Residential
Real
Estate
     Commercial
and
Industrial
     Consumer
and
Other
     Total  

Purchased credit-impaired loans

     —          —          —          6        —          6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 4,345      $ 5,875      $ 3,605      $ 7,866      $ 47      $ 21,738  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                 

Individually evaluated for impairment

   $ 165      $ —        $ 694      $ 2,466      $ —        $ 3,325  

Collectively evaluated for impairment

     523,495        716,607        601,989        460,488        3,899        2,306,478  

Purchased credit-impaired loans

     —          371        96        1,973        —          2,440  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 523,660      $ 716,978      $ 602,779      $ 464,927      $ 3,899      $ 2,312,243  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2017

                 

Allowance for loan losses:

                 

Ending allowance balance attributable to loans:

                 

Individually evaluated for impairment

   $ —        $ —        $ —        $ 879      $ —        $ 879  

Collectively evaluated for impairment

     3,802        5,981        3,834        6,708        43        20,368  

Purchased credit-impaired loans

     —          —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 3,802      $ 5,981      $ 3,834      $ 7,587      $ 43      $ 21,247  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                 

Individually evaluated for impairment

   $ 217      $ —        $ 834      $ 3,090      $ —        $ 4,141  

Collectively evaluated for impairment

     494,601        678,238        576,501        498,916        3,781        2,252,037  

Purchased credit-impaired loans

     —          380        105        1,908        —          2,393  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 494,818      $ 678,618      $ 577,440      $ 503,914      $ 3,781      $ 2,258,571  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans collectively evaluated for impairment reported at March 31, 2018 include certain acquired loans. At March 31, 2018, these non-PCI loans had a carrying value of $50,759, comprised of contractually unpaid principal totaling $52,121 and discounts totaling $1,362. Management evaluated these loans for credit deterioration since acquisition and determined that $10 in allowance for loan losses was necessary at March 31, 2018. As of December 31, 2017, these non-PCI loans had a carrying value of $50,341, comprised of contractually unpaid principal totaling $51,767 and discounts totaling $1,426. Management evaluated these loans for credit deterioration since acquisition and determined that a $10 allowance for loan losses was necessary at December 31, 2017.

The following table presents information related to impaired loans by class of loans as of March 31, 2018 and December 31, 2017:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance for
Loan Losses
Allocated
 

March 31, 2018

        

With no allowance recorded:

        

Construction and land development

   $ 203      $ 165      $ —    

Commercial real estate:

        

Nonfarm, nonresidential

     —          —          —    

Residential real estate:

        

Closed-end 1-4 family

     581        581        —    

Other

     113        113        —    

Commercial and industrial

     92        92        —    

Consumer and other

     —          —          —    
  

 

 

    

 

 

    

 

 

 

Subtotal

     989        951        —    

With an allowance recorded:

        

Commercial and industrial

     2,374        2,374        543  
  

 

 

    

 

 

    

 

 

 

Subtotal

     2,374        2,374        543  
  

 

 

    

 

 

    

 

 

 

Total

   $ 3,363      $ 3,325      $ 543  
  

 

 

    

 

 

    

 

 

 

December 31, 2017

        

With no allowance recorded:

        

Construction and land development

   $ 217      $ 217      $ —    

 

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Table of Contents
     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance for
Loan Losses
Allocated
 

Residential real estate:

        

Closed-end 1-4 family

     14        14        —    

Other

     820        820        —    

Commercial and industrial

     108        108        —    
  

 

 

    

 

 

    

 

 

 

Subtotal

     1,159        1,159        —    
  

 

 

    

 

 

    

 

 

 

With an allowance recorded:

        

Commercial and industrial

     2,982        2,982        879  
  

 

 

    

 

 

    

 

 

 

Subtotal

     2,982        2,982        879  
  

 

 

    

 

 

    

 

 

 

Total

   $ 4,141      $ 4,141      $ 879  
  

 

 

    

 

 

    

 

 

 

The following table presents the average recorded investment of impaired loans by class of loans for the three months ended March 31, 2018 and 2017:

 

    

Three Months Ended

March 31,

 

Average Recorded Investment

   2018      2017  

With no allowance recorded:

     

Construction and land development

   $ 367      $ —    

Commercial real estate:

     

Nonfarm, nonresidential

     —          4,128  

Residential real estate:

     

Closed-end 1-4 family

     420        1,799  

Other

     372        120  

Commercial and industrial

     626        —    
  

 

 

    

 

 

 

Subtotal

     1,785        6,047  
  

 

 

    

 

 

 

With an allowance recorded:

     

Commercial and industrial

   $ 1,785      $ 2,585  
  

 

 

    

 

 

 

Subtotal

     1,785        2,585  
  

 

 

    

 

 

 

Total

   $ 3,570      $ 8,632  
  

 

 

    

 

 

 

The impact on net interest income for these loans was not material to the Company’s results of operations for the three months ended March 31, 2018 and 2017.

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 March 31, 2018 and December 31, 2017:

 

     Nonaccrual      Loans Past Due
Over 90 Days
 

March 31, 2018

     

Construction and land development

   $ 165      $ —    

Residential real estate:

     

Closed-end 1-4 family

     581        —    

Other

     113        12  

Commercial and industrial

     2,466        166  
  

 

 

    

 

 

 

Total

   $ 3,325      $ 178  
  

 

 

    

 

 

 

December 31, 2017

     

Residential real estate:

     

Closed-end 1-4 family

   $ 257      $ 14  

Other

     114        —    

Commercial and industrial

     2,466        191  
  

 

 

    

 

 

 

Total

   $ 2,837      $ 205  
  

 

 

    

 

 

 

 

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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 March 31, 2018 and December 31, 2017 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  

March 31, 2018

                       

Construction and land development

   $ 473      $ —        $ —        $ 165      $ 638      $ 523,022      $ —        $ 523,660  

Commercial real estate:

                       

Nonfarm, nonresidential

     —          —          —          —          —          673,497        371        673,868  

Other

     5        —          —          —          5        43,105        —          43,110  

Residential real estate:

                       

Closed-end 1-4 family

     610        1,060        —          581        2,251        428,216        96        430,563  

Other

     116        —          12        113        241        171,975        —          172,216  

Commercial and industrial

     440        195        166        2,466        3,267        459,687        1,973        464,927  

Consumer and other

     —          200        —          —          200        3,699        —          3,899  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,644      $ 1,455      $ 178      $ 3,325      $ 6,602      $ 2,303,201      $ 2,440      $ 2,312,243  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2017

                       

Construction and land development

   $ 1,918      $ 136      $ —        $ —        $ 2,054      $ 492,764      $ —        $ 494,818  

Commercial real estate:

                       

Nonfarm, nonresidential

     —          —          —          —          —          628,554        380        628,934  

Other

     —          —          —          —          —          49,681        —          49,684  

Residential real estate:

                       

Closed-end 1-4 family

     —          —          14        257        271        407,424        105        407,800  

Other

     146        719        —          114        979        168,661        —          169,640  

Commercial and industrial

     532        27        191        2,466        3,216        498,790        1,908        503,914  

Consumer and other

     —          —          —          —          —          3,781        —          3,781  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,596      $ 882      $ 205      $ 2,837      $ 6,520      $ 2,249,658      $ 2,393      $ 2,258,571  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

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Table of Contents

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 March 31, 2018 and December 31, 2017:

 

     Pass      Special
Mention
     Substandard      Total  

March 31, 2018

           

Construction and land development

   $ 519,831      $ 3,664      $ 165      $ 523,660  

Commercial real estate:

           

Nonfarm, nonresidential

     658,683        11,098        4,087        673,868  

Other

     42,730        —          380        43,110  

Residential real estate:

           

Closed-end 1-4 family

     426,856        —          3,707        430,563  

Other

     170,467        —          1,749        172,216  

Commercial and industrial

     448,395        9,003        7,529        464,927  

Consumer and other

     3,896        3        —          3,899  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,270,858      $ 23,768      $ 17,617      $ 2,312,243  
  

 

 

    

 

 

    

 

 

    

 

 

 
     Pass      Special
Mention
     Substandard      Total  

December 31, 2017

           

Construction and land development

   $ 494,601      $ —        $ 217      $ 494,818  

Commercial real estate:

           

Nonfarm, nonresidential

     609,458        12,602        6,874        628,934  

Other

     49,303        —          381        49,684  

Residential real estate:

           

1-4 family

     404,832        615        2,353        407,800  

Other

     167,886        —          1,754        169,640  

Commercial and industrial

     485,363        10,350        8,201        503,914  

Consumer and other

     3,777        4        —          3,781  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,215,220      $ 23,571      $ 19,780      $ 2,258,571  
  

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings

As of March 31, 2018 and December 31, 2017, the Company’s loan portfolio contains one loan that has been modified in a troubled debt restructuring with a balance of $165 and $608, respectively. During the first quarter of 2018 one loan was added as a troubled debt restructuring with a balance of $165, and the loan that was previously reported as a troubled debt restructuring at December 31, 2017 was paid down by $575 by the borrower, and the remaining $33 was charged off.

NOTE 4—LOAN SERVICING

Loans serviced for others are not reported as assets. The principal balances of these loans at March 31, 2018 and December 31, 2017 are as follows:

 

     March 31,
2018
     December 31,
2017
 

Loan portfolios serviced for:

     

Federal Home Loan Mortgage Corporation

   $ 507,375      $ 507,233  

Other

     4,589        4,626  

 

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Table of Contents

The components of net loan servicing fees for the three months ended March 31, 2018 and 2017 were as follows:

 

     Three Months Ended
March 31,
 
     2018      2017  

Loan servicing fees, net:

     

Loan servicing fees

   $ 333      $ 320  

Amortization of loan servicing fees

     (214      (213

Change in impairment

     —          —    
  

 

 

    

 

 

 

Total

   $ 119      $ 107  
  

 

 

    

 

 

 

The fair value of servicing rights was estimated by management to be approximately $5,305 at March 31, 2018. Fair value for March 31, 2018 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 9.4%. At December 31, 2017, the fair value of servicing rights was estimated by management to be approximately $5,089. Fair value for December 31, 2017 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 March 31, 2018 and December 31, 2017, these short-term borrowings totaled $36,071 and $31,004, respectively, and were secured by securities with carrying amounts of $41,377 and $41,618, respectively. At March 31, 2018, all of the Company’s repurchase agreements had one-day maturities.

The following table provides additional details as of March 31, 2018:

 

As of March 31, 2018

   Mortgage-
Backed
Securities:
Residential
    State and
Political
Subdivisions
    Total  

Market value of securities pledged

   $ 919     $ 40,845     $ 41,764  

Borrowings related to pledged amounts

   $ —       $ 36,071     $ 36,071  

Market value pledged as a % of borrowings

     —       113     116

The following table provides additional details as of December 31, 2017:

 

As of December 31, 2017

   Mortgage-
Backed
Securities:
Residential
    State and
Political
Subdivisions
    Total  

Market value of securities pledged

   $ 1,004     $ 42,109     $ 43,113  

Borrowings related to pledged amounts

   $ —       $ 31,004     $ 31,004  

Market value pledged as a % of borrowings

     —       136     139

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. The warrants were detachable from the common stock. There were 11,011 warrants exercised during the three months ended March 31, 2017. The warrants expired on March 30, 2017; therefore at March 31, 2018, there were no outstanding warrants associated with the 2010 offering. A summary of the stock warrant activity for the three months ended March 31, 2018 and 2017 follows:

 

     March 31,
2018
     March 31,
2017
 

Stock warrants exercised:

     

Intrinsic value of warrants exercised

   $ —        $ 291  

Cash received from warrants exercised

     —          132  

 

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Table of Contents

The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $759 and $447 for the three months ended March 31, 2018 and 2017, respectively. The total income tax benefit, which is shown on the Consolidated Statements of Income as a reduction of income tax expense, was $63 and $93 for the three months ended March 31, 2018 and 2017, respectively.

Stock Options: The Company’s 2007 Omnibus Equity Incentive Plan (the “2007 Plan”), as amended and shareholder-approved, provided for authorized shares up to 4,000,000. The 2007 Plan provided 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, an equity incentive plan, the 2017 Omnibus Equity Incentive Plan (the “2017 Plan”). The Company’s shareholders approved the 2017 Plan at the 2017 annual meeting of shareholders. The terms of the 2017 Plan are substantially similar to the terms of the 2007 Plan it was intended to replace. The 2017 Plan provides for authorized shares up to 5,000,000. At March 31, 2018, there were 4,709,454 authorized shares available for issuance under the 2017 Plan.

On April 12, 2018, the Compensation Committee of the Company’s Board of Directors (the “Committee”) approved the Amended and Restated 2017 Omnibus Equity Incentive Plan (the “Amended and Restated 2017 Plan”) in order to make the following amendments to the 2017 Plan in response to feedback the Company received from its shareholders:

 

    reduce the number of shares of common stock available for issuance from 5,000,000 shares under the 2017 Plan to 3,500,000 shares under the Amended and Restated 2017 Plan;

 

    revise the definition of Change in Control to include only actual changes in control (and removed triggering events that represented a potential change in control);

 

    remove the Committee’s authority to accelerate vesting (other than in cases of termination of the participant’s employment);

 

    remove certain provisions allowing recycling of shares and to clarify that (1) shares tendered in payment of an option, (2) shares delivered or withheld to satisfy tax withholding obligations and (3) shares covered by a stock-settled SAR or other awards that were not issued upon settlement of the award will not be available for issuance under the Amended and Restated 2017 Plan; and

 

    remove the ability to grant reload options (automatic granting of new options at the time of exercise).

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.

 

     March 31,
2018
    March 31,
2017
 

Risk-free interest rate

     2.49     2.28

Expected term

     7.5 years       7.4 years  

Expected stock price volatility

     32.48     34.20

Dividend yield

     0.00     0.04

The weighted average fair value of options granted for the three months ended March 31, 2018 and 2017 were $14.77 and $17.25, respectively.

 

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Table of Contents

A summary of the activity in the plans for the three months ended March 31, 2018 follows:

 

     Shares      Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value
 

Outstanding at beginning of year

     1,507,168      $ 21.37        6.55      $ 19,180  

Granted

     28,125        36.40        

Exercised

     (21,348      10.32        

Forfeited, expired, or cancelled

     (11,754      29.37        
  

 

 

          

Outstanding at period end

     1,502,191      $ 21.75        6.41      $ 16,299  
  

 

 

    

 

 

    

 

 

    

 

 

 

Vested or expected to vest

     1,427,082      $ 21.75        6.41      $ 15,484  

Exercisable at period end

     760,955      $ 14.17        4.75      $ 14,022  

 

     For the three months
ended March 31,
 
     2018      2017  

Stock options exercised:

     

Intrinsic value of options exercised

   $ 511      $ 610  

Cash received from options exercised

     220        177  

Tax benefit realized from option exercises

     63        93  

As of March 31, 2018, there was $5,708 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 1.6 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 three months ended March 31, 2018 is as follows:

 

Non-vested Shares

   Shares      Weighted-
Average
Grant-
Date
Fair Value
 

Non-vested at December 31, 2017

     94,181      $ 25.42  

Granted

     —          —    

Vested

     —          —    

Forfeited

     (334      37.35  
  

 

 

    

Non-vested at March 31, 2018

     96,409      $ 25.38  
  

 

 

    

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 March 31, 2018, there was $1,580 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 3.1 years. There were no shares that vested during the three months ended March 31, 2018 or 2017, 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.

 

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Table of Contents

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 2018 is 1.875%.

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 March 31, 2018, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Management believes that, as of March 31, 2018, 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 March 31, 2018 and December 31, 2017 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  

March 31, 2018

               

Company common equity Tier 1 capital to risk-weighted assets

   $ 310,218        11.45   $ 121,874        4.50     N/A        N/A  

Company Total Capital to risk weighted assets

   $ 390,600        14.42   $ 216,665        8.00     N/A        N/A  

Company Tier 1 (Core) Capital to risk weighted assets

   $ 310,218        11.45   $ 162,499        6.00     N/A        N/A  

Company Tier 1 (Core) Capital to average assets

   $ 310,218        7.80   $ 158,986        4.00     N/A        N/A  

Bank common equity Tier 1 capital to risk-weighted assets

   $ 365,295        13.49   $ 121,874        4.50   $ 176,040        6.50

Bank Total Capital to risk weighted assets

   $ 387,126        14.29   $ 216,665        8.00   $ 270,831        10.00

Bank Tier 1 (Core) Capital to risk weighted assets

   $ 365,295        13.49   $ 162,499        6.00   $ 216,665        8.00

Bank Tier 1 (Core) Capital to average assets

   $ 365,295        9.19   $ 158,857        4.00   $ 198,572        5.00

December 31, 2017

               

Company common equity Tier 1 capital to risk-weighted assets

   $ 299,229        11.37   $ 118,479        4.50     N/A        N/A  

Company Total Capital to risk weighted assets

   $ 379,083        14.40   $ 210,629        8.00     N/A        N/A  

Company Tier 1 (Core) Capital to risk weighted assets

   $ 299,229        11.37   $ 157,972        6.00     N/A        N/A  

Company Tier 1 (Core) Capital to average assets

   $ 299,229        8.25   $ 145,100        4.00     N/A        N/A  

Bank common equity Tier 1 capital to risk-weighted assets

   $ 353,512        13.43   $ 118,489        4.50   $ 171,151        6.50

Bank Total Capital to risk weighted assets

   $ 374,851        14.24   $ 210,647        8.00   $ 263,309        10.00

Bank Tier 1 (Core) Capital to risk weighted assets

   $ 353,512        13.43   $ 157,985        6.00   $ 210,647        8.00

Bank Tier 1 (Core) Capital to average assets

   $ 353,512        9.75   $ 145,003        4.00   $ 181,253        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. The Bank may not currently pay dividends without prior written approval from its primary regulatory agencies.

 

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Table of Contents

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).

 

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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
March 31, 2018 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. Treasury securities

   $ —        $ 288,571      $ —    

U.S. government sponsored entities and agencies

     —          19,894        —    

Mortgage-backed securities-residential

     —          763,128        —    

Mortgage-backed securities-commercial

     —          5,011        —    

State and political subdivisions

     —          109,816        —    
  

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ —        $ 1,186,420      $ —    
  

 

 

    

 

 

    

 

 

 

Loans held for sale

   $ —        $ 12,871      $ —    
  

 

 

    

 

 

    

 

 

 

Mortgage banking derivatives

   $ —        $ 382      $ —    
  

 

 

    

 

 

    

 

 

 

Financial Liabilities

     

Mortgage banking derivatives

   $ —        $ 45      $ —    
  

 

 

    

 

 

    

 

 

 
     Fair Value Measurements at
December 31, 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. Treasury securities

   $ —        $ 228,909      $ —    

U.S. government sponsored entities and agencies

     —          19,961        —    

Mortgage-backed securities-residential

     —          632,566        —    

Mortgage-backed securities-commercial

     —          5,074        —    

State and political subdivisions

     —          113,371        —    
  

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ —        $ 999,881      $ —    
  

 

 

    

 

 

    

 

 

 

Loans held for sale

   $ —        $ 12,024      $ —    
  

 

 

    

 

 

    

 

 

 

Mortgage banking derivatives

   $ —        $ 175      $ —    
  

 

 

    

 

 

    

 

 

 

Financial Liabilities

        

Mortgage banking derivatives

   $ —        $ 35      $ —    
  

 

 

    

 

 

    

 

 

 

As of March 31, 2018, the unpaid principal balance of loans held for sale was $12,554 resulting in an unrealized gain of $317 included in gains on sale of loans. As of December 31, 2017, the unpaid principal balance of loans held for sale was $11,681, resulting in an unrealized gain of $343 included in gains on sale of loans. For the three months ended March 31, 2018 and 2017, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $(26) and $113, respectively. None of these loans were 90 days or more past due or on nonaccrual as of March 31, 2018 and December 31, 2017.

There were no transfers between level 1 and 2 during 2018 or 2017.

 

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

There was one collateral-dependent commercial and industrial impaired loans carried at fair value of $1,831 as of March 31, 2018 and December 31, 2017. For the three months ended March 31, 2018 and 2017, there was no additional provision for loan losses 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 March 31, 2018 and December 31, 2017. The foreclosed property was previously collateral for a commercial real estate loan. There were no properties at March 31, 2018 or 2017 that had required write-downs to fair value resulting in no write downs for the three months ended March 31, 2018 and 2017, respectively.

The carrying amounts and estimated fair values of financial instruments at March 31, 2018 and December 31, 2017 are as follows:

 

     Carrying
Amount
     Fair Value Measurements at
March 31, 2018 Using:
 
        Level 1      Level 2      Level 3      Total  

Financial assets

              

Cash and cash equivalents

   $ 246,164      $ 246,164      $ —        $ —        $ 246,164  

Certificates of deposit held at other financial institutions

     2,855        —          2,855        —          2,855  

Securities available for sale

     1,186,420        —          1,186,420        —          1,186,420  

Securities held to maturity

     213,381        —          210,888        —          210,888  

Loans held for sale

     12,871        —          12,871        —          12,871  

Net loans

     2,288,280        —          —          2,295,275        2,295,275  

Restricted equity securities

     19,606        n/a        n/a        n/a        n/a  

Servicing rights, net

     3,602        —          —          5,305        5,305  

Mortgage banking derivative assets

     382        —          382        —          382  

Accrued interest receivable

     12,937        182        6,400        6,355        12,937  

Financial liabilities

              

Deposits

   $ 3,355,153      $ 2,026,994      $ 1,284,426      $ —        $ 3,311,420  

Repurchase agreements

     36,071        —          36,071        —          36,071  

Federal Home Loan Bank advances

     317,000        —          314,341        —          314,341  

Subordinated notes, net

     58,559        —          —          62,259        62,259  

Mortgage banking derivative liabilities

     45        —          45        —          45  

Accrued interest payable

     2,775        93        2,332        350        2,775  
     Carrying
Amount
     Fair Value Measurements at
December 31, 2017 Using:
 
        Level 1      Level 2      Level 3      Total  

Financial assets

              

Cash and cash equivalents

   $ 251,543      $ 251,543      $ —        $ —        $ 251,543  

Certificates of deposit held at other financial institutions

     2,855        —          2,855        —          2,855  

Securities available for sale

     999,881        —          999,881        —          999,881  

Securities held to maturity

     214,856        —          217,608        —          217,608  

Loans held for sale

     12,024        —          12,024        —          12,024  

Net loans

     2,235,361        —          —          2,230,607        2,230,607  

Restricted equity securities

     18,492        n/a        n/a        n/a        n/a  

Servicing rights, net

     3,620        —          —          5,089        5,089  

Mortgage banking derivative assets

     175        —          175        —          175  

Accrued interest receivable

     11,947        73        5,724        6,150        11,947  

Financial liabilities

              

Deposits

   $ 3,167,228      $ 1,911,928      $ 1,224,041      $ —        $ 3,135,969  

Federal funds purchased and repurchase agreements

     31,004        —          31,004        —          31,004  

Federal Home Loan Bank advances

     272,000        —          270,311        —          270,311  

Subordinated notes, net

     58,515        —          —          59,951        59,951  

Mortgage banking derivative liabilities

     35        —          35        —          35  

Accrued interest payable

     2,769        51        2,030        688        2,769  

 

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Table of Contents

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: In accordance with ASU 2016-01, the fair value of loans held for investment, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using a cash flow projection methodology that relies on three primary assumptions: (1) the expected prepayment rate of loans; (2) the magnitude of future net losses based on expected default rate and severity of loss; and (3) the discount rate applicable to the expected cash flows of the loan portfolio. Loans are considered a Level 3 classification.

(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.

 

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Table of Contents

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

March 31,

 
     2018      2017  

Basic

     

Net income available to common shareholders

   $ 10,052      $ 7,934  

Less: earnings allocated to participating securities

     (71      (65
  

 

 

    

 

 

 

Net income allocated to common shareholders

   $ 9,981      $ 7,869  
  

 

 

    

 

 

 

Weighted average common shares outstanding including participating securities

     13,249,728        13,049,012  

Less: Participating securities

     (94,010      (106,323
  

 

 

    

 

 

 

Average shares

     13,155,718        12,942,689  
  

 

 

    

 

 

 

Basic earnings per common share

   $ 0.76      $ 0.61  
  

 

 

    

 

 

 

Diluted

     

Net income allocated to common shareholders

   $ 9,981      $ 7,869  

Weighted average common shares outstanding for basic earnings per common share

     13,155,718        12,942,689  

Add: Dilutive effects of assumed exercises of stock options

     516,666        708,694  

Add: Dilutive effects of assumed exercises of stock warrants

     —          5,974  
  

 

 

    

 

 

 

Average shares and dilutive potential common shares

     13,672,384        13,657,357  
  

 

 

    

 

 

 

Diluted earnings per common share

   $ 0.73      $ 0.58  
  

 

 

    

 

 

 

For the three months ended March 31, 2018 and 2017, stock options for 411,279 and 108,000 shares of common stock were not considered in computing diluted earnings per common share because they were antidilutive.

NOTE 10—SUBORDINATED DEBT ISSUANCE

The Company’s subordinated notes, net of issuance costs, totaled $58,559 and $58,515 at March 31, 2018 and at December 31, 2017, 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.

 

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Table of Contents

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 March 31, 2018 and 2017, amortization of issuance costs has amounted to $45 for both periods.

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

 

* Through March 31, 2018 all interest payments have been made in accordance with the terms of the agreements.

 

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Table of Contents

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, 2018, 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 14 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, 2018. 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.

 

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Table of Contents

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.

COMPARISON OF RESULTS OF OPERATIONS FOR

THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $10,052 and $7,934 for the three months ended March 31, 2018 and 2017, respectively. The primary reasons for the increase in net income for the three months ended March 31, 2018 were increased interest income on loans and investment securities due to organic growth in these portfolios, decreased provision for loan losses related to the Company’s loan quality and the decrease in income tax expense related to the Tax Act legislation that was passed in December 2017.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets, less interest expense. Net interest income for the three months ended March 31, 2018 and 2017 totaled $25,116 and $23,643, respectively, an increase of $1,473, or 6.2%. For the three months ended March 31, 2018 and 2017, interest income was $38,047 and $30,541, respectively, an increase of 24.6%, due to growth in both the loan and investment securities portfolios. For the three months ended March 31, 2018 and 2017, interest expense was $12,931 and $6,898, respectively, an increase of 87.5%, which is a result of increases in interest-bearing deposits and Federal Home Loan Bank advances.

Interest-earning assets averaged $3,867,957 and $3,184,516 during the three months ended March 31, 2018 and 2017, respectively, an increase of $683,441, or 21.5%. This increase was due to organic growth in both the loan portfolio and the securities portfolio over the past year, as well as growth in the average balance of federal funds sold. Average loans increased 23.5%, average investment securities increased 5.7% and average federal funds sold and other increased 208.0%, when comparing the three months ended March 31, 2018 with the same period in 2017.

When comparing the three months ended March 31, 2018 and 2017, the yield on average interest earning assets, adjusted for tax-equivalent yield, remained consistent at 4.06%. When comparing the first quarter of 2018 with the same period in 2017, the tax-equivalent yield on loans increased by 16 basis points. The increase is primarily related to an increase in current interest rates.

For the three months ended March 31, 2018, the tax-equivalent yield on available for sale securities was 2.52%, and for the three months ended March 31, 2017, the tax-equivalent yield on available for sale securities was 2.69%. For the three months ended March 31, 2018, the tax-equivalent yield on held to maturity securities was 3.83%, and for the three months ended March 31, 2017, the tax-equivalent yield on held to maturity securities was 4.20%. The primary driver for the yield decreases in both available for sale securities and held to maturity securities was the decrease in volume of tax-exempt securities that have been purchased combined with the reduction of the effective tax rate.

Interest-bearing liabilities averaged $3,371,827 during the three months ended March 31, 2018, compared to $2,750,555 for the same period in 2017, an increase of $621,272, or 22.6%. Total average interest-bearing deposits grew $533,604, including increases in average brokered deposits of $195,915 and average interest-bearing public funds deposits of $165,726 for the three-month period ended March 31, 2018, as compared to the same period during 2017. Rapid growth in the loan portfolio also resulted in increases in average Federal Home Loan Bank advances of $100,111, when comparing the first three months of 2018 with the same period in 2017.

For the three month periods ended March 31, 2018 and 2017, the cost of average interest-bearing liabilities increased 54 basis points to 1.56% from 1.02%. The increase was primarily due to rate increases in interest-bearing checking, money market deposits, time deposits, and Federal Home Loan Bank advances when comparing the first quarter of 2018 with the first quarter of 2017.

 

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Table of Contents

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-months ended March 31, 2018 and 2017:

Average Balances—Yields & Rates(1)

(Dollars are in thousands)

 

     Three Months Ended March 31,  
     2018     2017  
     Average
Balance(1)
    Interest
Inc / Exp
     Average
Yield /
Rate
    Average
Balance(1)
    Interest
Inc / Exp
     Average
Yield /
Rate
 

ASSETS:

              

Loans(2)(6)

   $ 2,307,899     $ 28,805        5.06   $ 1,868,678     $ 22,583        4.90

Securities available for sale(6)

     1,074,981       6,682        2.52     991,679       6,584        2.69

Securities held to maturity(6)

     214,214       2,021        3.83     227,662       2,355        4.20

Restricted equity securities

     18,658       274        5.96     13,695       181        5.36

Certificates of deposit at other financial institutions

     2,814       12        1.73     1,820       7        1.56

Federal funds sold and other(3)

     249,391       942        1.53     80,982       156        0.78
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 3,867,957     $ 38,736        4.06   $ 3,184,516     $ 31,866        4.06

Allowance for loan losses

     (21,683          (17,162     

All other assets

     125,590            96,018       
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 3,971,864          $ 3,263,372       

LIABILITIES & EQUITY

              

Deposits:

              

Interest checking

   $ 918,332     $ 3,166        1.40   $ 701,983     $ 1,062        0.61

Money market

     744,473       2,600        1.42     613,574       1,228        0.81

Savings

     50,442       38        0.31     55,613       42        0.31

Time deposits

     1,271,558       4,839        1.54     1,080,031       2,914        1.09

Federal Home Loan Bank advances

     296,667       1,110        1.52     196,556       508        1.05

Federal funds purchased and repurchase agreements

     31,823       96        1.22     44,446       70        0.64

Subordinated notes and other borrowings

     58,532       1,082        7.50     58,352       1,074        7.46
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 3,371,827     $ 12,931        1.56   $ 2,750,555     $ 6,898        1.02

Demand deposits

     286,918            230,494       

Other liabilities

     13,279            9,610       

Total equity

     299,840            272,713       
  

 

 

        

 

 

      

TOTAL LIABILITIES AND EQUITY

   $ 3,971,864          $ 3,263,372       

NET INTEREST SPREAD(4)

          2.50          3.04

NET INTEREST INCOME

     $ 25,805          $ 24,968     

NET INTEREST MARGIN(5)

          2.71          3.18

 

(1)  Average balances are average daily balances.
(2)  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.
(3)  Includes federal funds sold and interest-bearing deposits at the Federal Reserve Bank, the Federal Home Loan Bank and at other financial institutions.
(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.

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

 

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Analysis of Changes in Interest Income and Expenses

 

     Net change three months ended
March 31, 2018 versus March 31, 2017
 
     Volume      Rate      Net Change  

INTEREST INCOME

        

Loans

   $ 5,311      $ 911      $ 6,222  

Securities available for sale

     549        (451      98  

Securities held to maturity

     (139      (195      (334

Restricted equity securities

     65        28        93  

Certificates of deposit at other financial institutions

     4        1        5  

Federal funds sold and other

     325        461        786  
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST INCOME

   $ 6,115      $ 755      $ 6,870  
  

 

 

    

 

 

    

 

 

 

INTEREST EXPENSE

        

Deposits

        

Interest checking

   $ 315      $ 1,789      $ 2,104  

Money market accounts

     252        1,120        1,372  

Savings

     (4      —          (4

Time deposits

     514        1,411        1,925  

Federal Home Loan Bank advances

     258        344        602  

Federal funds purchased and repurchase agreements

     (20      46        26  

Subordinated notes and other borrowings

     2        6        8  
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST EXPENSE

   $ 1,317      $ 4,716      $ 6,033  
  

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME

   $ 4,798      $ (3,961    $ 837  
  

 

 

    

 

 

    

 

 

 

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 $573 and $1,855 for the three months ended March 31, 2018 and 2017, respectively. The decrease in loan loss provision is due primarily to the Company’s loan quality. Nonperforming loans at March 31, 2018 totaled $3,503 compared to $4,036 at March 31, 2017, representing 0.15% and 0.21% of total loans, respectively.

Non-Interest Income

Non-interest income for the three months ended March 31, 2018 and 2017 was $3,456 and $4,008, respectively. The following is a summary of the components of non-interest income (in thousands):

 

    

Three Months Ended

March 31,

     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017        

Service charges on deposit accounts

   $ 42      $ 30      $ 12        40.0

Other service charges and fees

     751        752        (1      (0.1 %) 

Net gains on sale of loans

     1,439        2,334        (895      (38.3 %) 

Wealth management

     704        593        111        18.7

Loan servicing fees, net

     119        107        12        11.2

Net gain on sale of foreclosed assets

     3        3        —         

Other

     398        189        209        110.6
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

   $ 3,456      $ 4,008      $ (552      (13.8 %) 
  

 

 

    

 

 

    

 

 

    

 

 

 

Net gains on the sale of loans include net gains realized from the sales of mortgage loans and from the fair value adjustments related to mortgage loan derivatives. Net gains on the sale of mortgage loans are based, in part, on differences between the carrying value of loans being sold to third-party investors and the selling price. Also included are changes in the fair value of mortgage banking derivatives entered

 

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into by the Company to hedge the change in interest rates on loan commitments prior to their sale in the secondary market. Fluctuations in mortgage interest rates, changes in the demand for certain loans by investors, and whether servicing rights associated with the loans being sold are retained or released all affect the net gains on mortgage loan sales. Net gains for the three months ending March 31, 2018 were $1,439, a decrease of $895, or 38.3%, from $2,334 for the three months ended March 31, 2017. The decrease was due to the volume of mortgage loans originated, the sales related to those loans, and less favorable market rates in first quarter 2018, which resulted in less favorable fair value adjustments on mortgage derivatives.

Wealth management income for the three months ended March 31, 2018 increased $111, or 18.7%, in comparison with the same period in 2017. The increase was primarily due to the growth in the client base and the assets under management in the wealth management division.

Other non-interest income increased $209, or 110.6%, when comparing first quarter 2018 with first quarter 2017. The increase is primarily attributed to bank owned life insurance income increasing $211 when compared to the first quarter of 2017.

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2018 and 2017 was $15,488 and $14,276, respectively, an increase of $1,212, or 8.5%. This increase was the result of the following components listed in the table below (in thousands):

 

    

Three Months Ended

March 31,

     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017        

Salaries and employee benefits

   $ 9,188      $ 8,033      $ 1,155        14.4

Occupancy and equipment

     2,594        2,095        499        23.8

FDIC assessment expense

     660        760        (100      (13.2 %) 

Marketing

     280        267        13        4.9

Professional fees

     869        1,035        (166      (16.0 %) 

Amortization of core deposit intangible

     104        127        (23      (18.1 %) 

Other

     1,793        1,959        (166      (8.5 %) 
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 15,488      $ 14,276      $ 1,212        8.5
  

 

 

    

 

 

    

 

 

    

 

 

 

The increase in non-interest expense noted in the table above is indicative of the Company’s overall growth. The Company’s biggest variances for the three months ended March 31, 2018, in comparison with the same period of 2017, were in salaries and benefits, occupancy and equipment, FDIC assessment expense, professional fees, and other non-interest expense.

Salaries and employee benefits increased $1,155, or 14.4%, when comparing the three months ended March 31, 2018 with the same period in 2017, primarily due to the Company’s staffing growth from 274 full-time equivalent employees as of March 31, 2017, to 299 as of March 31, 2018. The Company added several lending professionals and lending support personnel, additional compliance professionals, additional credit administration professionals and other operational staff, to support the Company’s growth and to provide enhanced corporate governance. The Company also experienced growth in incentive expenses related to the Company’s overall financial performance and in stock option expense.

Occupancy and equipment expense increased $499, or 23.8%, when comparing the three months ended March 31, 2018 with the same period in 2017. This variance is attributable to increases in building rent expense ($237), software maintenance fees ($125), other furniture, fixture and equipment expense ($49) and furniture, fixture and equipment depreciation expense ($24).

The Company’s FDIC assessment expense decreased $100, or 13.2%, when comparing the three months ended March 31, 2018 with the same period in 2017. The decrease is primarily due to the change in the base assessment rate of the Company, on which FDIC assessments are calculated.

The $166, or 16.0%, decrease in professional fees, when comparing the three months ended March 31, 2018 with the same period in 2017, is attributable to a decrease in other professional fees ($204), which was offset by an increase in legal fees ($31).

For the three months ended March 31, 2018, other non-interest expenses decreased $166, or 8.5%, from the same period during 2017. The reduction in other non-interest expense is attributed to larger decreases in the following expense types: appraisal expenses ($125); and foreclosed property expenses ($75).

Income Tax Expense

The Company recognized an income tax expense for the three months ended March 31, 2018 and 2017, of $2,459 and $3,586, respectively. The Company’s year-to-date income tax expense for the period ended March 31, 2018 reflects an effective income tax rate of 19.7%, compared to 31.1% for the same period in 2017. The decrease in the effective tax rate for the three months ended March 31, 2018 is a result of the 2017 Tax Cuts and Jobs Act enacted in December 2017.

 

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Table of Contents

COMPARISON OF BALANCE SHEETS AT MARCH 31, 2018 AND DECEMBER 31, 2017

Overview

The Company’s total assets increased by $240,137, or 6.2%, from December 31, 2017 to March 31, 2018. The increase in total assets has primarily been the result of organic growth in the loan and investment securities portfolios.

Loans

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

The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, at March 31, 2018 and December 31, 2017 were $2,310,018 and $2,256,608, respectively, an increase of $53,410, or 2.4%. Growth in the loan portfolio is primarily due to increased market penetration and a healthy local economy.

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

 

     March 31, 2018     December 31, 2017  
Types of Loans    Amount      % of Total
Loans
    Amount      % of Total
Loans
 

Total loans, excluding PCI loans

          

Real estate:

          

Construction and land development

   $ 523,660        22.6   $ 494,818        21.9

Commercial

     716,607        31.0     678,238        30.0

Residential

     602,683        26.1     577,335        25.6

Commercial and industrial

     462,954        20.0     502,006        22.2

Consumer and other

     3,899        0.2     3,781        0.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans—gross, excluding PCI loans

     2,309,803        99.9     2,256,178        99.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total PCI loans

     2,440        0.1     2,393        0.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total gross loans

     2,312,243        100.0     2,258,571        100.0
     

 

 

      

 

 

 

Less: deferred loan fees, net

     (2,225        (1,963   

Allowance for loan losses

     (21,738        (21,247   
  

 

 

      

 

 

    

Total loans, net allowance for loan losses

   $ 2,288,280        $ 2,235,361     
  

 

 

      

 

 

    

Gross loans increased 2.4% during the first three months of 2018, primarily due to organic growth as a result of continued market penetration and the strength of the local economies. During this period, the Company experienced growth in real estate loans of 5.3% with the majority of the growth occurring in the commercial real estate (5.7%) and construction and land development (5.8%) segments. The Company also experienced a decline of 7.7% in the commercial and industrial segment during the first three months of 2018.

Real estate loans comprised 79.7% of the loan portfolio at March 31, 2018. The largest portion of the real estate segments as of March 31, 2018, was commercial real estate loans, which totaled 38.9% of real estate loans. Commercial real estate loans comprised 31.0% of the total loan portfolio. The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm, nonresidential real estate properties and multi-family residential properties.

The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit and other junior lien mortgage loans. Residential real estate loans totaled $602,779 at March 31, 2018 and comprised 32.7% of real estate loans and 26.1% of total loans.

Construction and land development loans totaled $523,660 at March 31, 2018, and comprised 28.4% of total real estate loans and 22.6% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development.

Commercial and industrial loans totaled $464,927 at March 31, 2018 and comprised 20.1% of total loans at March 31, 2018. The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and healthcare loans.

 

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Table of Contents

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 March 31, 2018, excluding unearned net fees and costs.

Loan Maturity Schedule

 

     March 31, 2018  
     One year
or less
     Over one
year to five
years
     Over five
years
     Total  

Real estate:

           

Construction and land development

   $ 304,484      $ 145,396      $ 73,780      $ 523,660  

Commercial

     46,613        205,124        465,241        716,978  

Residential

     44,473        118,380        439,926        602,779  

Commercial and industrial

     90,923        312,226        61,778        464,927  

Consumer and other

     2,124        1,411        364        3,899  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 488,617      $ 782,537      $ 1,041,089      $ 2,312,243  
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed interest rate

   $ 182,630      $ 338,721      $ 548,296      $ 1,069,647  

Variable interest rate

     305,987        443,816        492,793        1,242,596  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 488,617      $ 782,537      $ 1,041,089      $ 2,312,243  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 at March 31, 2018 and December 31, 2017.

 

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Table of Contents
     March 31, 2018     December 31, 2017     Increase (Decrease)  
     Loan
Balance
     ALLL
Balance
     %     Loan
Balance
     ALLL
Balance
     %     Loan
Balance
    ALLL
Balance
       

Non impaired loans

   $ 2,255,719      $ 21,179        0.94   $ 2,201,515      $ 20,358        0.92   $ 54,204     $ 821       2 bps  

Non-PCI acquired loans (Note 1)

     50,759        10        0.02     50,522        10        0.02     237       —         —    

Impaired loans

     3,325        543        16.33     4,141        879        21.23     (816     (336     -490 bps  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Non-PCI loans

     2,309,803        21,732        0.94     2,256,178        21,247        0.94     53,625       485       —    

PCI loans

     2,440        6        0.25     2,393        —              47       6       25 bps  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 2,312,243      $ 21,738        0.94   $ 2,258,571      $ 21,247        0.94   $ 53,672     $ 491       —    

 

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 March 31, 2018, $10 in allowance for loan loss was recorded related to the loans acquired from MidSouth.

At March 31, 2018, the allowance for loan losses was $21,738, compared to $21,247 at December 31, 2017. The allowance for loan losses as a percentage of total loans was 0.94% at both March 31, 2018 and December 31, 2017. Loan growth during the first quarter of 2018 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.

 

     Three Months Ended
March 31, 2018
    Three Months Ended
March 31, 2017
 

Beginning balance

   $ 21,247     $ 16,553  

Loans charged-off:

    

Construction & land development

     39       —    

Commercial real estate

     —         —    

Residential real estate

     7       —    

Commercial & industrial

     49       300  

Consumer & other

     11       23  
  

 

 

   

 

 

 

Total loans charged-off

     106       323  

Recoveries on loans previously charged-off:

    

Construction & land development

     —         —    

Commercial real estate

     —         —    

Residential real estate

     19       12  

Commercial & industrial

     —         —    

Consumer & other

     5       8  
  

 

 

   

 

 

 

Total loan recoveries

     24       20  

Net charge-offs

     (82     (303

Provision for loan losses charged to expense

     573       1,855  
  

 

 

   

 

 

 

Total allowance at end of period

   $ 21,738     $ 18,105  
  

 

 

   

 

 

 

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

   $ 2,312,243     $ 1,950,686  
  

 

 

   

 

 

 

Average gross loans (1)

   $ 2,301,054     $ 1,860,081  
  

 

 

   

 

 

 

Allowance to total loans

     0.94     0.93
  

 

 

   

 

 

 

Net charge-offs to average loans, annualized

     0.01     0.07
  

 

 

   

 

 

 

 

(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.

 

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Table of Contents
     March 31, 2018     December 31, 2017  
     Amount      % of
Allowance
to Total
    Amount      % of
Allowance
to Total
 

Real estate loans:

          

Construction and land development

   $ 4,345        20.0   $ 3,802        21.9

Commercial

     5,875        27.0     5,981        30.0

Residential

     3,605        16.6     3,834        25.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

     13,825        63.6     13,617        77.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Commercial and industrial

     7,866        36.2     7,587        22.3

Consumer and other

     47        0.2     43        0.2
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 21,738        100.0   $ 21,247        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 other real estate owned (“OREO”), i.e., real estate acquired through foreclosure or deed in lieu of foreclosure. Loans are placed on non-accrual status when they are past due 90 days and management believes the borrower’s financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. When a loan is placed on non-accrual status, interest accruals cease and uncollected interest is reversed and charged against current income. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The primary component of non-performing loans is non-accrual loans, which as of March 31, 2018 totaled $3,503. 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 $178 that were past due 90 days or more and still accruing interest at March 31, 2018.

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

 

     March 31,
2018
    December 31,
2017
 

Non-accrual loans

   $ 3,325     $ 2,837  

Past due loans 90 days or more and still accruing interest

     178       205  
  

 

 

   

 

 

 

Total non-performing loans

     3,503       3,042  

Foreclosed real estate (“OREO”)

     1,503       1,503  
  

 

 

   

 

 

 

Total non-performing assets

     5,006       4,545  

Total non-performing loans as a percentage of total loans

     0.2     0.1

Total non-performing assets as a percentage of total assets

     0.1     0.1

Allowance for loan losses as a percentage of non-performing loans

     621     698

As of March 31, 2018, there were nine 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

   $ 165        5.0     1  

Residential real estate

     694        20.9     3  

Commercial & industrial

     2,466        74.1     5  
  

 

 

    

 

 

   

 

 

 

Total non-accrual loans

   $ 3,325        100.0     9  
  

 

 

    

 

 

   

 

 

 

 

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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 $1,186,420 at March 31, 2018, compared to $999,881 at December 31, 2017, an increase of $186,539, or 18.7%. The increase in available-for-sale securities was primarily attributed to the volume of securities purchased during the first quarter of 2018.

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 $213,381 at March 31, 2018, compared to $214,856 at December 31, 2017, a decrease of $1,475, or 0.7%. The decrease is attributable to securities that matured during the first quarter of 2018.

The combined portfolios represented 34.3% and 31.6% of total assets at March 31, 2018 and December 31, 2017, respectively. At March 31, 2018, the Company had no securities that were classified as having Other Than Temporary Impairment.

The Company also had other investments of $19,606 and $18,492 at March 31, 2018 and December 31, 2017, 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 $10,941 at March 31, 2018 compared to $11,281 at December 31, 2017, a decrease of $340, or 3.0%. This decrease was the result of the increase in accumulated depreciation in the normal course of business.

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 March 31, 2018, total deposits were $3,355,153, an increase of $187,925, or 5.9%, compared to $3,167,228 at December 31, 2017. The growth in deposits is attributable to growth in public funds deposits, money market deposits, noninterest-bearing deposits, and interest checking deposits.

Included in the Company’s funding strategy are brokered deposits. Total brokered deposits increased from $779,886 at December 31, 2017 to $855,256 at March 31, 2018, 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 $10,477, or 1.1%, from $1,002,584 at December 31, 2017 to $992,107 at March 31, 2018.

Time deposits excluding brokered deposits as of March 31, 2018, amounted to $667,958, compared to $675,150 as of December 31, 2017, a decrease of $7,193, or 1.1%, primarily due to a decrease in Local Government Investment Pool (LGIP) deposits of $30,000 during the first quarter of 2018. Non-public funds money market accounts, excluding brokered deposits, increased $16,721, or 3.5%, from December 31, 2017 to March 31, 2018. Noninterest-bearing checking deposits grew $26,331, or 9.7%, and non-public funds interest checking accounts, excluding brokered deposits, grew $60,536, or 45.2%, respectively, when comparing deposit balances from March 31, 2018 with balances at December 31, 2017.

 

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Table of Contents

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

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

 

     March 31,
2018
 

Three months or less

   $ 241,833  

Three through six months

     72,936  

Six through twelve months

     71,190  

Over twelve months

     144,681  
  

 

 

 

Total

   $ 530,640  
  

 

 

 

Federal Funds Purchased and Repurchase Agreements

As of March 31, 2018 and December 31, 2017, the Company had no federal funds purchased from correspondent banks. Securities sold under agreements to repurchase had an outstanding balance of $36,071 as of March 31, 2018, compared to $31,004 as of December 31, 2017. 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. At March 31, 2018 and at December 31, 2017, advances totaled $317,000 and $272,000, respectively.

At March 31, 2018, the scheduled maturities and interest rates of these advances were as follows:

 

Scheduled Maturities

   Amount      Weighted
Average Rates
 

2018

     152,000        1.41

2019

     110,000        1.78

2020

     55,000        1.72
  

 

 

    

 

 

 

Total

   $ 317,000        1.59
  

 

 

    

 

 

 

Subordinated Notes

At March 31, 2018, the Company’s subordinated notes, net of issuance costs, totaled $58,559, compared with $58,515 at December 31, 2017. 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 Reserve Bank, described in “Other Events” in ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS and in “ITEM 1A. RISK FACTORS,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, 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 March 31, 2018, $1,186,420 of the investment securities portfolio was classified as available-for-sale and is reported at fair value on the consolidated balance sheet. Another $213,381 of the portfolio was classified as held-to-maturity and is reported at amortized cost. Approximately $1,168,275 of the total $1,399,801 investment securities portfolio on hand at March 31, 2018, 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.

 

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Table of Contents

Equity

As of March 31, 2018, the Company’s equity was $304,865, as compared with $304,653 as of December 31, 2017. The increase in equity was due to the Company’s earnings of $10,052 in the first quarter of 2018 and the increase in common stock of $929 during the first quarter, offset by a $10,769 reduction in other comprehensive income from the reduced 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 March 31, 2018, the Company had unfunded loan commitments outstanding of $41,381, unused lines of credit of $621,697, and outstanding standby letters of credit of $31,951.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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Table of Contents

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:

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  
   Mar 31,
2018
    Dec 31,
2017
    Sept 30,
2017
    Jun 30,
2017
    Mar 31,
2017
 

Total shareholders’ equity

   $ 304,762     $ 304,550     $ 303,594     $ 292,918     $ 278,407  

Less: Preferred stock

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total common shareholders’ equity

     304,762       304,550       303,594       292,918       278,407  

Less: Goodwill and other intangible assets

     10,074       10,181       10,294       10,356       10,477  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible common shareholders’ equity

   $ 294,688     $ 294,369     $ 293,300     $ 282,562     $ 267,930  

Common shares outstanding

     13,258,142       13,237,128       13,209,055       13,181,501       13,064,110  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Tangible book value per share

   $ 22.23     $ 22.24     $ 22.20     $ 21.44     $ 20.51  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average total common equity

     299,840       304,847       298,088       285,659     $ 272,713  

Less: Average Goodwill and other intangible assets

     10,136       10,247       10,321       10,427       10,565  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average tangible common shareholders’ equity

   $ 289,704     $ 294,600     $ 287,767     $ 275,232     $ 262,148  

Net income available to common shareholders

     10,052       2,394       8,889       8,866       7,934  

Average tangible common equity

     289,704       294,600       287,767       275,232       262,148  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on average tangible common equity

     14.07     3.22     12.26     12.92     12.27
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency Ratio:

          

Net interest income

   $ 25,116     $ 24,608     $ 24,326     $ 24,469     $ 23,643  

Noninterest income

     3,456       3,264       3,569       3,880       4,008  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating revenue

     28,572       27,872       27,895       28,349       27,651  

Expense

          

Total noninterest expense

     15,488       15,987       15,278       15,283       14,276  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency ratio

     54.21     57.36     54.77     53.91     51.63
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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  
     Mar 31, 2018      Dec 31, 2017      Sept 30, 2017     Jun 30, 2017      Mar 31, 2017  

Income Statement Data ($):

 

       

Interest income

     38,047        35,121        33,780       33,011        30,541  

Interest expense

     12,931        10,513        9,454       8,542        6,898  

Net interest income

     25,116        24,608        24,326