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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 2018

or

 

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 Exchange Act).    Yes  ☐    No  ☒

The number of shares outstanding of the registrant’s common stock, no par value per share, as of July 31, 2018, was 14,487,695.

 

 

 


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

     29  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     47  

Item 4. Controls and Procedures

     48  

PART II OTHER INFORMATION

  

Item 1. Legal Proceedings

     48  

Item 1A. Risk Factors

     48  

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

     49  

Item 3. Defaults Upon Senior Securities

     49  

Item 4. Mine Safety Disclosures

     49  

Item 5. Other Information

     49  

Item 6. Exhibits

     49  

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, unless otherwise required by law.

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 Part I of our Annual Report on Form 10-K for the year ended December 31, 2017.

 

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)

 

     June 30,
2018
    December 31,
2017
 
     (Unaudited)        

ASSETS

    

Cash and due from financial institutions

   $ 176,870     $ 251,543  

Federal funds sold

     8,314       —    

Certificates of deposit at other financial institutions

     3,354       2,855  

Securities available for sale

     1,148,679       999,881  

Securities held to maturity (fair value 2018—$206,408 and 2017—$227,892)

     209,239       214,856  

Loans held for sale, at fair value

     16,769       12,024  

Loans

     2,472,093       2,256,608  

Allowance for loan losses

     (22,341     (21,247
  

 

 

   

 

 

 

Net loans

     2,449,752       2,235,361  
  

 

 

   

 

 

 

Restricted equity securities, at cost

     20,533       18,492  

Premises and equipment, net

     11,578       11,281  

Accrued interest receivable

     13,490       11,947  

Bank owned life insurance

     54,466       49,085  

Deferred tax asset

     15,090       10,007  

Foreclosed assets

     1,853       1,503  

Servicing rights, net

     3,536       3,620  

Goodwill

     18,176       9,124  

Core deposit intangible, net

     1,279       1,007  

Other assets

     12,260       10,940  
  

 

 

   

 

 

 

Total assets

   $ 4,165,238     $ 3,843,526  
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Deposits

    

Non-interest bearing

   $ 308,698     $ 272,172  

Interest bearing

     3,089,327       2,895,056  
  

 

 

   

 

 

 

Total deposits

     3,398,025       3,167,228  

Federal Home Loan Bank advances

     351,500       272,000  

Federal funds purchased and repurchase agreements

     345       31,004  

Subordinated notes, net

     58,604       58,515  

Accrued interest payable

     3,927       2,769  

Other liabilities

     4,675       7,357  
  

 

 

   

 

 

 

Total liabilities

     3,817,076       3,538,873  

Equity

    

Preferred stock, no par value: 1,000,000 shares authorized; no shares outstanding at June 30, 2018 and December 31, 2017

     —         —    

Common stock, no par value: 30,000,000 and 30,000,000 shares authorized at June 30, 2018 and December 31, 2017 , respectively; 14,480,240 and 13,237,128 issued at June 30, 2018 and December 31, 2017 , respectively

     259,517       222,665  

Retained earnings

     108,884       88,671  

Accumulated other comprehensive loss

     (20,342     (6,786
  

 

 

   

 

 

 

Total shareholders’ equity

     348,059       304,550  

Non-controlling interest in consolidated subsidiary

     103       103  
  

 

 

   

 

 

 

Total equity

     348,162       304,653  
  

 

 

   

 

 

 

Total liabilities and equity

   $ 4,165,238     $ 3,843,526  
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

 

2


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

June 30,

   

Six Months Ended

June 30,

 
     2018     2017     2018     2017  

Interest income and dividends

        

Loans, including fees

   $ 32,312     $ 24,662     $ 61,105     $ 47,222  

Securities:

        

Taxable

     6,905       5,700       13,016       11,317  

Tax-Exempt

     1,929       2,212       3,844       4,232  

Dividends on restricted equity securities

     329       213       603       394  

Federal funds sold and other

     661       224       1,615       387  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     42,136       33,011       80,183       63,552  
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

        

Deposits

     12,604       6,561       23,247       11,807  

Federal funds purchased and repurchase agreements

     131       147       227       217  

Federal Home Loan Bank advances

     1,414       752       2,524       1,260  

Subordinated notes and other borrowings

     1,082       1,082       2,164       2,156  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     15,231       8,542       28,162       15,440  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     26,905       24,469       52,021       48,112  

Provision for loan losses

     570       573       1,143       2,428  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     26,335       23,896       50,878       45,684  
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

        

Service charges on deposit accounts

     51       45       93       75  

Other service charges and fees

     823       758       1,574       1,510  

Net gains on sale of loans

     1,941       2,067       3,380       4,401  

Wealth management

     789       648       1,493       1,241  

Loan servicing fees, net

     103       53       222       160  

Gain on sale or call of securities

     1       120       1       120  

Net gain on sale of foreclosed assets

     3       3       6       6  

Other

     436       186       834       375  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     4,147       3,880       7,603       7,888  
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense

        

Salaries and employee benefits

     10,268       9,128       19,456       17,161  

Occupancy and equipment

     2,885       2,195       5,479       4,290  

FDIC assessment expense

     778       1,015       1,438       1,775  

Marketing

     269       285       549       552  

Professional fees

     1,362       702       2,231       1,737  

Amortization of core deposit intangible

     182       121       286       248  

Other

     2,306       1,837       4,099       3,796  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     18,050       15,283       33,538       29,559  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     12,432       12,493       24,943       24,013  

Income tax expense

     2,263       3,619       4,722       7,205  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     10,169       8,874       20,221       16,808  

Earnings attributable to noncontrolling interest

     (8     (8     (8     (8

Dividends paid on Series A preferred stock

     —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to common shareholders

   $ 10,161     $ 8,866     $ 20,213     $ 16,800  
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 0.71     $ 0.68     $ 1.46     $ 1.28  

Diluted

     0.68       0.64       1.41       1.22  

See accompanying notes to consolidated financial statements.

 

3


Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

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

(Unaudited)

 

    

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
     2018     2017     2018     2017  

Net income

   $ 10,169     $ 8,874     $ 20,221     $ 16,808  

Other comprehensive income, net of tax:

        

Unrealized gains on securities:

        

Unrealized holding gain (loss) arising during the period

     (3,774     6,671       (18,351     6,031  

Reclassification adjustment for gains included in net income

     (1     (120     (1     (120
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses)

     (3,775     6,551       (18,352     5,911  

Tax effect

     986       (2,569     4,796       (2,317
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

     (2,789     3,982       (13,556     3,594  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 7,380     $ 12,856     $ 6,665     $ 20,402  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

4


Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Six Months Ended June 30, 2018 and 2017

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

(Unaudited)

 

     Shareholders’ Equity               
     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

     —          109,663       1,055       —         —         —          1,055  

Exercise of common stock warrants

     —          12,461       150       —         —         —          150  

Stock based compensation expense, net of restricted share forfeitures

     —          26,911       1,235       —         —         —          1,235  

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

     —          (4,488     (174     —         —         —          (174

Noncontrolling interest distributions

     —          —         —         (8     —         —          (8

Net income

     —          —         —         16,808       —         —          16,808  

Other comprehensive income

     —          —         —         —         3,594       —          3,594  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2017

   $ —        13,181,501     $ 220,620     $ 76,186     $ (3,888     103      $ 293,021  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at December 31, 2017

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

Exercise of common stock options

     —          157,231       1,937       —         —         —          1,937  

Stock based compensation expense, net of forfeitures

     —          —         2,078       —         —         —          2,078  

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

     —          (2,815     (95     —         —         —          (95

Issuance of restricted stock, net of forfeitures

     —          118,306       —         —         —         —          —    

Stock issued for acquisition (net of issuance costs)

     —          970,390       32,932       —         —         —          32,932  

Noncontrolling interest distributions

     —          —         —         (8     —         —          (8

Net income

     —          —         —         20,221       —         —          20,221  

Other comprehensive loss

     —          —         —         —         (13,556     —          (13,556
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2018

   $ —        14,480,240     $ 259,517     $ 108,884     $ (20,342     103      $ 348,162  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

5


Table of Contents

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

(Unaudited)

 

    

Six Months Ended

June 30,

 
     2018     2017  

Cash flows from operating activities

    

Net income

   $ 20,221     $ 16,808  

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation and amortization on premises and equipment

     841       741  

Accretion of purchase accounting adjustments

     (610     (714

Net amortization of securities

     4,073       4,998  

Amortization of loan servicing right asset

     441       479  

Amortization of core deposit intangible

     286       248  

Amortization of debt issuance costs

     89       89  

Provision for loan losses

     1,143       2,428  

Deferred income tax benefit

     (216     (558

Origination of loans held for sale

     (184,835     (175,918

Proceeds from sale of loans held for sale

     183,113       191,855  

Net gain on sale of loans

     (3,380     (4,401

Gain on sale of available for sale securities

     (1     (120

Income from bank owned life insurance

     (762     (310

Loss on sale of assets held for sale

     —         —    

Stock-based compensation

     2,078       1,235  

Compensation expense related to common stock issued to 401(k) plan

     —         —    

Deferred gain on sale of loans

     (8     (58

Deferred gain on sale of foreclosed assets

     (6     (6

Net change in:

    

Accrued interest receivable and other assets

     (2,153     (2,674

Accrued interest payable and other liabilities

     (3,327     1,331  
  

 

 

   

 

 

 

Net cash from operating activities

     16,987       35,453  

Cash flows from investing activities

    

Securities available for sale :

    

Sales

     —         61,190  

Purchases

     (226,362     (394,219

Maturities, prepayments and calls

     87,779       68,721  

Securities held to maturity :

    

Purchases

     (1,676     (1,996

Maturities, prepayments and calls

     6,393       7,579  

Net change in loans

     (118,539     (239,256

Purchase of restricted equity securities

     (1,165     (5,483

Purchases of premises and equipment, net

     (885     (2,076

Capitalization of foreclosed assets

     —         (35

Increase in certificates of deposits at other financial institutions

     —         (1,475

Purchase of bank owned life insurance

     (119     —    

Net cash acquired from acquisition (See Note 2)

     24,660       —    
  

 

 

   

 

 

 

Net cash from investing activities

     (229,914     (507,050

Cash flows from financing activities

    

Increase in deposits

     107,635       362,607  

Decrease in federal funds purchased and repurchase agreements

     (30,659     (41,219

Proceeds from Federal Home Loan Bank advances

     250,000       320,000  

Repayment of Federal Home Loan Bank advances

     (182,000     (165,000

Proceeds from issuance of common stock, net of offering costs

     (242     —    

Proceeds from exercise of common stock warrants

     —         150  

Proceeds from exercise of common stock options

     1,937       1,055  

Divestment of common stock issued to 401(k) plan

     (95     (174

Noncontrolling interest distributions

     (8     (8
  

 

 

   

 

 

 

Net cash from financing activities

     146,568       477,411  
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (66,359     5,814  

Cash and cash equivalents at beginning of period

     251,543       90,927  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 185,184     $ 96,741  
  

 

 

   

 

 

 

Supplemental information:

    

Interest paid

   $ 27,004     $ 14,793  

Income taxes paid

     6,632       9,085  

Non-cash supplemental information:

    

Fair value of stock and stock options issued related to Civic Bank acquisition*

   $ 33,174     $ —    

Transfers from loans to foreclosed assets

     350       1,315  

 

*

See Note 2 for non-cash assets acquired and liabilities assumed in business combinations.

See accompanying notes to consolidated financial statements.

 

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Table of Contents

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.

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 9, “Fair Value,” for further information regarding the valuation of these loans.

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.

 

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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. The Company’s current minimum lease commitments amount to approximately $58.5 million.

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

In 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.

NOTE 2—BUSINESS COMBINATIONS

As of April 1, 2018, Civic Bank & Trust (“Civic”) merged with and into Franklin Synergy with Franklin Synergy continuing as the surviving company. Under the terms of the acquisition, Civic’s common shareholders received a total of 970,390 shares of the Company’s common stock in exchange for the outstanding shares of Civic common stock. With the completion of the acquisition, the Company has its first full service branch office in Nashville, Tennessee located in the Davidson County market. The results of Civic’s operations are included in the Company’s results for the first time in this Form 10-Q. Acquisition-related costs of $482 and $565, respectively, are included in other noninterest expense in the Company’s income statement for the three and six months ended June 30, 2018. The fair value of the common shares issued as part of the consideration paid for Civic was determined using the basis of the closing price of the Company’s common shares on the acquisition date.

 

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Goodwill of $9,052 arising from the acquisition consisted largely of synergies resulting from the combining of the operations of the companies. The fair value of intangible assets related to core deposits was determined to be $558.

The following table summarizes the consideration paid for Civic and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

 

Consideration:

  

Common stock issued to Civic shareholders

   $ 31,635  

Fair value of stock options issued to Civic option holders

     1,539  
  

 

 

 

Fair value of total consideration

   $ 33,174  
  

 

 

 

Recognized amounts of identifiable assets acquired and liabilities assumed:*

  

Cash and cash equivalents

   $ 24,660  

Certificates of deposit at other financial institutions

     500  

Securities available for sale

     31,734  

Loans

     96,385  

Equity securities

     876  

Premises and equipment

     253  

Core deposit intangibles

     558  

Foreclosed assets

     350  

Other assets

     5,209  
  

 

 

 

Total assets acquired

     160,601  
  

 

 

 

Deposits

     123,161  

Federal Home Loan Bank advances

     11,500  

Other liabilities

     1,817  
  

 

 

 

Total liabilities assumed

     136,479  
  

 

 

 

Total net assets acquired

     24,122  
  

 

 

 

Goodwill

   $ 9,052  
  

 

 

 

 

*

Amounts shown in the table above are subject to adjustment.

The fair value of net assets acquired includes fair value adjustments to certain loan receivables that were not considered impaired as of the acquisition date. As such, these receivables were not subject to the guidance relating to purchased credit-impaired loans. Receivables acquired include loans and customer receivables with a fair value and gross contractual amounts receivable of $96,385 and $96,903 on the date of acquisition.

 

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The following table presents supplemental pro forma information as if the Civic acquisition had occurred at the beginning of 2017. The unaudited pro forma information includes adjustments for interest income on loans acquired, amortization of intangibles arising from the transaction, interest expense on deposits acquired, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effected on the assumed dates.

 

     Six Months Ended June 30,  
     2018      2017  

Net interest income – pro forma (unaudited)

   $ 53,381      $ 51,236  

Net income – pro forma (unaudited)

   $ 20,347      $ 17,868  

Earnings per share – pro forma (unaudited):

     

Basic

   $ 1.34      $ 1.27  

Diluted

   $ 1.31      $ 1.26  

NOTE 3—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available for sale portfolio at June 30, 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
 

June 30, 2018

           

U.S. Treasury securities

   $ 254,456      $ —      $ (373    $ 254,083  

U.S. government sponsored entities and agencies

     26,363        —          (218      26,145  

Mortgage-backed securities: residential

     771,100        3        (23,104      747,999  

Mortgage-backed securities: commercial

     5,113        —          (131      4,982  

State and political subdivisions

     119,182        385        (4,097      115,470  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,176,214      $ 388      $ (27,923    $ 1,148,679  
  

 

 

    

 

 

    

 

 

    

 

 

 
     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 June 30, 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
 

June 30, 2018

           

Mortgage backed securities: residential

   $ 88,769      $ 76      $ (3,814    $ 85,031  

State and political subdivisions

     120,470        1,152        (245      121,377  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 209,239      $ 1,228      $ (4,059    $ 206,408  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

June 30,

    

Six Months Ended

June 30,

 
     2018      2017      2018      2017  

Proceeds

   $ 1      $ 61,190      $ 1      $ 61,190  

Gross gains

     1        246        1        246  

Gross losses

     —          (126      —          (126

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

 

     June 30, 2018  
     Amortized
Cost
     Fair
Value
 

Available for sale

     

One year or less

   $ 274,536      $ 273,974  

Over one year through five years

     2,665        2,653  

Over five years through ten years

     2,982        2,965  

Over ten years

     119,818        116,106  

Mortgage-backed securities: residential

     771,100        747,999  

Mortgage-backed securities: commercial

     5,113        4,982  
  

 

 

    

 

 

 

Total

   $ 1,176,214      $ 1,148,679  
  

 

 

    

 

 

 

Held to maturity

     

One year or less

   $ 501      $ 508  

Over one year through five years

     1,106        1,118  

Over five years through ten years

     12,868        12,948  

Over ten years

     105,995        106,803  

Mortgage-backed securities: residential

     88,769        85,031  
  

 

 

    

 

 

 

Total

   $ 209,239      $ 206,408  
  

 

 

    

 

 

 

Securities pledged at June 30, 2018 and December 31, 2017 had a carrying amount of $1,038,465 and $975,518, respectively, and were pledged to secure public deposits and repurchase agreements.

At June 30, 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 June 30, 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
 

June 30, 2018

               

Available for sale

               

U.S. Treasury securities

   $ 254,084      $ (373   $ —      $ —     $ 254,084      $ (373

U.S. government sponsored entities and agencies

     6,169        (27     19,890        (191     26,059        (218

Mortgage-backed securities: residential

     457,808        (10,073     289,591        (13,031     747,399        (23,104

Mortgage-backed securities: commercial

     4,982        (131     —          —         4,982        (131

State and political subdivisions

     16,853        (233     60,575        (3,864     77,428        (4,097
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available for sale

   $ 739,896      $ (10,837   $ 370,056      $ (17,086   $ 1,109,952      $ (27,923
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     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

   $ 14,961      $ (387   $ 65,670      $ (3,427   $ 80,631      $ (3,814

State and political subdivisions

     30,065        (192     1,129        (53     31,194        (245
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held to maturity

   $ 45,026      $ (579   $ 66,799      $ (3,480   $ 111,825      $ (4,059
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     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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NOTE 4—LOANS

Loans at June 30, 2018 and December 31, 2017 were as follows:

 

     June 30,
2018
     December 31,
2017
 

Loans that are not PCI loans

     

Construction and land development

   $ 562,696      $ 494,818  

Commercial real estate:

     

Nonfarm, nonresidential

     716,918        628,554  

Other

     45,659        49,684  

Residential real estate:

     

Closed-end 1-4 family

     464,531        407,695  

Other

     183,718        169,640  

Commercial and industrial

     491,567        502,006  

Consumer and other

     6,800        3,781  
  

 

 

    

 

 

 

Loans before net deferred loan fees

     2,471,889        2,256,178  

Deferred loan fees, net

     (2,209      (1,963
  

 

 

    

 

 

 

Total loans that are not PCI loans

     2,469,680        2,254,215  

Total PCI loans

     2,413        2,393  

Allowance for loan losses

     (22,341      (21,247
  

 

 

    

 

 

 

Total loans, net of allowance for loan losses

   $ 2,449,752      $ 2,235,361  
  

 

 

    

 

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three-month periods ended June 30, 2018 and 2017:

 

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

Three Months Ended June 30, 2018

             

Allowance for loan losses:

             

Beginning balance

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

Provision for loan losses

     267       288        909       (900     6       570  

Loans charged-off

     —         —          —         —         (5     (5

Recoveries

     1       —          19       10       8       38  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 4,613     $ 6,163      $ 4,533     $ 6,976     $ 56     $ 22,341  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2017

             

Allowance for loan losses:

             

Beginning balance

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

Provision for loan losses

     (41     352        255       9       (2     573  

Loans charged-off

     —         —          (1     —         (2     (3

Recoveries

     —         —          13       —         1       14  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 3,796     $ 5,011      $ 2,939     $ 6,894     $ 49     $ 18,689  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the six-month periods ended June 30, 2018 and 2017:

 

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

Six Months Ended June 30, 2018

             

Allowance for loan losses:

             

Beginning balance

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

Provision for loan losses

     848       182        668       (572     17       1,143  

Loans charged-off

     (38     —          (7     (49     (17     (111

 

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

Recoveries

     1        —          38       10       13       62  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 4,613      $ 6,163      $ 4,533     $ 6,976     $ 56     $ 22,341  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2017

              

Allowance for loan losses:

              

Beginning balance

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

Provision for loan losses

     20        745        517       1,126       20       2,428  

Loans charged-off

     —          —          (1     (300     (25     (326

Recoveries

     —          —          13       —         1       14  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 3,796      $ 5,011      $ 2,939     $ 6,894     $ 49     $ 18,689  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

As of both June 30, 2018 and December 31, 2017, there was no allowance for loan losses for PCI loans.

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 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  

June 30, 2018

                 

Allowance for loan losses:

                 

Ending allowance balance attributable to loans:

                 

Individually evaluated for impairment

   $ —      $ —      $ —      $ 16      $ —      $ 16  

Collectively evaluated for impairment

     4,613        6,163        4,533        6,960        56        22,325  

Purchased credit-impaired loans

     —          —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 4,613      $ 6,163      $ 4,533      $ 6,976      $ 56      $ 22,341  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                 

Individually evaluated for impairment

   $ —      $ —      $ 441      $ 2,633      $ —      $ 3,074  

Collectively evaluated for impairment

     562,696        762,577        647,808        488,934        6,800        2,468,815  

Purchased credit-impaired loans

     —          363        86        1,964        —          2,413  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 562,696      $ 762,940      $ 648,335      $ 493,531      $ 6,800      $ 2,474,302  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Loans collectively evaluated for impairment reported at June 30, 2018 include certain acquired loans. At June 30, 2018, these non-PCI loans had a carrying value of $133,413, comprised of contractually unpaid principal totaling $134,986 and discounts totaling $1,573. Management evaluated these loans for credit deterioration since acquisition and determined that an allowance for loan losses of $343 was necessary at June 30, 2018.

The following table presents information related to impaired loans by class of loans as of June 30, 2018 and December 31, 2017:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance for
Loan Losses
Allocated
 

June 30, 2018

        

With no allowance recorded:

        

Residential real estate:

        

Closed-end 1-4 family

   $ 337      $ 330        —    

Other

     111        111        —    

Commercial and industrial

     2,466        2,466        —    
  

 

 

    

 

 

    

 

 

 

Subtotal

     2,914        2,907        —    

With an allowance recorded:

        

Commercial and industrial

     167        167        16  
  

 

 

    

 

 

    

 

 

 

Subtotal

     167        167        16  
  

 

 

    

 

 

    

 

 

 

Total

   $ 3,081      $ 3,074      $ 16  
  

 

 

    

 

 

    

 

 

 

December 31, 2017

        

With no allowance recorded:

        

Construction and land development

   $ 217      $ 217      $ —  

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 and six months ended June 30, 2018 and 2017:

 

    

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 

Average Recorded Investment

   2018      2017      2018      2017  

With no allowance recorded:

           

Construction and land development

   $ —      $ 2,250      $ 100      $ 1,125  

Commercial real estate:

           

Nonfarm, nonresidential

     —          2,242        —          3,185  

Residential real estate:

           

Closed-end 1-4 family

     496        604        432        1,202  

Other

     112        181        192        151  

Commercial and industrial

     883        568        867        705  

Consumer and other

     —          2        —          1  
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     1,491        5,847        1,591        6,369  
  

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

           

Commercial and industrial

   $ 1,638      $ 2,855      $ 1,785      $ 2,720  
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     1,638        2,855        1,785        2,720  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,129      $ 8,702      $ 3,376      $ 9,089  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The impact on net interest income for these loans was not material to the Company’s results of operations for the three and six months ended June 30, 2018 and 2017.

The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still on accrual by class of loans as of June 30, 2018 and December 31, 2017:

 

     Nonaccrual      Loans Past Due
Over 90 Days
 

June 30, 2018

     

Residential real estate:

     

Closed-end 1-4 family

   $ 330      $ —  

Other

     111        —    

Commercial and industrial

     2,466        530  
  

 

 

    

 

 

 

Total

   $ 2,907      $ 530  
  

 

 

    

 

 

 

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  
  

 

 

    

 

 

 

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

The following table presents the aging of the recorded investment in past due loans as of June 30, 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  

June 30, 2018

                       

Construction and land development

   $ 1,379      $ 750      $ —      $ —      $ 2,129      $ 560,567      $ —      $ 562,696  

Commercial real estate:

                       

Nonfarm, nonresidential

     —          —          —          —          —          716,918        363        717,281  

Other

     3        —          —          —          3        45,656        —          45,659  

Residential real estate:

                       

Closed-end 1-4 family

     1,323        —          —          330        1,653        462,878        86        464,617  

Other

     1,003        50        —          111        1,164        182,554        —          183,718  

Commercial and industrial

     167        69        530        2,466        3,232        488,335        1,964        493,531  

Consumer and other

     —          —          —          —          —          6,800        —          6,800  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,875      $ 869      $ 530      $ 2,907      $ 8,181      $ 2,463,708      $ 2,413      $ 2,474,302  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

     —          —          —          —          —          49,684        —          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  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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

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

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

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. The following table includes PCI loans, which are included in the “Substandard” column. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of June 30, 2018 and December 31, 2017:

 

     Pass      Special
Mention
     Substandard      Total  

June 30, 2018

           

Construction and land development

   $ 558,958      $ 3,738      $ —      $ 562,696  

Commercial real estate:

           

Nonfarm, nonresidential

     701,611        11,606        4,064        717,281  

Other

     45,276        —          383        45,659  

Residential real estate:

           

Closed-end 1-4 family

     462,668        —          1,949        464,617  

Other

     181,919        —          1,799        183,718  

Commercial and industrial

     479,214        5,425        8,892        493,531  

Consumer and other

     6,796        3        1        6,800  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,436,442      $ 20,772      $ 17,088      $ 2,474,302  
  

 

 

    

 

 

    

 

 

    

 

 

 
     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  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Troubled Debt Restructurings

As of June, 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 $166 and $608, respectively. During the second quarter of 2018 one loan was added as a troubled debt restructuring with a balance of $166, and the loan that was a troubled debt restructuring at December 31, 2017 was paid off after $33 of the loan balance was charged off.

NOTE 5—LOAN SERVICING

Loans serviced for others are not reported as assets. The principal balances of these loans at June 30, 2018 and December 31, 2017 are as follows:

 

     June 30,
2018
     December 31,
2017
 

Loan portfolios serviced for:

     

Federal Home Loan Mortgage Corporation

   $ 501,280      $ 507,233  

Other

     3,862        4,626  

The components of net loan servicing fees for the three and six months ended June 30, 2018 and 2017 were as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2018      2017      2018      2017  

Loan servicing fees, net:

           

Loan servicing fees

   $ 330      $ 319      $ 662      $ 639  

Amortization of loan servicing fees

     (227      (266      (440      (479

Change in impairment

     —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 103      $ 53      $ 222      $ 160  
  

 

 

    

 

 

    

 

 

    

 

 

 

The fair value of servicing rights was estimated by management to be approximately $5,127 at June 30, 2018. Fair value for June 30, 2018 was determined using a weighted average discount rate of 10.5% and a weighted average prepayment speed of 10.2%. 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 6—SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

Our subsidiary bank enters into borrowing arrangements with our retail business customers and correspondent banks through agreements to repurchase (“securities sold under agreements to repurchase”) under which the bank pledges investment securities owned and under its control as collateral against these short-term borrowing arrangements. At maturity the securities underlying the agreements are returned to the Company. At June 30, 2018 and December 31, 2017, these short-term borrowings totaled $345 and $31,004, respectively, and were secured by securities with carrying amounts of $1,998 and $41,136, respectively. At June 30, 2018, all of the Company’s repurchase agreements had one-day maturities.

The following table provides additional details as of June 30, 2018:

 

As of June 30, 2018

   State and
Political
Subdivisions
    Total  

Market value of securities pledged

   $ 2,048     $ 2,048  

Borrowings related to pledged amounts

   $ 345     $ 345  

Market value pledged as a % of borrowings

     594     594

 

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Table of Contents

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 7—SHARE-BASED PAYMENTS

In connection with the Company’s 2010 private offering, 32,425 warrants were issued to shareholders, one warrant for every twenty shares of common stock purchased. Each warrant allows the shareholders to purchase an additional share of common stock at $12.00 per share. The warrants were issued with an effective date of March 30, 2010 and 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 0 and 12,461 warrants exercised during the six months ended June 30, 2018 and 2017, respectively.

A summary of the stock warrant activity for the six months ended June 30, 2018 and 2017 follows:

 

     June 30,
2018
     June 30,
2017
 

Stock warrants exercised:

     

Intrinsic value of warrants exercised

   $ —      $ 329  

Cash received from warrants exercised

     —          150  

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

The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $1,318 and $788 and $2,078 and $1,235 for the three and six months ended June 30, 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 $220 and $283 for the three and six months ended June 30, 2018. The total income tax benefit for the three and six months ended June 30, 2017 was $357 and $450.

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 June 30, 2018, there were 4,280,623 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

 

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Table of Contents
   

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.

 

     June 30,
2018
    June 30,
2017
 

Risk-free interest rate

     2.96     2.03

Expected term

     7.5 years       6.7 years  

Expected stock price volatility

     32.09     33.36

Dividend yield

     0.00     0.03

The weighted average fair value of options granted for the six months ended June 30, 2018 and 2017 were $12.03 and $14.38, respectively.

A summary of the activity in the plans for the six months ended June 30, 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

     505,637        29.69        

Exercised

     (183,823      16.10        

Forfeited, expired, or cancelled

     (12,654      29.30        
  

 

 

          

Outstanding at period end

     1,816,328      $ 24.08        7.14      $ 24,557  
  

 

 

    

 

 

    

 

 

    

 

 

 

Vested or expected to vest

     1,725,512      $ 24.08        7.14      $ 23,329  

Exercisable at period end

     1,007,612      $ 18.27        6.00      $ 19,474  

 

     For the six months
ended June 30,
 
     2018      2017  

Stock options exercised:

     

Intrinsic value of options exercised

   $ 3,745      $ 3,460  

Cash received from options exercised

     1,937        1,055  

Tax benefit realized from option exercises

     283        450  

As of June 30, 2018, there was $7,127 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 2.3 years.

Restricted Stock: Additionally, the 2007 Plan and the Amended and Restated 2017 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.

 

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A summary of activity for non-vested restricted share awards for the six months ended June 30, 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

     120,038        32.99  

Vested

     (33,031      27.27  

Forfeited

     (1,732      32.19  
  

 

 

    

Non-vested at June 30, 2018

     179,456      $ 30.49  
  

 

 

    

Compensation expense associated with the restricted share awards is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of June 30, 2018, there was $4,964 of total unrecognized compensation cost related to non-vested shares granted under the 2007 Plan and Amended and Restated 2017 Plan. The cost is expected to be recognized over a weighted-average period of 2.9 years.

NOTE 8—REGULATORY CAPITAL MATTERS

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

The Basel III rules additionally provide for countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Under the Basel III rules, banks must maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital equal to 2.5% of risk-weighted assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying certain discretionary bonuses. This new capital conservation buffer requirement was phased in beginning January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented at 2.5% in January 2019. The capital conservation buffer in effect for 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 June 30, 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 June 30, 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 June 30, 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  

June 30, 2018

               

Company common equity Tier 1 capital to risk-weighted assets

   $ 347,175        12.14   $ 128,657        4.50     N/A        N/A  

Company Total Capital to risk weighted assets

   $ 428,214        14.98   $ 228,723        8.00     N/A        N/A  

Company Tier 1 (Core) Capital to risk weighted assets

   $ 347,175        12.14   $ 171,543        6.00     N/A        N/A  

Company Tier 1 (Core) Capital to average assets

   $ 347,175        8.33   $ 167,722        4.00     N/A        N/A  

Bank common equity Tier 1 capital to risk-weighted assets

   $ 401,965        14.06   $ 128,661        4.50   $ 185,843        6.50

Bank Total Capital to risk weighted assets

   $ 424,400        14.84   $ 228,730        8.00   $ 285,913        10.00

Bank Tier 1 (Core) Capital to risk weighted assets

   $ 401,965        14.06   $ 171,548        6.00   $ 228,730        8.00

Bank Tier 1 (Core) Capital to average assets

   $ 401,965        9.65   $ 166,615        4.00   $ 208,269        5.00

 

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

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. Neither the Company nor the Bank may currently pay dividends without prior written approval from its primary regulatory agencies.

NOTE 9—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 and 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.

 

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Table of Contents

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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Table of Contents

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

 

     Fair Value Measurements at
June 30, 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

   $ —      $ 254,083      $ —  

U.S. government sponsored entities and agencies

     —          26,145        —    

Mortgage-backed securities-residential

     —          747,999        —    

Mortgage-backed securities-commercial

     —          4,982        —    

State and political subdivisions

     —          115,470        —    
  

 

 

    

 

 

    

 

 

 

Total securities available for sale

   $ —      $ 1,148,679      $ —  
  

 

 

    

 

 

    

 

 

 

Loans held for sale

   $ —      $ 16,769      $ —  
  

 

 

    

 

 

    

 

 

 

Mortgage banking derivatives

   $ —      $ 393      $ —  
  

 

 

    

 

 

    

 

 

 

Financial Liabilities

     

Mortgage banking derivatives

   $ —      $ 83      $ —  
  

 

 

    

 

 

    

 

 

 
     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 June 30, 2018, the unpaid principal balance of loans held for sale was $16,232 resulting in an unrealized gain of $537 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 June 30, 2018 and 2017, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $220 and $(8), respectively. For the six months ended June 30, 2018 and 2017, the change in fair value related to loans held for sale, which is included in gain on sale of loans, was $194 and $105, respectively. None of these loans were 90 days or more past due or on nonaccrual as of June 30, 2018 and December 31, 2017.

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

 

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Table of Contents

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

There was one collateral-dependent impaired loans carried at fair value of $150 as of June 30, 2018 and one collateral-dependent impaired loan carried at fair value of $1,650 as of December 31, 2017. For the three and six months ended June 30, 2018, $16 in additional provision for loan losses was recorded related to impaired loans recorded at fair value of collateral. For the three and six months ended June 30, 2017, $194 in additional provision for loan losses was recorded related to impaired loans recorded at fair value of collateral.

Foreclosed assets measured at fair value less costs to sell, had a net carrying amount of $1,853 as of June 30, 2018 and $1,503 as of December 31, 2017. There were no properties at June 30, 2018 or 2017 that had required write-downs to fair value which resulted in no write-downs for the three and six months ended June 30, 2018 and 2017, respectively.

The carrying amounts and estimated fair values of financial instruments at June 30, 2018 and December 31, 2017 are as follows:

 

     Carrying
Amount
     Fair Value Measurements at
June 30, 2018 Using:
 
     Level 1      Level 2      Level 3      Total  

Financial assets

              

Cash and cash equivalents

   $ 185,184      $ 185,184      $ —      $ —      $ 185,184  

Certificates of deposit held at other financial institutions

     3,354        —          3,354        —          3,354  

Securities available for sale

     1,148,679        —          1,148,679        —          1,148,679  

Securities held to maturity

     209,239        —          206,408        —          206,408  

Loans held for sale

     16,769        —          16,769        —          16,769  

Net loans

     2,449,752        —          —          2,421,662        2,421,662  

Restricted equity securities

     20,533        n/a        n/a        n/a        n/a  

Servicing rights, net

     3,536        —          —          5,127        5,127  

Mortgage banking derivative assets

     393        —          393        —          393  

Accrued interest receivable

     13,490        13        6,477        7,000        13,490  

Financial liabilities

              

Deposits

   $ 3,398,025      $ 1,854,909      $ 1,439,128      $ —      $ 3,294,037  

Federal funds purchased and repurchase agreements

     345        —          345        —          345  

Federal Home Loan Bank advances

     351,500        —          349,215        —          349,215  

Subordinated notes, net

     58,604        —          —          61,204        61,204  

Mortgage banking derivative liabilities

     83        —          83        —          83  

Accrued interest payable

     3,927        95        687        3,145        3,927  

 

     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 10—EARNINGS PER SHARE

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

 

    

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
     2018      2017      2018      2017  

Basic

           

Net income available to common shareholders

   $ 10,161      $ 8,866      $ 20,213      $ 16,800  

Less: earnings allocated to participating securities

     (118      (76      (192      (140
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income allocated to common shareholders

   $ 10,043      $ 8,790      $ 20,021      $ 16,660  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding including participating securities

     14,383,493        13,118,201        13,819,742        13,083,797  

Less: Participating securities

     (167,381      (111,977      (130,898      (109,166
  

 

 

    

 

 

    

 

 

    

 

 

 

Average shares

     14,216,112        13,006,224        13,688,844        12,974,631  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per common share

   $ 0.71      $ 0.68      $ 1.46      $ 1.28  
  

 

 

    

 

 

    

 

 

    

 

 

 
    

Three Months Ended

June 30,

    

Six Months Ended

June 30,

 
     2018      2017      2018      2017  

Diluted

           

Net income allocated to common shareholders

   $ 10,043      $ 8,790      $ 20,021      $ 16,660  

Weighted average common shares outstanding for basic earnings per common share

     14,216,112        13,006,224        13,688,844        12,974,631  

Add: Dilutive effects of assumed exercises of stock options

     597,947        695,199        557,307        701,947  

Add: Dilutive effects of assumed exercises of stock warrants

     —          339        —          3,157  
  

 

 

    

 

 

    

 

 

    

 

 

 

Average shares and dilutive potential common shares

     14,814,059        13,701,762        14,246,151        13,679,735  
  

 

 

    

 

 

    

 

 

    

 

 

 

Dilutive earnings per common share

   $ 0.68      $ 0.64      $ 1.41      $ 1.22  
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three months ended June 30, 2018 and 2017, stock options for 659,291and 302,570 shares of common stock were not considered in computing diluted earnings per common share because they were antidilutive. Stock options for 535,285 and 205,285 shares of common stock were not considered in computing diluted earnings per common share for the six months ended June 30, 2018 and 2017 because they were antidilutive.

NOTE 11—SUBORDINATED DEBT ISSUANCE

The Company’s subordinated notes, net of issuance costs, totaled $58,604 and $58,515 at June 30, 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 8 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

 

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

The issuance costs related to the March 2016 Subordinated Notes amounted to $1,382 and are being amortized as interest expense over the ten-year term of the March 2016 Subordinated Notes. The issuance costs related to the June 2016 Subordinated Notes were $404 and are being amortized as interest expense over the ten-year term of the June 2016 Subordinated Notes. For the three months ended June 30, 2018 and 2017, amortization of issuance costs has amounted to $45 and $45, respectively. For the six months ended June 30, 2018 and 2017, amortization of issuance costs has amounted to $89 and $89, respectively.

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

 

     March 2016
Subordinated
Notes
  June 2016
Subordinated
Notes

Principal amount issued

   $40,000   $20,000

Maturity date

   March 30, 2026   July 1, 2026

Initial fixed interest rate

   6.875%   7.00%

Initial interest rate period

   5 years   5 years

First interest rate change date

   March 30, 2021   July 1, 2021

Interest payment frequency through year five*

   Semiannually   Semiannually

Interest payment frequency after five years*

   Quarterly   Quarterly

Interest repricing index and margin

   3-month LIBOR

plus 5.636%

  3-month LIBOR

plus 6.04%

Repricing frequency after five years

   Quarterly   Quarterly

 

*

The Company currently may not make interest payments on either series of subordinated notes without prior written approval from its primary regulatory agencies. Through June 30, 2018 all interest payments have been made in accordance with the terms of the agreements.

 

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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 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“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.

As of April 1, 2018, Civic Bank & Trust (“Civic”), which was located in Nashville, Tennessee, merged with and into Franklin Synergy with Franklin Synergy continuing as the surviving company. Under the terms of the acquisition, Civic’s common shareholders received 0.3686 of a share of the Company’s common stock in exchange for each share of Civic common stock. With the completion of the acquisition of Civic, the Company added its first full service branch office in Nashville, Tennessee located in the very vibrant Davidson County market. The results of Civic’s operations are included in the Company’s results for the first time in this Form 10-Q. Effective with the acquisition, Dr. Anil Patel, who was the chairman of the Civic board of directors, was added to the Company’s board of directors.

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 Annual Report on 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 a loan balance has become uncollectible. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.

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

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

 

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

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

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

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

COMPARISON OF RESULTS OF OPERATIONS FOR

THE THREE AND SIX MONTHS ENDED JUNE 30, 2018 AND 2017

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $10,169 and $20,221 for the three and six months ended June 30, 2018, respectively, compared to $8,874 and $16,608 for the three and six months ended June 30, 2017, respectively. After earnings attributable to noncontrolling interest, the Company’s net earnings available to common shareholders for the three and six months ended June 30, 2018 was $10,161 and $20,213, respectively, compared to $8,866 and $16,800 for the three and six months ended June 30, 2017, respectively. The increase in net earnings available to common shareholders for the three and six months ended June 30, 2018 was attributable to the increase in net interest income and the decrease in income tax expense related to the Tax Cuts and Jobs Act (the “Tax Act”) that was passed in December 2017.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets less interest expense paid on interest-bearing liabilities and is the most significant component of our revenues. Net interest income for the three and six months ended June 30, 2018, totaled $26,905 and $52,021, respectively, compared to $24,469 and $48,112 for the same periods in 2017, an increase of $2,436 and $3,909, or 10.0% and 8.1%, between the respective periods. For the three and six months ended June 30, 2018, interest income increased $9,125 and $16,631, or 27.6% and 26.2%, respectively, compared with the same periods in 2017, due to growth in both the loan and investment securities portfolios. For the three and six months ended June 30, 2018, interest expense increased $6,689 and $12,722, or 78.3% and 82.4%, respectively, primarily due to increases in interest-bearing deposits combined with an increase in interest rates for deposits, Federal Home Loan Bank (“FHLB”) advances, federal funds purchased and other borrowings.

Interest-earning assets averaged $4,046,709 and $3,375,905 during the three months ended June 30, 2018 and 2017, respectively, an increase of $670,804, or 19.9%. This increase was due to growth in all types of interest-earning assets, but the largest growth occurred in loans and investment securities. Average loans increased 22.7%, and available for sale securities increased 15.0%, when comparing the three months ended June 30, 2018 with the same period in 2017.

When comparing the three months ended June 30, 2018 and 2017, the yield on average interest earning assets, adjusted for tax equivalent yield, increased 16 basis points in 2018 to 4.25% compared to 4.09% for the same period during 2017. For the three months ended June 30, 2018, the tax equivalent yield on available for sale securities was 2.53%, and for the three months ended June 30, 2017, the tax equivalent yield on available for sale securities was 2.68%. For the three months ended June 30, 2018, the tax equivalent yield on held to maturity securities was 3.74%, and for the three months ended June 30, 2017, the tax equivalent yield on held to maturity securities was 4.24%. 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.

 

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Interest-bearing liabilities averaged $3,518,299 during the three months ended June 30, 2018, compared to $2,909,508 for the same period in 2017, an increase of $608,791, or 20.9%. Total average interest-bearing deposits grew $543,441, or 21.2%, including increases in average interest checking of $219,332 and average time deposits of $168,571 for the three-month period ended June 30, 2018, as compared to the same period during 2017. The growth in the loan portfolio also resulted in an increase in average FHLB advances of $89,912.

For the three-month periods ended June 30, 2018 and 2017, the cost of average interest-bearing liabilities increased 56 basis points to 1.74% from 1.18%. The increase was due to rate increases in the cost of funds for interest-bearing deposits, FHLB advances and federal funds purchased.

Interest-earning assets averaged $3,957,827 and $3,280,739 during the six months ended June 30, 2018 and 2017, respectively, an increase of $677,088, or 20.6%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 23.1%, and investment securities increased 8.6%, when comparing the six months ended June 30, 2018 with the same period in 2017. When comparing the six months ended June 30, 2018 and 2017, the yield on average interest earning assets, adjusted for tax equivalent yield increased 8 basis points to 4.16% in 2018 compared to 4.08% for the same period during 2017.

For the six months ended June 30, 2018 and 2017, the tax equivalent yield on loans was 5.17% and 4.92% respectively. The primary driver for the increase in yields on loans for the six-month period ended June 30, 2018 was the increase in interest rates during the past year.

For the six months ended June 30, 2018, the tax equivalent yield on available for sale securities was 2.52%, and for the six months ended June 30, 2017, the tax equivalent yield on available for sale securities was 2.69%. For the six months ended June 30, 2018, the tax equivalent yield on held to maturity securities was 3.78%, and for the six months ended June 30, 2017, the tax equivalent yield on held to maturity securities was 4.22%. 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 $3,444,835 during the six months ended June 30, 2018, compared to $2,830,471 for the same period in 2017, an increase of $614,364, or 21.7%. Total average interest-bearing deposits grew $537,918, including increases in interest-bearing checking of $217,818 and average time deposits of $179,986 for the six-month period ended June 30, 2018, as compared to the same period during 2017. Rapid growth in the loan portfolio also resulted in an increase in average FHLB advances of $94,983.

For the six-month periods ended June 30, 2018 and 2017, the cost of average interest-bearing liabilities increased 55 basis points from 1.10% to 1.65%. The increase was due to increases in the cost of funds from interest-bearing deposits, FHLB advances, federal funds purchased and repurchase agreements.

 

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The tables below summarize average balances, annualized yields and rates, cost of funds, and the analysis of changes in interest income and interest expense for the three and six months ended June 30, 2018 and 2017:

Average Balances—Yields & Rates (7)

(Dollars are in thousands)

 

     Three Months Ended June 30,  
     2018     2017  
     Average
Balance
    Interest
Inc / Exp
     Average
Yield /
Rate
    Average
Balance
    Interest
Inc / Exp
     Average
Yield /
Rate
 

ASSETS:

              

Loans(1)(6)

   $ 2,462,120     $ 32,339        5.27   $ 2,006,536     $ 24,685        4.93

Securities available for sale(6)

     1,198,583       7,548        2.53     1,041,892       6,969        2.68

Securities held to maturity(6)

     211,535       1,970        3.74     224,628       2,374        4.24

Restricted equity securities

     20,619       329        6.40     16,360       213        5.22

Certificates of deposit at other financial institutions

     3,459       19        2.20     2,296       8        1.40

Federal funds sold and other(2)

     150,393       642        1.71     84,193       216        1.03
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 4,046,709     $ 42,847        4.25   $ 3,375,905     $ 34,465        4.09

Allowance for loan losses

     (21,994          (18,475     

All other assets

     144,738            98,237       
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 4,169,453          $ 3,455,667       

LIABILITIES & EQUITY

              

Deposits:

              

Interest checking

   $ 861,235     $ 3,329        1.55   $ 641,903     $ 1,239        0.77

Money market

     772,032       3,048        1.58     608,119       1,481        0.98

Savings

     47,807       38        0.32     56,182       43        0.31

Time deposits

     1,417,141       6,189        1.75     1,248,570       3,798        1.22

Federal Home Loan Bank advances

     330,758       1,414        1.71     240,846       752        1.25

Federal funds purchased and other(3)

     30,750       131        1.71     55,491       147        1.06

Subordinated notes and other borrowings

     58,576       1,082        7.41     58,397       1,082        7.43
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 3,518,299     $ 15,231        1.74   $ 2,909,508     $ 8,542        1.18

Demand deposits

     298,125            248,069       

Other liabilities

     12,854            12,431       

Total equity

     340,175            285,659       
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL LIABILITIES AND EQUITY

   $ 4,169,453          $ 3,455,667       

NET INTEREST SPREAD(4)

          2.51          2.91

NET INTEREST INCOME

     $ 27,616          $ 25,923     

NET INTEREST MARGIN(5)

          2.74          3.08

 

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     Six Months Ended June 30,  
     2018     2017  
     Average
Balance
    Interest
Inc / Exp
     Average
Yield /
Rate
    Average
Balance
    Interest
Inc / Exp
     Average
Yield /
Rate
 

ASSETS:

              

Loans(1)(6)

   $ 2,385,436     $ 61,144        5.17   $ 1,937,988     $ 47,268        4.92

Securities available for sale(6)

     1,137,124       14,231        2.52     1,016,924       13,553        2.69

Securities held to maturity(6)

     212,867       3,991        3.78     226,137       4,730        4.22

Restricted equity securities

     19,644       603        6.19     15,035       394        5.28

Certificates of deposit at other financial institutions

     3,138       31        1.99     2,059       15        1.47

Federal funds sold and other(2)

     199,918       1,584        1.60     82,596       372        0.91
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST EARNING ASSETS

   $ 3,957,827     $ 81,584        4.16   $ 3,280,739     $ 66,332        4.08

Allowance for loan losses

     (21,840          (17,822     

All other assets

     135,177            97,166       
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 4,071,164          $ 3,360,083       

LIABILITIES & EQUITY

              

Deposits:

              

Interest checking

   $ 889,625     $ 6,495        1.47   $ 671,777     $ 2,301        0.69

Money market

     757,698       5,648        1.50     610,832       2,709        0.89

Savings

     49,117       76        0.31     55,899       85        0.31

Time deposits

     1,344,752       11,028        1.65     1,164,766       6,712        1.16

Federal Home Loan Bank advances

     313,806       2,524        1.62     218,823       1,260        1.16

Federal funds purchased and other(3)

     31,283       227        1.46     49,999       217        0.88

Subordinated notes and other borrowings

     58,554       2,164        7.45     58,375       2,156        7.45
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL INTEREST BEARING LIABILITIES

   $ 3,444,835     $ 28,162        1.65   $ 2,830,471     $ 15,440        1.10

Demand deposits

     292,553            239,330       

Other liabilities

     13,657            11,060       

Total equity

     320,119            279,222       
  

 

 

        

 

 

      

TOTAL LIABILITIES AND EQUITY

   $ 4,071,164          $ 3,360,083       

NET INTEREST SPREAD(4)

          2.51          2.98

NET INTEREST INCOME

     $ 53,422          $ 50,892     

NET INTEREST MARGIN(5)

          2.72          3.13

 

(1) 

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

(2) 

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

(3) 

Includes repurchase agreements.

(4) 

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

(5) 

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

(6) 

Interest income and rates include the effects of tax-equivalent adjustments to adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis.

(7) 

Average balances are average daily balances.

 

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Analysis of Changes in Interest Income and Expenses

 

     Net change three months ended
June 30, 2018 versus June 30, 2017
 
     Volume      Rate      Net Change  

INTEREST INCOME

        

Loans

   $ 5,567      $ 2,087      $ 7,654  

Securities available for sale

     1,027        (448      579  

Securities held to maturity

     (140      (264      (404

Restricted equity securities

     55        61        116  

Certificates of deposit at other financial institutions

     4        7        11  

Federal funds sold and other

     171        255        426  
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST INCOME

   $ 6,684      $ 1,698      $ 8,382  
  

 

 

    

 

 

    

 

 

 

INTEREST EXPENSE

        

Deposits

        

Interest checking

   $ 415      $ 1,675      $ 2,090  

Money market accounts

     412        1,155        1,567  

Savings

     (6      1        (5

Time deposits

     518        1,873        2,391  

Federal Home Loan Bank advances

     283        379        662  

Fed funds purchased and other borrowed funds

     (66      50        (16

Subordinated Notes and other borrowings

     3        (3      —    
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST EXPENSE

   $ 1,559      $ 5,130        6,689  
  

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME

   $ 5,125      $ (3,432    $ 1,693  
  

 

 

    

 

 

    

 

 

 
     Net change six months ended
June 30, 2018 versus June 30, 2017
 
     Volume      Rate      Net Change  

INTEREST INCOME

        

Loans

   $ 10,919      $ 2,957      $ 13,876  

Securities available for sale

     1,637        (959      678  

Securities held to maturity

     (275      (464      (739

Restricted equity securities

     120        89        209  

Certificates of deposit at other financial institutions

     8        8        16  

Federal funds sold and other

     528        684        1,212  
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST INCOME

   $ 12,937      $ 2,315      $ 15,252  
  

 

 

    

 

 

    

 

 

 

INTEREST EXPENSE

        

Deposits

        

Interest checking

   $ 753      $ 3,441      $ 4,194  

Money market accounts

     645        2,294        2,939  

Savings

     (9      —          (9

Time deposits

     1,048        3,268        4,316  

Federal Home Loan Bank advances

     548        716        1,264  

Fed funds purchased and other borrowed funds

     (82      92        10  

Subordinated notes and other borrowings

     8        —          8  
  

 

 

    

 

 

    

 

 

 

TOTAL INTEREST EXPENSE

   $ 2,911      $ 9,811      $ 12,722  
  

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME

   $ 10,026      $ (7,496    $ 2,530  
  

 

 

    

 

 

    

 

 

 

 

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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 $570 and $573 for the three months ended June 30, 2018 and 2017, respectively, and $1,143 and $2,428 for the six months ended June 30, 2018 and 2017, respectively. The lower provision for the three and six months ended June 30, 2018 compared to the same periods in 2017 is based on the Company’s analysis of its allowance for loan losses which, based on the loan portfolio’s risk profile and comparatively less loan growth, required less provision be recorded. Nonperforming loans at June 30, 2018 totaled $3,437 compared to $3,042 at December 31, 2017, representing 0.1% of total loans for both of these periods.

Non-Interest Income

Non-interest income for the three and six months ended June 30, 2018 was $4,147 and $7,603, respectively, compared to $3,880 and $7,888 for the same periods in 2017, respectively. The following is a summary of the components of non-interest income (in thousands):

 

     Three Months Ended
June 30,
     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017  

Service charges on deposit accounts

   $ 51      $ 45      $ 6        13.3

Other service charges and fees

     823        758        65        8.6

Net gains on sale of loans

     1,941        2,067        (126      (6.1 %) 

Wealth management

     789        648        141        21.8

Loan servicing fees, net

     103        53        50        94.3

Gain on sales of investment securities, net

     1        120        (119      (99.2 %) 

Net gain on foreclosed assets

     3        3        —          —  

Other

     436        186        250        134.4
  

 

 

    

 

 

    

 

 

    

Total non-interest income

   $ 4,147      $ 3,880      $ 267        6.9
  

 

 

    

 

 

    

 

 

    
     Six Months Ended
June 30,
     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017  

Service charges on deposit accounts

   $ 93      $ 75      $ 18        24.0

Other service charges and fees

     1,574        1,510        64        4.2

Net gains on sale of loans

     3,380        4,401        (1,021      23.2

Wealth management

     1,493        1,241        252        20.3

Loan servicing fees, net

     222        160        62        38.8

Gain on sales of investment securities, net

     1        120        (119      (99.2 %) 

Net gain on foreclosed assets

     6        6        —          —  

Other

     834        375        459        122.4
  

 

 

    

 

 

    

 

 

    

Total non-interest income

   $ 7,603      $ 7,888      $ (285      3.6
  

 

 

    

 

 

    

 

 

    

Net gain on sale of loans decreased $126 and $1,021 for the three and six months ended June 30, 2018, respectively, when compared to the three and six months ended June 30, 2017. The decrease was due to the volume of mortgage loans originated, the sales related to those loans, and less favorable market rates in 2018, which resulted in less favorable fair value adjustments on mortgage derivatives.

Wealth management income for the three and six months ended June 30, 2018 increased $141 and $252, or 21.8% and 20.3%, respectively, in comparison with the same periods in 2017. The increase was attributed to the growth in the client base and assets under management in the wealth management division, as well as improvement in the stock markets. As a comparison, the Company had assets under management at June 30, 2018 and 2017 of $384,391 and $343,757, respectively.

Net gain on sale of investment securities decreased $119, or 99.2%, for both the three and six months ended June 30, 2018 when comparing with the same periods in 2017. The decreases were primarily due to the gains on securities that were recognized in the second quarter of 2017.

 

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Table of Contents

Other non-interest income increased by $250 and $459, or 134.4% and 122.4%, respectively, when comparing the three and six months ended June 30, 2018 with the same periods 2017. The increase for the three and six months ended June 30, 2018 is primarily attributed to the increase in bank-owned life insurance (“BOLI”) income of $241 and $452, respectively.

Non-Interest Expense

Non-interest expense for the three and six months ended June 30, 2018 was $18,050 and $33,538, respectively, compared to $15,283 and $29,559 for the same periods in 2017, respectively. The increases were the result of the following components listed in the table below (in thousands):

 

     Three Months Ended
June 30,
     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017  

Salaries and employee benefits

   $ 10,268      $ 9,128      $ 1,140        12.5

Occupancy and equipment

     2,885        2,195        690        31.4

FDIC assessment expense

     778        1,015        (237      (23.3 %) 

Marketing

     269        285        (16      (5.6 %) 

Professional fees

     1,362        702        660        94.0

Amortization of core deposit intangible

     182        121        61        50.4

Other

     2,306        1,837        469        25.5
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 18,050      $ 15,283      $ 2,767        18.1
  

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended
June 30,
     $
Increase
(Decrease)
     %
Increase
(Decrease)
 
     2018      2017  

Salaries and employee benefits

   $ 19,456      $ 17,161      $ 2,295        13.4

Occupancy and equipment

     5,479        4,290        1,189        27.7

FDIC assessment expense

     1,438        1,775        (337      (19.0 %) 

Marketing

     549        552        (3      (0.1 %) 

Professional fees

     2,231        1,737        494        28.4

Amortization of core deposit intangible

     286        248        38        15.3

Other

     4,099        3,796        303        8.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 33,538      $ 29,559      $ 3,979        13.5