Franklin Financial Network (FSB) 10-Q 2018 Q3 Quarterly report

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 September 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 every Interactive Data File required to be submitted 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 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	☐	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 October 31, 2018, was 14,525,973.

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
Cautionary Note Regarding Forward-Looking Statements	1
Item 1. Consolidated Financial Statements (unaudited)	2
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	30
Item  3. Quantitative and Qualitative Disclosures About Market Risk	49
Item 4. Controls and Procedures	49
PART II OTHER INFORMATION
Item 1. Legal Proceedings	50
Item 1A. Risk Factors	50
Item  2. Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3. Defaults Upon Senior Securities	50
Item 4. Mine Safety Disclosures	50
Item 5. Other Information	50
Item 6. Exhibits	50
SIGNATURES

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED BALANCE SHEETS

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

	September 30, 2018			December 31, 2017
	(Unaudited)
ASSETS
Cash and due from financial institutions	$	144,660		$	251,543
Certificates of deposit at other financial institutions		3,104			2,855
Securities available for sale		1,115,187			999,881
Securities held to maturity (fair value 2018—$199,927 and 2017—$217,608)		204,587			214,856
Loans held for sale, at fair value		14,563			12,024
Loans		2,550,121			2,256,608
Allowance for loan losses		(22,479	)		(21,247	)
Net loans		2,527,642			2,235,361
Restricted equity securities, at cost		21,793			18,492
Premises and equipment, net		11,852			11,281
Accrued interest receivable		14,391			11,947
Bank owned life insurance		54,859			49,085
Deferred tax asset		17,366			10,007
Foreclosed assets		1,853			1,503
Servicing rights, net		3,465			3,620
Goodwill		18,176			9,124
Core deposit intangible, net		1,109			1,007
Other assets		13,206			10,940
Total assets	$	4,167,813		$	3,843,526
LIABILITIES AND EQUITY
Deposits
Non-interest bearing	$	321,108		$	272,172
Interest bearing		3,050,442			2,895,056
Total deposits		3,371,550			3,167,228
Federal Home Loan Bank advances		371,500			272,000
Federal funds purchased and repurchase agreements		—			31,004
Subordinated notes, net		58,649			58,515
Accrued interest payable		4,726			2,769
Other liabilities		5,211			7,357
Total liabilities		3,811,636			3,538,873
Equity
Preferred stock, no par value: 1,000,000 shares authorized; no shares    outstanding at September 30, 2018 and December 31, 2017		—			—
Common stock, no par value: 30,000,000 and 30,000,000 shares authorized    at September 30, 2018 and December 31, 2017 , respectively; 14,525,351 and    13,237,128 issued at September 30, 2018 and December 31, 2017 , respectively		261,623			222,665
Retained earnings		119,433			88,671
Accumulated other comprehensive loss		(24,982	)		(6,786	)
Total shareholders’ equity		356,074			304,550
Non-controlling interest in consolidated subsidiary		103			103
Total equity		356,177			304,653
Total liabilities and equity	$	4,167,813		$	3,843,526

See accompanying notes to consolidated financial statements.

2

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF INCOME

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

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Interest income and dividends
Loans, including fees	$	34,435		$	25,973		$	95,541		$	73,195
Securities:
Taxable		6,460			5,041			19,476			16,358
Tax-Exempt		1,926			2,217			5,770			6,449
Dividends on restricted equity securities		313			269			916			663
Federal funds sold and other		583			280			2,197			667
Total interest income		43,717			33,780			123,900			97,332
Interest expense
Deposits		14,137			7,311			37,385			19,118
Federal funds purchased and repurchase agreements		69			92			296			309
Federal Home Loan Bank advances		1,867			968			4,390			2,228
Subordinated notes and other borrowings		1,082			1,083			3,246			3,239
Total interest expense		17,155			9,454			45,317			24,894
Net interest income		26,562			24,326			78,583			72,438
Provision for loan losses		136			590			1,279			3,018
Net interest income after provision for loan losses		26,426			23,736			77,304			69,420
Noninterest income
Service charges on deposit accounts		58			39			151			114
Other service charges and fees		747			787			2,321			2,297
Net gains on sale of loans		1,379			1,517			4,759			5,918
Wealth management		705			643			2,198			1,884
Loan servicing fees, net		111			70			333			230
Gain (loss) on sale or call of securities		(1	)		350			—			470
Net gain on sale of foreclosed assets		3			(16	)		9			(10	)
Other		440			179			1,274			554
Total noninterest income		3,442			3,569			11,045			11,457
Noninterest expense
Salaries and employee benefits		10,723			9,011			30,179			26,172
Occupancy and equipment		2,933			2,399			8,412			6,689
FDIC assessment expense		1,020			900			2,458			2,675
Marketing		306			192			855			744
Professional fees		1,023			821			3,254			2,558
Amortization of core deposit intangible		169			115			455			363
Other		2,077			1,840			6,176			5,636
Total noninterest expense		18,251			15,278			51,789			44,837
Income before income tax expense		11,617			12,027			36,560			36,040
Income tax expense		1,068			3,138			5,790			10,343
Net income		10,549			8,889			30,770			25,697
Earnings attributable to noncontrolling interest		—			—			(8	)		(8	)
Net income available to common shareholders	$	10,549		$	8,889		$	30,762		$	25,689
Earnings per share:
Basic	$	0.73		$	0.67		$	2.19		$	1.96
Diluted		0.70			0.65			2.10			1.86

See accompanying notes to consolidated financial statements.

3

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

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

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	10,549		$	8,889		$	30,770		$	25,697
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gain (loss) arising during the period		(6,279	)		1,610			(24,625	)		7,641
Reclassification adjustment for gains included in net    income		1			(350	)		—			(470	)
Net unrealized gains (losses)		(6,278	)		1,260			(24,625	)		7,171
Tax effect		1,639			(494	)		6,429			(2,812	)
Total other comprehensive income (loss)		(4,639	)		766			(18,196	)		4,359
Comprehensive income	$	5,910		$	9,655		$	12,574		$	30,056

See accompanying notes to consolidated financial statements.

4

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine Months Ended September 30, 2018 and September 30, 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		—		138,007			1,361			—			—			—		1,361
Exercise of common stock warrants		—		12,461			150			—			—			—		150
Stock based compensation expense, net of restricted    share forfeitures		—		26,718			1,970			—			—			—		1,970
Stock issued in conjunction with 401(k) employer    match, net of distributions		—		(5,085	)		(193	)		—			—			—		(193	)
Noncontrolling interest distributions		—		—			—			(8	)		—			—		(8	)
Net income		—		—			—			25,697			—			—		25,697
Other comprehensive income		—		—			—			—			4,359			—		4,359
Balance at September 30, 2017	$	—		13,209,055		$	221,642		$	85,075		$	(3,123	)	$	103	$	303,697
Balance at December 31, 2017	$	—		13,237,128		$	222,665		$	88,671		$	(6,786	)	$	103	$	304,653
Exercise of common stock options		—		207,472			2,845			—			—			—		2,845
Stock based compensation expense, net    of forfeitures		—		—			3,454			—			—			—		3,454
Stock issued in conjunction with 401(k) employer    match, net of distributions		—		(7,271	)		(273	)		—			—			—		(273	)
Issuance of restricted stock, net of forfeitures		—		117,632			—			—			—			—		-
Stock issued for acquisition (net of issuance costs)		—		970,390			32,932			—			—			—		32,932
Noncontrolling interest distributions		—		—			—			(8	)		—			—		(8	)
Net income		—		—			—			30,770			—			—		30,770
Other comprehensive loss		—		—			—			—	��		(18,196	)		—		(18,196	)
Balance at September 30, 2018	$	—		14,525,351		$	261,623		$	119,433		$	(24,982	)	$	103	$	356,177

See accompanying notes to consolidated financial statements.

5

FRANKLIN FINANCIAL NETWORK, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

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

(Unaudited)

	Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities
Net income	$	30,770		$	25,697
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization on premises and equipment		1,279			1,118
Accretion of purchase accounting adjustments		(1,122	)		(873	)
Net amortization of securities		6,323			7,654
Amortization of loan servicing right asset		643			721
Amortization of core deposit intangible		455			363
Amortization of debt issuance costs		134			133
Provision for loan losses		1,279			3,018
Deferred income tax benefit		(853	)		(1,394	)
Origination of loans held for sale		(267,862	)		(270,876	)
Proceeds from sale of loans held for sale		269,594			290,669
Net gain on sale of loans		(4,759	)		(5,918	)
Gain on sale of available for sale securities		—			(470	)
Income from bank owned life insurance		(1,155	)		(465	)
Net loss on foreclosed assets		—			10
Stock-based compensation		3,454			1,970
Deferred gain on sale of loans		(11	)		(58	)
Deferred gain on sale of foreclosed assets		(9	)		-
Net change in:
Accrued interest receivable and other assets		(4,002	)		(5,949	)
Accrued interest payable and other liabilities		(1,984	)		1,120
Net cash from operating activities		32,174			46,470
Cash flows from investing activities
Securities available for sale :
Sales		—			122,837
Purchases		(235,319	)		(455,700	)
Maturities, prepayments and calls		122,172			108,339
Securities held to maturity :
Purchases		(1,676	)		(1,996	)
Maturities, prepayments and calls		10,571			12,110
Net change in loans		(196,053	)		(346,595	)
Purchase of restricted equity securities		(2,425	)		(6,629	)
Purchases of premises and equipment, net		(1,597	)		(2,784	)
Proceeds from sale of foreclosed assets		—			1,330
Capitalization of foreclosed assets		—			(35	)
Decrease (Increase) in certificates of deposits at other financial institutions		251			(1,310	)
Purchase of bank owned life insurance		(119	)		—
Net cash acquired from acquisition (See Note 2)		24,660			—
Net cash from investing activities		(279,535	)		(570,433	)
Cash flows from financing activities
Increase in deposits		81,160			433,007
Decrease in federal funds purchased and repurchase agreements		(31,004	)		(50,439	)
Proceeds from Federal Home Loan Bank advances		270,000			370,000
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		2,845			1,361
Divestment of common stock issued to 401(k) plan		(273	)		(193	)
Noncontrolling interest distributions		(8	)		(8	)
Net cash from financing activities		140,478			588,878
Net change in cash and cash equivalents		(106,883	)		64,915
Cash and cash equivalents at beginning of period		251,543			90,927
Cash and cash equivalents at end of period	$	144,660		$	155,842
Supplemental information:
Interest paid	$	44,159		$	24,221
Income taxes paid		6,632			12,380
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			2,818
Transfers from loans to loans held for sale		—			2,685

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

See accompanying notes to consolidated financial statements.

6

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.

7

Recent Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases” which requires recognition in the statement of financial position of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The guidance requires that a lessee should recognize lease assets and lease liabilities as compared to previous GAAP that did not require lease assets and lease liabilities to be recognized for operating leases. The guidance becomes effective for the Company on January 1, 2019.  Had this standard been effective as of September 30, 2018, we would have recorded a right of use asset and lease liability of approximately $56.9 million. In July 2018, the FASB issued Accounting Standards Update 2018-10, “Codification Improvements to Topic 842, Leases” which provides technical corrections and improvements to ASU 2016-02. It is not anticipated that this update will have an impact on our adoption of ASU 2016-02. Also in July 2018, the FASB issued Accounting Standards Update 2018-11, “Leases (Topic 842): Targeted Improvements” which provides an optional transition method to adopt the new requirements of ASU 2016-02 as of the adoption date with no adjustment to the presentation or disclosure of comparative prior periods included in the financial statements in the period of adoption. Franklin Synergy intends to elect the optional transition method which will result in presentation of periods prior to adoption under the prior lease guidance of ASC Topic 840.

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 and has formed a committee to formulate the methodology to be used. Most importantly, the Company is evaluating the outcome of scenarios to determine which calculations will produce results that are indicative of the risk within the portfolio. Management is assessing the potential impact of adopting ASU 2016-13.

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 approach to adopting this new standard, but does not expect the potential impact on the Company’s consolidated financial statements to be material.

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”. The purpose of this Update is to better align a company‘s financial reporting for hedging activities with the economic objectives of those activities.  This Update is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period permitted. The Update requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption.  While the Company continues to assess all potential impacts of the standard, the Company currently expects the adoption to have an immaterial impact on our consolidated financial statements.  

8

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 since April 1, 2018. Acquisition-related costs of $0 and $565, respectively, are included in other noninterest expense in the Company’s income statement for the three and nine months ended September 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.

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		5,285
Total assets acquired		160,601
Deposits		123,162
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, respectively, on the date of acquisition.

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.

9

	Nine Months Ended September 30,
	2018		2017
Net interest income – pro forma (unaudited)	$	79,860	$	77,004
Net income – pro forma (unaudited)	$	30,834	$	26,926
Earnings per share – pro forma (unaudited):
Basic	$	2.05	$	1.91
Diluted	$	1.98	$	1.82

NOTE 3—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available for sale portfolio at September 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
September 30, 2018
U.S. Treasury securities	$	254,750	$	—	$	(215	)	$	254,535
U.S. government sponsored entities and agencies		25,984		1		(249	)		25,736
Mortgage-backed securities: residential		735,120		2		(27,971	)		707,151
Mortgage-backed securities: commercial		5,104		—		(143	)		4,961
Asset-backed securities		8,458		—		(28	)		8,430
State and political subdivisions		119,585		90		(5,301	)		114,374
Total	$	1,149,001	$	93	$	(33,907	)	$	1,115,187

	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

The amortized cost and fair value of the securities held to maturity portfolio at September 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
September 30, 2018
Mortgage backed securities: residential	$	84,377	$	29	$	(4,393	)	$	80,013
State and political subdivisions		120,210		366		(662	)		119,914
Total	$	204,587	$	395	$	(5,055	)	$	199,927
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

10

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018		2017
Proceeds	$	—		$	61,647		$	—	$	122,837
Gross gains		—			414			—		659
Gross losses		(1	)		(64	)		—		(189	)

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

	September 30, 2018
	Amortized Cost		Fair Value
Available for sale
One year or less	$	275,319	$	274,944
Over one year through five years		2,221		2,201
Over five years through ten years		2,758		2,732
Over ten years		128,479		123,198
Mortgage-backed securities: residential		735,120		707,151
Mortgage-backed securities: commercial		5,104		4,961
Total	$	1,149,001	$	1,115,187
Held to maturity
One year or less	$	500	$	505
Over one year through five years		1,106		1,109
Over five years through ten years		13,662		13,678
Over ten years		104,942		104,622
Mortgage-backed securities: residential		84,377		80,013
Total	$	204,587	$	199,927

Securities pledged at September 30, 2018 and December 31, 2017 had a carrying amount of $967,505 and $975,518, respectively, and were pledged to secure public deposits and repurchase agreements.

At September 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.

The following table summarizes the securities with unrealized and unrecognized losses at September 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
September 30, 2018
Available for sale
U.S. Treasury securities	$	254,535	$	(215	)	$	—	$	—		$	254,535	$	(215	)
U.S. government sponsored entities and agencies		5,186		(90	)		19,899		(159	)		25,085		(249	)
Mortgage-backed securities: residential		235,919		(5,666	)		470,855		(22,305	)		706,774		(27,971	)
Mortgage-backed securities: commercial		—		—			4,961		(143	)		4,961		(143	)
Asset-backed securities		4,923		(28	)		—		—			4,923		(28	)
State and political subdivisions		44,606		(609	)		59,664		(4,692	)		104,270		(5,301	)
Total available for sale	$	545,169	$	(6,608	)	$	555,379	$	(27,299	)	$	1,100,548	$	(33,907	)

11

	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	$	12,039	$	(416	)	$	63,970	$	(3,977	)	$	76,009	$	(4,393	)
State and political subdivisions		58,496		(596	)		1,377		(66	)		59,873		(662	)
Total held to maturity	$	70,535	$	(1,012	)	$	65,347	$	(4,043	)	$	135,882	$	(5,055	)

	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.

NOTE 4—LOANS

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

	September 30, 2018			December 31, 2017
Loans that are not PCI loans
Construction and land development	$	587,736		$	494,818
Commercial real estate:
Nonfarm, nonresidential		731,987			628,554
Other		46,002			49,684
Residential real estate:
Closed-end 1-4 family		477,050			407,695
Other		181,622			169,640
Commercial and industrial		520,727			502,006
Consumer and other		5,539			3,781
Loans before net deferred loan fees		2,550,663			2,256,178
Deferred loan fees, net		(2,565	)		(1,963	)
Total loans that are not PCI loans		2,548,098			2,254,215
Total PCI loans		2,023			2,393
Allowance for loan losses		(22,479	)		(21,247	)
Total loans, net of allowance for loan losses	$	2,527,642		$	2,235,361

12

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

	Construction and Land Development			Commercial Real Estate			Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Three Months Ended September 30, 2018
Allowance for loan losses:
Beginning balance	$	4,613		$	6,163		$	4,533		$	6,976		$	56		$	22,341
Provision for loan losses		172			(18	)		(30	)		13			(1	)		136
Loans charged-off		—			—			—			—			(5	)		(5	)
Recoveries		—			—			5			—			2			7
Total ending allowance balance	$	4,785		$	6,145		$	4,508		$	6,989		$	52		$	22,479
Three Months Ended September 30, 2017
Allowance for loan losses:
Beginning balance	$	3,796		$	5,011		$	2,939		$	6,894		$	49		$	18,689
Provision for loan losses		(507	)		212			169			707			9			590
Loans charged-off		—			—			-			(9	)		(11	)		(20	)
Recoveries		668			—			14			—			3			685
Total ending allowance balance	$	3,957		$	5,223		$	3,122		$	7,592		$	50		$	19,944

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2018 and 2017:

	Construction and Land Development			Commercial Real Estate		Residential Real Estate			Commercial and Industrial			Consumer and Other			Total
Nine Months Ended September 30, 2018
Allowance for loan losses:
Beginning balance	$	3,802		$	5,981	$	3,834		$	7,587		$	43		$	21,247
Provision for loan losses		1,021			164		638			(559	)		15		$	1,279
Loans charged-off		(39	)		—		(7	)		(49	)		(22	)	$	(117	)
Recoveries		1			—		43			10			16		$	70
Total ending allowance balance	$	4,785		$	6,145	$	4,508		$	6,989		$	52		$	22,479
Nine Months Ended September 30, 2017
Allowance for loan losses:
Beginning balance	$	3,776		$	4,266	$	2,398		$	6,068		$	45		$	16,553
Provision for loan losses		(487	)		957		687			1,833			28		$	3,018
Loans charged-off		—			—		(1	)		(309	)		(36	)	$	(346	)
Recoveries		668			—		38			—			13		$	719
Total ending allowance balance	$	3,957		$	5,223	$	3,122		$	7,592		$	50		$	19,944

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

13

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2018 and December 31, 2017. For purposes of this disclosure, recorded investment in loans excludes accrued interest receivable and net deferred loan fees due to immateriality.

	Construction and Land Development		Commercial Real Estate		Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
September 30, 2018
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	23	$	—	$	23
Collectively evaluated for impairment		4,785		6,145		4,508		6,966		52		22,456
Purchased credit-impaired loans		—		—		—		—		—		—
Total ending allowance balance	$	4,785	$	6,145	$	4,508	$	6,989	$	52	$	22,479
Loans:
Individually evaluated for impairment	$	548	$	—	$	2,490	$	266	$	—	$	3,304
Collectively evaluated for impairment		587,188		777,989		656,182		520,461		5,539		2,547,359
Purchased credit-impaired loans		—		—		83		1,940		—		2,023
Total ending loans balance	$	587,736	$	777,989	$	658,755	$	522,667	$	5,539	$	2,552,686
December 31, 2017
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	—	$	—	$	879	$	—	$	879
Collectively evaluated for impairment		3,802		5,981		3,834		6,708		43		20,368
Purchased credit-impaired loans		—		—		—		—		—		—
Total ending allowance balance	$	3,802	$	5,981	$	3,834	$	7,587	$	43	$	21,247
Loans:
Individually evaluated for impairment	$	217	$	—	$	834	$	3,090	$	—	$	4,141
Collectively evaluated for impairment		494,601		678,238		576,501		498,916		3,781		2,252,037
Purchased credit-impaired loans		—		380		105		1,908		—		2,393
Total ending loans balance	$	494,818	$	678,618	$	577,440	$	503,914	$	3,781	$	2,258,571

Loans collectively evaluated for impairment reported at September 30, 2018 include certain acquired loans. At September 30, 2018, these non-PCI loans had a carrying value of $111,022, comprised of contractually unpaid principal totaling $112,384 and discounts totaling $1,362. Management evaluated these loans for credit deterioration since acquisition and determined that an allowance for loan losses of $269 was necessary at September 30, 2018.

14

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

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
September 30, 2018
With no allowance recorded:
Construction and land development	$	548	$	548		—
Residential real estate:
Closed-end 1-4 family		1,357		1,356		—
Other		1,150		1,134		—
Commercial and industrial		92		92		—
Subtotal		3,147		3,130		—
With an allowance recorded:
Commercial and industrial		174		174		23
Subtotal		174		174		23
Total	$	3,321	$	3,304	$	23
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 nine months ended September 30, 2018 and 2017:

	Three Months Ended September 30,				Nine Months Ended September 30,
Average Recorded Investment	2018		2017		2018		2017
With no allowance recorded:
Construction and land development	$	548	$	1,348	$	649	$	1,199
Commercial real estate:
Nonfarm, nonresidential		—		812		—		2,394
Residential real estate:
Closed-end 1-4 family		1,465		112		1,991		863
Other		1,025		199		1,025		245
Commercial and industrial		2,466		499		1,099		657
Consumer and other		—		-		—		1
Subtotal		5,504		2,970		4,764		5,359
With an allowance recorded:
Commercial and industrial	$	177	$	2,998	$	2,017	$	2,820
Subtotal		177		2,998		2,017		2,820
Total	$	5,681	$	5,968	$	6,781	$	8,179

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

15

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 September 30, 2018 and December 31, 2017:

	Nonaccrual		Loans Past Due Over 90 Days
September 30, 2018
Construction and land    development	$	548	$	274
Residential real estate:
Closed-end 1-4 family		1,683		—
Other		1,084		50
Commercial and industrial		92		241
Total	$	3,407	$	565
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.

16

The following table presents the aging of the recorded investment in past due loans as of September 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
September 30, 2018
Construction and land    development	$	—	$	—	$	274	$	548	$	822	$	586,914	$	—	$	587,736
Commercial real estate:
Nonfarm,    nonresidential		847		—		—		—		847		731,140		—		731,987
Other		—		—		—		—		—		46,002		—		46,002
Residential real estate:
Closed-end 1-4 family		37		154		—		1,683		1,874		475,176		83		477,133
Other		65		820		50		1,084		2,019		179,603		—		181,622
Commercial and industrial		233		73		241		92		639		520,088		1,940		522,667
Consumer and other		—		—		—		—		—		5,539		—		5,539
	$	1,182	$	1,047	$	565	$	3,407	$	6,201	$	2,544,462	$	2,023	$	2,552,686
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

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.

17

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

	Pass		Special Mention		Substandard		Total
September 30, 2018
Construction and land development	$	583,091	$	3,508	$	1,137	$	587,736
Commercial real estate:
Nonfarm, nonresidential		716,869		15,118		—		731,987
Other		45,615		—		387		46,002
Residential real estate:
Closed-end 1-4 family		471,522		2,853		2,758		477,133
Other		179,073		404		2,145		181,622
Commercial and industrial		502,762		9,328		10,577		522,667
Consumer and other		5,537		2		—		5,539
	$	2,504,469	$	31,213	$	17,004	$	2,552,686

	Pass		Special Mention		Substandard		Total
December 31, 2017
Construction and land development	$	494,601	$	—	$	217	$	494,818
Commercial real estate:
Nonfarm, nonresidential		609,458		12,602		6,874		628,934
Other		49,303		—		381		49,684
Residential real estate:
1-4 family		404,832		615		2,353		407,800
Other		167,886		—		1,754		169,640
Commercial and industrial		485,363		10,350		8,201		503,914
Consumer and other		3,777		4		—		3,781
	$	2,215,220	$	23,571	$	19,780	$	2,258,571

Troubled Debt Restructurings

As of September 30, 2018 the Company’s loan portfolio contains two loans that have been modified in a troubled debt restructuring with a balance of $883.  The troubled debt restructurings described above increased the allowance for loan loss by $23 with $0 being charged-off as of September 30, 2018. There were also no first payment defaults on the loans modified as a troubled debt restructuring during the three and nine months ended September 30, 2018. As of December 31, 2017, the Company’s loan portfolio contained one loan that had been modified in a troubled debt restructuring with a balance of $608. During the three months ended September 30, 2018 two loans were added as a troubled debt restructuring with a balance of $883, and the loan that was a troubled debt restructuring at December 31, 2017 was paid off with $0 of the loan balance being charged off.

NOTE 5—LOAN SERVICING

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

	September 30, 2018		December 31, 2017
Loan portfolios serviced for:
Federal Home Loan Mortgage Corporation	$	496,037	$	507,233
Other		3,831		4,626

18

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Loan servicing fees, net:
Loan servicing fees	$	314		$	312		$	976		$	951
Amortization of loan servicing fees		(203	)		(242	)		(643	)		(721	)
Change in impairment		—			—			—			—
Total	$	111		$	70		$	333		$	230

The fair value of servicing rights was estimated by management to be approximately $5,348 at September 30, 2018. Fair value for September 30, 2018 was determined using a weighted average discount rate of 10.0% and a weighted average prepayment speed of 9.7%. 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 September 30, 2018 and December 31, 2017, these short-term borrowings totaled $0 and $31,004, respectively, and were secured by securities with carrying amounts of $0 and $41,136, respectively.

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 nine months ended September 30, 2018 and 2017, respectively.

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

	September 30, 2018		September 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 September 30, 2018, 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 $1,376 and $735 and $3,454 and $1,970 for the three and nine months ended September 30, 2018 and

19

2017, respectively. The total income tax benefit, which is shown on the Consolidated Statements of Income as a reduction of income tax expense, was $285 and $568 for the three and nine months ended September 30, 2018, respectively. The total income tax benefit for the three and nine months ended September 30, 2017 was $261 and $711, respectively.

Stock Options: The Company’s 2007 Omnibus Equity Incentive Plan (the “2007 Plan”), as amended and shareholder-approved, provided for authorized shares up to 4,000,000. The 2007 Plan provided that no options intended to be ISOs may be granted after April 9, 2017. As a result, the Company’s board of directors approved, and recommended to its shareholders for approval, an equity incentive plan, the 2017 Omnibus Equity Incentive Plan (the “2017 Plan”). The Company’s shareholders approved the 2017 Plan at the 2017 annual meeting of shareholders. The terms of the 2017 Plan are substantially similar to the terms of the 2007 Plan it was intended to replace. The 2017 Plan provides for authorized shares up to 3,500,000. At September 30, 2018, there were 2,765,423 authorized shares available for issuance under the 2017 Plan.

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

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

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

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

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

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

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

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

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

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

	September 30, 2018			September 30, 2017
Risk-free interest rate		2.83	%		2.16	%
Expected term	7.5 years			6.8 years
Expected stock price volatility		31.42	%		32.32	%
Dividend yield		0.00	%		0.03	%

The weighted average fair value of options granted for the nine months ended September 30, 2018 and 2017 were $11.31 and $14.51, respectively.

20

A summary of the activity in the plans for the nine months ended September 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		542,637			30.14
Exercised		(235,381	)		16.61
Forfeited, expired, or cancelled		(19,053	)		29.96
Outstanding at period end		1,795,371			24.47		6.55	$	26,265
Vested or expected to vest		1,705,602			24.47		6.55	$	24,952
Exercisable at period end		975,485			18.42		5.43	$	20,152

	For the Nine Months Ended September 30,
	2018		2017
Stock options exercised:
Intrinsic value of options exercised	$	4,828	$	4,141
Cash received from options exercised		2,845		1,361
Tax benefit realized from option exercises		568		406

As of September 30, 2018, there was $6,276 of total unrecognized compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted-average period of 1.2 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 typically have a vesting period of three to five years and vest in equal annual installments on the anniversary date of the grant.

A summary of activity for non-vested restricted share awards for the nine months ended September 30, 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		121,288			31.00
Vested		(40,114	)		26.67
Forfeited		(3,656	)		31.77
Non-vested at September 30, 2018		171,699		$	31.00

Compensation expense associated with the restricted share awards is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of September 30, 2018, there was $4,434 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 1.8 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

21

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 September 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 September 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 September 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
September 30, 2018
Company common equity Tier 1 capital to    risk-weighted assets	$	359,881		12.24	%	$	132,313		4.50	%	N/A		N/A
Company Total Capital to risk weighted assets	$	441,103		15.00	%	$	235,223		8.00	%	N/A		N/A
Company Tier 1 (Core) Capital to risk weighted    assets	$	359,881		12.24	%	$	176,417		6.00	%	N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	359,881		8.71	%	$	165,295		4.00	%	N/A		N/A
Bank common equity Tier 1 capital to    risk-weighted assets	$	413,850		14.08	%	$	132,305		4.50	%	$	185,843		6.50	%
Bank Total Capital to risk weighted assets	$	436,423		14.84	%	$	235,208		8.00	%	$	285,913		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	413,850		14.08	%	$	176,406		6.00	%	$	228,730		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	413,850		10.02	%	$	165,185		4.00	%	$	208,269		5.00	%
December 31, 2017
Company common equity Tier 1 capital to    risk-weighted assets	$	299,229		11.37	%	$	118,479		4.50	%	N/A		N/A
Company Total Capital to risk weighted assets	$	379,083		14.40	%	$	210,629		8.00	%	N/A		N/A
Company Tier 1 (Core) Capital to risk weighted    assets	$	299,229		11.37	%	$	157,972		6.00	%	N/A		N/A
Company Tier 1 (Core) Capital to average assets	$	299,229		8.25	%	$	145,100		4.00	%	N/A		N/A
Bank common equity Tier 1 capital to    risk-weighted assets	$	353,512		13.43	%	$	118,489		4.50	%	$	171,151		6.50	%
Bank Total Capital to risk weighted assets	$	374,851		14.24	%	$	210,647		8.00	%	$	263,309		10.00	%
Bank Tier 1 (Core) Capital to risk weighted assets	$	353,512		13.43	%	$	157,985		6.00	%	$	210,647		8.00	%
Bank Tier 1 (Core) Capital to average assets	$	353,512		9.75	%	$	145,003		4.00	%	$	181,253		5.00	%

Note: Minimum ratios presented exclude the capital conservation buffer

Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net

22

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.

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

23

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).

24

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

	Fair Value Measurements at September 30, 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	$	—	$	254,535	$	—
U.S. government sponsored entities and agencies		—		25,736		—
Mortgage-backed securities-residential		—		707,151		—
Mortgage-backed securities-commercial		—		4,961		—
Asset-backed securities		—		8,430		—
State and political subdivisions		—		114,374		—
Total securities available for sale	$	—	$	1,115,187	$	—
Loans held for sale	$	—	$	14,563	$	—
Mortgage banking derivatives	$	—	$	200	$	—
Financial Liabilities
Mortgage banking derivatives	$	—	$	—	$	—

	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 September 30, 2018, the unpaid principal balance of loans held for sale was $14,185 resulting in an unrealized gain of $378 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 September 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 ($160) and ($48), respectively. For the nine months ended September 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 $34 and $57, respectively. None of these loans were 90 days or more past due or on nonaccrual as of September 30, 2018 and December 31, 2017.

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

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

25

There was one collateral-dependent impaired loans carried at fair value of $150 as of September 30, 2018 and one collateral-dependent impaired loan carried at fair value of $1,650 as of December 31, 2017. For the three and nine months ended September 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 nine months ended September 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 September 30, 2018 and $1,503 as of December 31, 2017. There were no properties at September 30, 2018 or 2017 that had required write-downs to fair value.

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

			Fair Value Measurements at September 30, 2018 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	144,660	$	144,660	$	—	$	—	$	144,660
Certificates of deposit held at other financial    institutions		3,104		—		3,104		—		3,104
Securities available for sale		1,115,187		—		1,115,187		—		1,115,187
Securities held to maturity		204,587		—		199,927		—		199,927
Loans held for sale		14,563		—		14,563		—		14,563
Net loans		2,527,642		—		—		2,489,418		2,489,418
Restricted equity securities		21,793	n/a		n/a		n/a		n/a
Servicing rights, net		3,465		—		—		5,348		5,348
Mortgage banking derivative assets		200		—		200		—		200
Accrued interest receivable		14,391		34		6,501		7,856		14,391
Financial liabilities
Deposits	$	3,371,550	$	1,850,538	$	1,511,884	$	—	$	3,362,422
Federal Home Loan Bank advances		371,500		—		369,239		—		369,239
Subordinated notes, net		58,649		—		—		60,732		60,732
Accrued interest payable		4,726		115		350		4,260		4,725

			Fair Value Measurements at December 31, 2017 Using:
	Carrying Amount		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

26

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.

27

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 September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Basic
Net income available to common shareholders	$	10,549		$	8,889		$	30,762		$	25,689
Less: earnings allocated to participating securities		(126	)		(66	)		(318	)		(206	)
Net income allocated to common shareholders	$	10,423		$	8,823		$	30,444		$	25,483
Weighted average common shares outstanding    including participating securities		14,497,840			13,188,761			14,048,270			13,119,170
Less: Participating securities		(173,541	)		(97,842	)		(145,432	)		(105,350	)
Average shares		14,324,299			13,090,919			13,902,838			13,013,820
Basic earnings per common share	$	0.73		$	0.67		$	2.19		$	1.96

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Diluted
Net income allocated to common shareholders	$	10,423	$	8,823	$	30,444	$	25,483
Weighted average common shares outstanding for    basic earnings per common share		14,324,299		13,090,919		13,902,838		13,013,820
Add: Dilutive effects of assumed exercises of stock    options		579,452		584,778		564,688		662,890
Add: Dilutive effects of assumed exercises of stock    warrants		—		-		—		2,104
Average shares and dilutive potential common shares		14,903,751		13,675,697		14,467,526		13,678,814
Dilutive earnings per common share	$	0.70	$	0.65	$	2.10	$	1.86

For three months ended September 30, 2018 and 2017, stock options for 397,974 and 352,042 shares of common stock, respectively, were not considered in computing diluted earnings per common share because they were antidilutive. Stock options for 489,515 and 254,204 shares of common stock, respectively, were not considered in computing diluted earnings per common share for the nine months ended September 30, 2018 and 2017 because they were antidilutive.

NOTE 11—SUBORDINATED DEBT ISSUANCE

The Company’s subordinated notes, net of issuance costs, totaled $58,649 and $58,515 at September 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 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.

28

The issuance costs related to the March 2016 Subordinated Notes amounted to $1,382 and are being amortized as interest expense over the ten-year term of the March 2016 Subordinated Notes. The issuance costs related to the June 2016 Subordinated Notes were $404 and are being amortized as interest expense over the ten-year term of the June 2016 Subordinated Notes. For the three months ended September 30, 2018 and 2017, amortization of issuance costs has amounted to $45 and $45, respectively. For the nine months ended September 30, 2018 and 2017, amortization of issuance costs has amounted to $134 and $133, respectively.

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

	March 2016 Subordinated Notes	June 2016 Subordinated Notes
Principal amount issued	$40,000	$20,000
Maturity date	March 30, 2026	July 1, 2026
Initial fixed interest rate	6.875%	7.00%
Initial interest rate period	5 years	5 years
First interest rate change date	March 30, 2021	July 1, 2021
Interest payment frequency through year five*	Semiannually	Semiannually
Interest payment frequency after five years*	Quarterly	Quarterly
Interest repricing index and margin	3-month LIBOR plus 5.636%	3-month LIBOR plus 6.04%
Repricing frequency after five years	Quarterly	Quarterly

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

29

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 since April 1, 2018. 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 and Lease 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.

30

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

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

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

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

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank’s loss history and loss history from the Bank’s peer group over the past three years. This actual loss experience is supplemented with other qualitative 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 NINE MONTHS ENDED SEPTEMBER 30, 2018 and 2017

(Dollar Amounts in Thousands)

Overview

The Company reported net income of $10,549 and $30,770 for the three and nine months ended September 30, 2018, respectively, compared to $8,889 and $25,697 for the three and nine months ended September 30, 2017, respectively. After earnings attributable to noncontrolling interest, the Company’s net earnings available to common shareholders for the three and nine months ended September 30, 2018 was $10,549 and $30,762, respectively, compared to $8,889 and $25,689 for the three and nine months ended September 30, 2017, respectively. The increase in net earnings available to common shareholders for the three and nine months ended September 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 and to state tax credits resulting from the extension of a significant Community Reinvestment Act (CRA)-qualified loan.

Net Interest Income/Margin

Net interest income consists of interest income generated by earning-assets less interest expense paid on interest-bearing liabilities and is the most significant component of our revenues. Net interest income for the three and nine months ended September 30, 2018, totaled $26,562 and $78,583, respectively, compared to $24,326 and $72,438 for the same periods in 2017, an increase of $2,236 and $6,145, or 9.2% and 8.5%, between the respective periods. For the three and nine months ended September 30, 2018, interest income increased $9,937 and $26,568, or 29.4% and 27.3%, respectively, compared with the same periods in 2017, due to growth in both the loan and investment securities portfolios. For the three and nine months ended September 30, 2018, interest expense increased $7,701 and $20,423, or 81.5% and 82.0%, respectively, primarily due to increases in interest-bearing deposits combined with an increase in interest rates for deposits and Federal Home Loan Bank (“FHLB”) advances.

31

Interest-earning assets averaged $4,001,611 and $3,351,421 during the three months ended September 30, 2018 and 2017, respectively, an increase of $650,190, or 19.4%. 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 23.4%, and available for sale securities increased 16.5%, when comparing the three months ended September 30, 2018 with the same period in 2017.

When comparing the three months ended September 30, 2018 and 2017, the yield on average interest earning assets, adjusted for tax equivalent yield, increased 23 basis points in 2018 to 4.40% compared to 4.17% for the same period during 2017. For the three months ended September 30, 2018, the tax equivalent yield on loans was 5.41%, and for the three months ended September 30, 2017, the tax equivalent yield on loans was 5.03%. The primary driver for the increase in yields on loans was the increase in market interest rates when compared to the same quarter in the previous year.

Interest-bearing liabilities averaged $3,463,037 during the three months ended September 30, 2018, compared to $2,856,337 for the same period in 2017, an increase of 606,700, or 21.2%. Total average interest-bearing deposits grew $569,091, or 23.0%, including increases in average interest checking of $238,231 and average time deposits of $207,451 for the three months ended September 30, 2018, as compared to the same period during 2017. The growth in the loan portfolio contributed to an increase in average FHLB advances of $62,000.

When comparing the three months ended September 30, 2018 and 2017, the cost of average interest-bearing liabilities increased 66 basis points to 1.97% from 1.31%. 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 $3,967,909 and $3,304,558 during the nine months ended September 30, 2018 and 2017, respectively, an increase of $663,351, or 20.1%. This increase was due to growth in both the loan portfolio and the securities portfolio over the past year. Average loans increased 23.2%, and investment securities increased 9.8%, when comparing the nine months ended September 30, 2018 with the same period in 2017. When comparing the nine months ended September 30, 2018 and 2017, the yield on average interest-earning assets, adjusted for tax equivalent yield, increased 14 basis points to 4.25% in 2018 compared to 4.11% for the same period during 2017.

For the nine months ended September 30, 2018 and 2017, the tax equivalent yield on loans was 5.25% and 4.96% respectively. The primary driver for the increase in yield on loans for the nine months ended September 30, 2018 was the increase in market interest rates during the past year.

For the nine months ended September 30, 2018, the tax equivalent yield on available for sale securities was 2.52%, and for the nine months ended September 30, 2017, the tax equivalent yield on available for sale securities was 2.66%. For the nine months ended September 30, 2018, the tax equivalent yield on held to maturity securities was 3.75%, and for the nine months ended September 30, 2017, the tax equivalent yield on held to maturity securities was 4.18%. 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 $3,451,403 during the nine months ended September 30, 2018, compared to $2,839,188 for the same period in 2017, an increase of $612,215, or 21.6%. Total average interest-bearing deposits grew $548,856, including increases in interest-bearing checking of $224,717 and average time deposits of $189,256 for the nine months ended September 30, 2018, as compared to the same period during 2017. The growth in the loan portfolio also contributed to an increase in average FHLB advances of $83,869.

When comparing the nine months ended September 30, 2018 and 2017, the cost of average interest-bearing liabilities increased 59 basis points from 1.17% to 1.76%. The increase was due to increases in the cost of funds from interest-bearing deposits, FHLB advances, federal funds purchased and repurchase agreements.

32

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

Average Balances—Yields & Rates (7)

(Dollars are in thousands)

	Three Months Ended September 30,
	2018								2017
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans(1)(6)	$	2,528,604		$	34,457		5.41	%	$	2,049,575		$	26,006		5.03	%
Securities available for sale(6)		1,133,536			7,141		2.50	%		972,988			6,405		2.61	%
Securities held to maturity(6)		207,419			1,924		3.68	%		220,313			2,283		4.11	%
Restricted equity securities		21,067			313		5.89	%		17,396			269		6.13	%
Certificates of deposit at other financial institutions		3,113			16		2.04	%		2,412			9		1.48	%
Federal funds sold and other(2)		107,872			567		2.09	%		88,737			271		1.21	%
TOTAL INTEREST EARNING ASSETS	$	4,001,611		$	44,418		4.40	%	$	3,351,421		$	35,243		4.17	%
Allowance for loan and lease losses		(22,588	)							(18,891	)
All other assets		153,478								94,334
TOTAL ASSETS	$	4,132,501							$	3,426,864
LIABILITIES & EQUITY
Deposits:
Interest checking	$	790,733		$	3,406		1.71	%	$	552,502		$	1,285		0.92	%
Money market		736,157			3,489		1.88	%		604,416			1,703		1.12	%
Savings		46,589			34		0.29	%		54,921			42		0.30	%
Time deposits		1,466,903			7,208		1.95	%		1,259,452			4,281		1.35	%
Federal Home Loan Bank advances		351,228			1,867		2.11	%		289,228			968		1.33	%
Federal funds purchased and other(3)		12,805			69		2.14	%		37,374			92		0.98	%
Subordinated notes and other borrowings		58,622			1,082		7.32	%		58,444			1,083		7.35	%
TOTAL INTEREST BEARING LIABILITIES	$	3,463,037		$	17,155		1.97	%	$	2,856,337		$	9,454		1.31	%
Demand deposits		305,432								261,127
Other liabilities		12,739								11,312
Total equity		351,293								298,088
TOTAL LIABILITIES AND EQUITY	$	4,132,501							$	3,426,864
NET INTEREST SPREAD(4)							2.43	%							2.86	%
NET INTEREST INCOME				$	27,263							$	25,789
NET INTEREST MARGIN(5)							2.70	%							3.05	%

33

	Nine Months Ended September 30,
	2018								2017
	Average Balance			Interest Inc / Exp		Average Yield / Rate			Average Balance			Interest Inc / Exp		Average Yield / Rate
ASSETS:
Loans(1)(6)	$	2,433,683		$	95,601		5.25	%	$	1,975,592		$	73,274		4.96	%
Securities available for sale(6)		1,135,915			21,372		2.52	%		1,002,118			19,958		2.66	%
Securities held to maturity(6)		211,031			5,915		3.75	%		224,174			7,012		4.18	%
Restricted equity securities		20,123			916		6.09	%		15,830			663		5.60	%
Certificates of deposit at other financial institutions		3,130			46		1.96	%		2,178			24		1.47	%
Federal funds sold and other(2)		164,027			2,151		1.75	%		84,666			643		1.02	%
TOTAL INTEREST EARNING ASSETS	$	3,967,909		$	126,001		4.25	%	$	3,304,558		$	101,574		4.11	%
Allowance for loan and lease losses		(22,092	)							(18,182	)
All other assets		146,044								92,425
TOTAL ASSETS	$	4,091,861							$	3,378,801
LIABILITIES & EQUITY
Deposits:
Interest checking	$	856,299		$	9,901		1.55	%	$	631,582		$	3,586		0.76	%
Money market		750,857			9,137		1.63	%		608,670			4,412		0.97	%
Savings		48,265			109		0.30	%		55,569			127		0.31	%
Time deposits		1,385,931			18,238		1.76	%		1,196,675			10,993		1.23	%
Federal Home Loan Bank advances		326,418			4,390		1.80	%		242,549			2,228		1.23	%
Federal funds purchased and other(3)		25,056			296		1.58	%		45,745			309		0.90	%
Subordinated notes and other borrowings		58,577			3,246		7.41	%		58,398			3,239		7.42	%
TOTAL INTEREST BEARING LIABILITIES	$	3,451,403		$	45,317		1.76	%	$	2,839,188		$	24,894		1.17	%
Demand deposits		296,893								246,675
Other liabilities		12,940								7,358
Total equity		330,625								285,580
TOTAL LIABILITIES AND EQUITY	$	4,091,861							$	3,378,801
NET INTEREST SPREAD(4)							2.49	%							2.94	%
NET INTEREST INCOME				$	80,684							$	76,680
NET INTEREST MARGIN(5)							2.72	%							3.10	%

⁽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.

34

Analysis of Changes in Interest Income and Expenses

	Net change three months ended September 30, 2018 versus September 30, 2017
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	6,073		$	2,378		$	8,451
Securities available for sale		1,056			(320	)		736
Securities held to maturity		(134	)		(225	)		(359	)
Restricted equity securities		57			(13	)		44
Certificates of deposit at other financial institutions		3			4			7
Federal funds sold and other		58			238			296
TOTAL INTEREST INCOME	$	7,113		$	2,062		$	9,175
INTEREST EXPENSE
Deposits
Interest checking	$	552		$	1,569		$	2,121
Money market accounts		372			1,414			1,786
Savings		(7	)		(1	)		(8	)
Time deposits		706			2,221			2,927
Federal Home Loan Bank advances		208			691			899
Fed funds purchased and other borrowed funds		(61	)		38			(23	)
Subordinated Notes and other borrowings		3			(4	)		(1	)
TOTAL INTEREST EXPENSE	$	1,773		$	5,928		$	7,701
NET INTEREST INCOME	$	5,340		$	(3,866	)	$	1,474

	Net change nine months ended September 30, 2018 versus September 30, 2017
	Volume			Rate			Net Change
INTEREST INCOME
Loans	$	16,994		$	5,333		$	22,327
Securities available for sale		2,662			(1,248	)		1,414
Securities held to maturity		(411	)		(686	)		(1,097	)
Restricted equity securities		180			73			253
Certificates of deposit at other financial institutions		10			12			22
Federal funds sold and other		605			903			1,508
TOTAL INTEREST INCOME	$	20,040		$	4,387		$	24,427
INTEREST EXPENSE
Deposits
Interest checking	$	1,277		$	5,038		$	6,315
Money market accounts		1,032			3,693			4,725
Savings		(17	)		(1	)		(18	)
Time deposits		1,741			5,504			7,245
Federal Home Loan Bank advances		772			1,390			2,162
Fed funds purchased and other borrowed funds		(139	)		126			(13	)
Subordinated notes and other borrowings		10			(3	)		7
TOTAL INTEREST EXPENSE	$	4,676		$	15,747		$	20,423
NET INTEREST INCOME	$	15,364		$	(11,360	)	$	4,004

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan and lease 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.

35

The provision for loan losses was $136 and $590 for the three months ended September 30, 2018 and 2017, respectively, and $1,279 and $3,018 for the nine months ended September 30, 2018 and 2017, respectively. The lower provision for the three and nine months ended September 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, resulted in less provision  being recorded. Nonperforming loans at September 30, 2018 totaled $3,972 compared to $3,042 at December 31, 2017, representing 0.16% and 0.14% of total loans for the respective periods.

Non-Interest Income

Non-interest income for the three and nine months ended September 30, 2018 was $3,442 and $11,045, respectively, compared to $3,569 and $11,457 for the same periods in 2017, respectively. The following is a summary of the components of non-interest income (in thousands):

	Three Months Ended September 30,						$ Increase			% Increase
	2018			2017			(Decrease)			(Decrease)
Service charges on deposit accounts	$	58		$	39		$	19			48.7	%
Other service charges and fees		747			787			(40	)		(5.1	%)
Net gains on sale of loans		1,379			1,517			(138	)		(9.1	%)
Wealth management		705			643			62			9.6	%
Loan servicing fees, net		111			70			41			58.6	%
Gain on sales of investment securities, net		(1	)		350			(351	)		(100.3	%)
Net gain on foreclosed assets		3			(16	)		19			(118.8	%)
Other		440			179			261			145.8	%
Total non-interest income	$	3,442		$	3,569		$	(127	)		(3.6	%)

	Nine Months Ended September 30,					$ Increase			% Increase
	2018		2017			(Decrease)			(Decrease)
Service charges on deposit accounts	$	151	$	114		$	37			32.5	%
Other service charges and fees		2,321		2,297			24			1.0	%
Net gains on sale of loans		4,759		5,918			(1,159	)		(19.6	%)
Wealth management		2,198		1,884			314			16.7	%
Loan servicing fees, net		333		230			103			44.8	%
Gain on sales of investment securities, net		—		470			(470	)		(100.0	%)
Net gain on foreclosed assets		9		(10	)		19			(190.0	%)
Other		1,274		554			720			130.0	%
Total non-interest income	$	11,045	$	11,457		$	(412	)		(3.6	%)

Net gain on sale of loans decreased $138 and $1,159 for the three and nine months ended September 30, 2018, respectively, when compared to the three and nine months ended September 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 nine months ended September 30, 2018 increased $62 and $314, or 9.6% and 16.7%, 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 September 30, 2018 and 2017 of $403,456 and $351,932, respectively.

Net gain on sale of investment securities decreased $351 and $470, or 100.3% and 100.0%, for the three and nine months ended September 30, 2018, respectively, when comparing with the same periods in 2017. The decreases were primarily due to the gains on securities that were recognized in 2017.

Other non-interest income increased by $261 and $720, or 145.8% and 130.0%, respectively, when comparing the three and nine months ended September 30, 2018 with the same periods 2017. The increase for the three and nine months ended September 30, 2018 is primarily attributed to the increase in bank-owned life insurance (“BOLI”) income of $238 and $690, respectively.

36

Non-Interest Expense

Non-interest expense for the three and nine months ended September 30, 2018 was $18,251 and $51,789, respectively, compared to $15,278 and $44,837 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 September 30,				$ Increase (Decrease)		% Increase (Decrease)
	2018		2017
Salaries and employee benefits	$	10,723	$	9,011	$	1,712		19.0	%
Occupancy and equipment		2,933		2,399		534		22.3	%
FDIC assessment expense		1,020		900		120		13.3	%
Marketing		306		192		114		59.4	%
Professional fees		1,023		821		202		24.6	%
Amortization of core deposit intangible		169		115		54		47.0	%
Other		2,077		1,840		237		12.9	%
Total non-interest expense	$	18,251	$	15,278	$	2,973		19.5	%

	Nine Months Ended September 30,				$ Increase (Decrease)			% Increase (Decrease)
	2018		2017
Salaries and employee benefits	$	30,179	$	26,172	$	4,007			15.3	%
Occupancy and equipment		8,412		6,689		1,723			25.8	%
FDIC assessment expense		2,458		2,675		(217	)		(8.1	%)
Marketing		855		744		111			14.9	%
Professional fees		3,254		2,558		696			27.2	%
Amortization of core deposit intangible		455		363		92			25.3	%
Other		6,176		5,636		540			9.6	%
Total non-interest expense	$	51,789	$	44,837	$	6,952			15.5	%

The increase in non-interest expense noted in the table above is related to the Company’s overall growth. The Company’s largest increases for the three and nine months ended September 30, 2018, in comparison with the same periods of 2017, were in salaries and employee benefits, occupancy and equipment, professional fees, and other non-interest expense.

Salaries and employee benefits increased $1,712 and $4,007, or 19.0% and 15.3%, respectively, when comparing the three and nine months ended September 30, 2018 with the same periods in 2017. The increases in both periods are primarily due to the Company’s staffing growth, during which the Company went from 279 full-time equivalent employees as of September 30, 2017, to 327 as of September 30, 2018, many of which were officer level positions as the Company has worked to enhance its management team to properly oversee the Company’s growth. Stock-based compensation expense also increased $641 and $1,485, respectively, for the three and nine months ended September 30, 2018 in comparison with the same periods in 2017.

Occupancy and equipment expense increased $534 and $1,723, or 22.3% and 25.8%, respectively, when comparing the three and nine months ended September 30, 2018 with the same periods in 2017. The variance for the three months ended September 30, 2018 versus the three months ended September 30, 2017 is primarily attributable to increases in building rent expense ($183) and software maintenance fees ($153). The variance when comparing the nine months ended September 30, 2018 with the nine months ended September 30, 2017 is attributable to increases in building rent expense ($682), software maintenance fees ($497) and other furniture, fixture & equipment expense ($153).

The Company’s FDIC assessment expense increased $120 and decreased $217, or 13.3% and 8.1%, respectively, when comparing the three and nine months ended September 30, 2018 with the same periods in 2017. The increase in comparing the three months ended September 30, 2018 to September 30, 2017 is due to asset growth and the decrease over the nine months is due to improvements in regulatory standing.

Professional fees increased $202 and $696, or 24.6% and 27.2%, respectively, when comparing the three and nine months ended September 30, 2018 with the same periods in 2017. The increase when comparing the three months ended September 30, 2018 with the same period in 2017 is due to increases in other professional fees ($133) and legal fees ($49). The increase, when comparing the nine months ended September 30, 2018 and 2017, is due to increases in merger-related expenses ($379), other professional fees ($185), legal fees ($90) and accounting and auditing fees ($71).

37

For the three and nine months ended September 30, 2018, other non-interest expense increased $237 and $540, or 12.9% and 9.6%, respectively, when compared to the three and nine months ended September 30, 2017. The increase in other non-interest expense for the nine months ended September 30, 2018 versus September 30, 2017 is attributed to increases in several types of expenses, but the following expense types represent the largest variances: director fees of $80; loan legal expenses of $77 and internet bill pay of $76.

Income Tax Expense

The Company recognized income tax expense for the three and nine months ended September 30, 2018, of $1,068 and $5,790, respectively, compared to $3,138 and $10,343, respectively, for the three and nine months ended September 30, 2017. The Company’s year-to-date income tax expense for the period ended September 30, 2018 reflects an effective income tax rate of 15.8%, which is a significant decrease compared to 28.7% for the same period in 2017 resulting from the positive impact of the Tax Cuts and Jobs Act enacted in December 2017 and the Company’s investment in Community Investment Tax Credit (CITC) qualified securities and loans that offer state tax credits in exchange for accepting less than market yields on projects to build low income housing.

COMPARISON OF BALANCE SHEETS AT September 30, 2018 and December 31, 2017

Overview

The Company’s total assets increased by $324,287, or 8.4%, from December 31, 2017 to September 30, 2018. The increase in total assets has primarily been the result of organic growth in the loan portfolio and from purchases of additional investment securities and the Civic acquisition, which closed on April 1, 2018.

Loans

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

The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, at September 30, 2018 and December 31, 2017 were $2,550,121 and $2,256,608, respectively, an increase of $293,513, or 13.0%. As a percentage of total assets, total loans, net of deferred fees, at September 30, 2018 and December 31, 2017 were 61.2% and 58.7% of total assets, respectively. Growth in the loan portfolio is primarily due to increased market penetration and a healthy local economy. The Company has also attracted a number of experienced commercial and mortgage lenders to develop new relationships and broaden its presence in its primary markets in Middle Tennessee which include, Williamson County, Davidson County and Rutherford County.

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

	September 30, 2018						December 31, 2017
Types of Loans	Amount			% of Total Loans			Amount			% of Total Loans
Total loans, excluding purchased credit impaired (“PCI”)    loans
Real estate:
Construction and land development	$	587,736			23.0	%	$	494,818			21.9	%
Commercial		777,989			30.5	%		678,238			30.0	%
Residential		658,672			25.8	%		577,335			25.6	%
Commercial and industrial		520,727			20.4	%		502,006			22.2	%
Consumer and other		5,539			0.2	%		3,781			0.2	%
Total loans—gross, excluding PCI loans		2,550,663			99.9	%		2,256,178			99.9	%
Total PCI loans		2,023			0.1	%		2,393			0.1	%
Total gross loans		2,552,686			100.0	%		2,258,571			100.0	%
Less: deferred loan fees, net		(2,565	)					(1,963	)
Allowance for loan losses		(22,479	)					(21,247	)
Total loans, net allowance for loan losses	$	2,527,642					$	2,235,361

38

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

Total gross loans increased 13.0% during the first nine months ended September 30, 2018, due to organic growth as a result of continued market penetration and the strength of the local economies, and also due to the Civic acquisition. During this period, the Company experienced growth in real estate loans of 15.7% with growth occurring in the residential real estate (14.1%), commercial real estate (14.7%) and construction and land development (18.8%) segments. The Company also experienced a slight increase of 3.7% in the commercial and industrial segment during the nine months ended September 30, 2018.

Real estate loans, including $83 of PCI loans, comprised 79.3% of the loan portfolio at September 30, 2018. The largest portion of the real estate segments as of September 30, 2018, was commercial real estate loans, which totaled 38.4% of real estate loans. Commercial real estate loans totaled $777,989 at September 30, 2018, and comprised 30.5% of the total loan portfolio. The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm, nonresidential real estate properties and other properties.

Construction and land development loans totaled $587,736 at September 30, 2018, and comprised 29.0% of total real estate loans and 23.0% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development.

The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit and other junior lien mortgage loans. Residential real estate loans totaled $658,755 and comprised 32.5% of real estate loans and 25.8% of total loans at September 30, 2018.

Commercial and industrial loans totaled $522,667 at September 30, 2018 which includes $1,940 of PCI loans. Loans in this classification comprised 20.5% of total loans at September 30, 2018. The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and commercial healthcare loans.

The repayment of loans is a source of additional liquidity for the Company. The following table sets forth the loans maturing within specific intervals at September 30, 2018, excluding unearned net fees and costs.

Loan Maturity Schedule

	September 30, 2018
	One year or less		Over one year to five years		Over five years		Total
Real estate:
Construction and land development	$	330,581	$	153,372	$	103,783	$	587,736
Commercial		40,305		241,073		496,611		777,989
Residential		42,556		142,456		473,743		658,755
Commercial and industrial		67,167		372,073		83,427		522,667
Consumer and other		1,958		3,232		349		5,539
Total	$	482,567	$	912,206	$	1,157,913	$	2,552,686
Fixed interest rate	$	135,905	$	405,588	$	599,692	$	1,141,185
Variable interest rate		346,662		506,618		558,221		1,411,501
Total	$	482,567	$	912,206	$	1,157,913	$	2,552,686

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

39

Allowance for Loan Losses

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

• past loan experience;

• the nature and volume of the portfolio;

• risks known about specific borrowers;

• underlying estimated values of collateral securing loans;

• current and anticipated economic conditions; and

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

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

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

In the table below, the components, as discussed above, of the allowance for loan losses are shown at September 30, 2018 and December 31, 2017.

	September 30, 2018							December 31, 2017							Increase (Decrease)
	Loan Balance		ALLL Balance		%			Loan Balance		ALLL Balance		%			Loan Balance			ALLL Balance
Non impaired loans	$	2,436,737	$	22,187		0.91	%	$	2,201,515	$	20,358		0.92	%	$	235,222		$	1,829		(1) bps
Non-PCI acquired loans    (Note 1)		110,622		269		0.24			50,522		10		0.02	%		60,100			259		22 bps
Impaired loans		3,304		23		0.70			4,141		879		21.23	%		(837	)		(856	)	(2053) bps
Non-PCI loans		2,550,663		22,479		0.88			2,256,178		21,247		0.94	%		294,485			1,232		(6) bps
PCI loans		2,023		—		—			2,393		—		—			(370	)		—			—
Total loans	$	2,552,686	$	22,479		0.88	%	$	2,258,571	$	21,247		0.94	%	$	294,115		$	1,232		(6) bps

Note 1: Loans acquired are performing loans recorded at estimated fair value at the acquisition date. Based on the analysis performed by management as of September 30, 2018, $269 in allowance for loan loss was recorded at September 30, 2018 related to the loans acquired and not otherwise considered PCI.

At September 30, 2018, the allowance for loan losses was $22,479, compared to $21,247 at December 31, 2017. The allowance for loan losses as a percentage of total loans was 0.88% at September 30, 2018 and 0.94% at December 31, 2017. Loan growth during the nine months of 2018 is the primary reason for the dollar increase in the allowance amount.

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

40

	Nine Months Ended September 30, 2018			Nine Months Ended September 30, 2017
Beginning balance	$	21,247		$	16,553
Loans charged-off:
Construction & land development		39			—
Commercial real estate		—			—
Residential real estate		7			1
Commercial & industrial		49			309
Consumer & other		22			36
Total loans charged-off		117			346
Recoveries on loans previously charged-off:
Construction & land development		1			668
Commercial real estate		—			—
Residential real estate		43			38
Commercial & industrial		10			—
Consumer & other		16			13
Total loan recoveries		70			719
Net charge-offs		(47	)		373
Provision for loan losses charged to expense		1,279			3,018
Total allowance at end of period	$	22,479		$	19,944
Total loans, gross, at end of period(1)	$	2,552,686		$	2,117,131
Average gross loans(1)	$	2,424,936		$	1,966,635
Allowance to total loans		0.88	%		0.94	%
Net charge-offs (recoveries) to average loans, annualized		0.00	%		(0.03	%)

⁽¹⁾ Loan balances exclude loans held for sale

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

	September 30, 2018					December 31, 2017
	Amount		% of Loan Segment to Total Loans			Amount		% of Loan Segment to Total Loans
Real estate loans:
Construction and land development	$	4,785		23.0	%	$	3,802		21.9	%
Commercial		6,145		30.5			5,981		30.0
Residential		4,508		25.8			3,834		25.6
Total real estate		15,438		79.3			13,617		77.5
Commercial and industrial		6,989		20.5			7,587		22.3
Consumer and other		52		0.2			43		0.2
	$	22,479		100.0	%	$	21,247		100.0	%

41

Nonperforming Assets

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

The primary component of non-performing loans is non-accrual loans, which as of September 30, 2018 totaled $3,407. The other component of non-performing loans are loans past due greater than 90 days and still accruing interest. Loans past due greater than 90 days are placed on non-accrual status, unless they are both well-secured and in the process of collection. There were outstanding loans totaling $565 that were past due 90 days or more and still accruing interest at September 30, 2018.

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

	September 30, 2018			December 31, 2017
Non-accrual loans	$	3,407		$	2,837
Past due loans 90 days or more and still accruing interest		565			205
Total non-performing loans		3,972			3,042
Foreclosed assets		1,853			1,503
Total non-performing assets		5,825			4,545
Total non-performing loans as a percentage of total loans		0.16	%		0.13	%
Total non-performing assets as a percentage of total assets		0.14	%		0.12	%
Allowance for loan losses as a percentage of non-performing    loans		566	%		698	%

As of September 30, 2018, there were eight loans on non-accrual status. The amount and number are further delineated by collateral segment and number of loans in the table below.

	Total Amount		Percentage of Total Loans			Number of Non-Accrual Loans
Construction & land development	$	548		0.1	%		1
Commercial real estate		—		—			—
Residential real estate		2,767		0.4			4
Commercial & industrial		92		0.0			3
Consumer		—		—			—
Total non-accrual loans	$	3,407		0.1	%		8

Investment Securities and Other Earning Assets

The investment securities portfolio is intended to provide the Company with adequate liquidity and a source of stable income. The portfolio is structured with minimal credit exposure to the Company and consists of both securities classified as available-for-sale and securities classified as held-to-maturity. All available-for sale securities are carried at fair value and may be used for liquidity purposes should management deem it to be in the Company’s best interest. Securities available-for-sale, consisting primarily of U.S. government sponsored enterprises and mortgage-backed securities, were $1,115,187 at September 30, 2018, compared to $999,881 at December 31, 2017, an increase of $115,306, or 11.5%. The increase in available-for-sale securities was primarily attributed to security purchases during the first nine months of 2018.

Held-to-maturity securities are carried at amortized cost. This portfolio, consisting of U.S. government sponsored enterprises, mortgage-backed securities and municipal securities, totaled $204,587 at September 30, 2018, compared to $214,856 at December 31, 2017, a decrease of $10,269, or 4.8%. The decrease is attributable to securities that matured or had principal pay downs during the first nine months of 2018.

42

The combined portfolios represented 31.7% and 31.6% of total assets at September 30, 2018 and December 31, 2017, respectively. At September 30, 2018, the Company had no securities that were classified as having other than temporary impairment.

The Company also had other investments of $21,793 and $18,492 at September 30, 2018 and December 31, 2017, respectively, primarily consisting of capital stock in the Federal Reserve and the Federal Home Loan Bank (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System). The Federal Home Loan Bank and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus, not liquid, have no ready market or quoted market value, and are carried at cost.

Bank Premises and Equipment

Bank premises and equipment totaled $11,852 at September 30, 2018 compared to $11,281 at December 31, 2017, an increase of $571, or 5.1%. This increase was primarily the result of adding leasehold improvements and furniture and equipment as part of the Civic acquisition, which closed on April 1, 2018.

Deposits

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

At September 30, 2018, total deposits were $3,371,550, an increase of $204,322, or 6.5%, compared to $3,167,228 at December 31, 2017. The growth in deposits is attributable to growth in time deposits and noninterest-bearing deposits.

Included in the Company’s funding strategy are brokered deposits. Total brokered deposits increased from $779,886 at December 31, 2017 to $887,113 at September 30, 2018, due to the increased need for funding for the Bank’s loan growth and due to certain brokered deposits that are interest-bearing checking and money market accounts that can fluctuate daily.

Public funds deposits in the form of local county deposits are a part of the Company’s funding strategy and are seasonal in nature, with the peak of those deposit balances occurring during the middle of the first quarter of each calendar year. Public funds declined $234,689, or 23.4%, from $1,002,584 at December 31, 2017 to $767,895 at September 30, 2018 due to expected seasonal fluctuations in county deposits that repeat each year.

Time deposits excluding brokered deposits as of September 30, 2018, amounted to $814,806, compared to $675,150 as of December 31, 2017, an increase of $139,656, or 20.7%, much of which is attributable to the Civic acquisition on April 1, 2018 and new legislation that reclassified reciprocal deposits from brokered deposits to non-brokered deposits. Non-public funds money market accounts, excluding brokered deposits, increased $61,427, or 12.9%, from December 31, 2017 to September 30, 2018. Noninterest-bearing checking deposits grew $35,489, or 12.4%, and non-public funds interest checking accounts, excluding brokered deposits, grew $74,231, or 53.4%, respectively, when comparing deposit balances from September 30, 2018 with balances at December 31, 2017, much of which is attributable to the Civic acquisition on April 1, 2018 and new legislation that reclassified reciprocal deposits from brokered deposits to non-brokered deposits.

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

	September 30, 2018
Three months or less	$	296,343
Three through six months		101,916
Six through twelve months		152,985
Over twelve months		144,647
Total	$	695,891

43

Federal Funds Purchased and Repurchase Agreements

The Company had no federal funds purchased from correspondent banks as of September 30, 2018 and December 31, 2017. Securities sold under agreements to repurchase had an outstanding balance of $0 as of September 30, 2018, compared to $31,004 as of December 31, 2017. Securities sold under agreements to repurchase are financing arrangements that mature daily or within a short period of time. At maturity, the securities underlying the agreements are returned to the Company.

Federal Home Loan Bank Advances

The Company has established a line of credit with the Federal Home Bank of Cincinnati which is secured by a blanket pledge of 1-4 family residential mortgages and home equity lines of credit. At September 30, 2018 and at December 31, 2017, advances totaled $371,500 and $272,000, respectively, and the scheduled maturities and interest rates of these advances were as follows:

Scheduled Maturities	Amount		Weighted Average Rates
2018		48,000		2.18	%
2019		268,500		2.21	%
2020		55,000		1.72	%
Total	$	371,500		2.13	%

Subordinated Notes

At September 30, 2018, the Company’s subordinated notes, net of issuance costs, totaled $58,649, compared with $58,515 at December 31, 2017. For more information related to the subordinated notes and the related issuance costs, please see Note 11 of the consolidated financial statements.

Liquidity

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

Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, management focuses on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet the Company’s needs. Our source of funds to pay interest on our subordinated notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. Under the terms of the informal agreement with the Federal Reserve Bank of Atlanta (the “Reserve Bank”) and the Tennessee Department of Financial Institutions (“TDFI”), described in “Other Events” in Management’s Discussion and Analysis and in “ITEM 1A. RISK FACTORS,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, the Bank is required to receive prior written approval from its regulatory agencies to pay dividends to the Company.

Funds are available from a number of basic banking activity sources including the core deposit base, the repayment and maturity of loans, payments of principal and interest as well as sales of investments classified as available-for-sale, and sales of brokered deposits. As of September 30, 2018, $1,115,187 of the investment securities portfolio was classified as available-for-sale and is reported at fair value on the consolidated balance sheet. Another $204,587 of the portfolio was classified as held-to-maturity and is reported at amortized cost. Approximately $967,505 of the total $1,115,187 investment securities portfolio on hand at September 30, 2018, was pledged to secure public deposits and repurchase agreements. Other funding sources available include repurchase agreements, federal funds purchased, and borrowings from the Federal Home Loan Bank.

Equity

As of September 30, 2018, the Company’s equity was $356,177, as compared with $304,653 as of December 31, 2017. The increase in equity was due to the Company’s earnings of $30,762 in the first nine months of 2018, the increase in common stock of $38,958, of which $33,174 was the result of common stock issued as part of the Civic acquisition, offset by the $18,196 decrease in the valuation of available-for-sale securities.

44

Effects of Inflation and Changing Prices

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

Off Balance Sheet Arrangements

The Company generally does not have any off-balance sheet arrangements other than approved and unfunded loans and lines and letters of credit to customers in the ordinary course of business. At September 30, 2018, the Company had unfunded loan commitments outstanding of $38,140, unused lines of credit of $653,192, and outstanding standby letters of credit of $33,398.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

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

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

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

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

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

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

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

45

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

	As of or for the Three Months Ended
(Amounts in thousands, except share/per share data and percentages)	September 30, 2018			June 30, 2018			Mar 31, 2018			Dec 31, 2017			Sept 30, 2017
Total shareholders’ equity	$	356,074		$	348,059		$	304,762		$	304,550		$	303,594
Less: Preferred stock		—			—			—			—			—
Total common shareholders’ equity		356,074			348,059			304,762			304,550			303,594
Common shares outstanding		14,525,351			14,480,240			13,258,142			13,237,128			13,209,055
Book value per share	$	24.51		$	24.04		$	22.99		$	23.01		$	22.98
Total common shareholders’ equity		356,074			348,059			304,762			304,550			303,594
Less: Goodwill and other intangible assets		19,327			19,499			10,074			10,181			10,294
Tangible common shareholders’ equity	$	336,747		$	328,560		$	294,688		$	294,369		$	293,300
Common shares outstanding		14,525,351			14,480,240			13,258,142			13,237,128			13,209,055
Tangible book value per share	$	23.18		$	22.69		$	22.23		$	22.24		$	22.20
Average total common equity		351,293		$	340,175		$	299,840		$	304,847		$	298,088
Less: Average Preferred stock		—			—			—			—			—
Less: Average Goodwill and other intangible assets		19,433			19,860			10,136			10,247			10,321
Average tangible common shareholders’ equity	$	331,860		$	320,315		$	289,704		$	294,600		$	287,767
Net income available to common shareholders		10,549			10,161			10,052			2,394			8,889
Average tangible common equity		331,860			320,315			289,704			294,600			287,767
Return on average tangible common equity		12.61	%		12.72	%		14.07	%		3.22	%		12.26	%
Efficiency Ratio:
Net interest income	$	26,562		$	26,905		$	25,116		$	24,608		$	24,326
Noninterest income		3,442			4,147			3,456			3,264			3,569
Operating revenue		30,004			31,052			28,572			27,872			27,895
Expense
Total noninterest expense		18,251			18,050			15,488			15,987			15,278
Efficiency ratio		60.83	%		58.13	%		54.21	%		57.36	%		54.77	%

46

FRANKLIN FINANCIAL NETWORK, INC.

SUMMARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)

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

	As of and for the three months ended
	Sept 30, 2018		Jun 30, 2018			Mar 31, 2018		Dec 31, 2017		Sept 30, 2017
Income Statement Data ($):
Interest income		43,717		42,136			38,047		35,121		33,780
Interest expense		17,155		15,231			12,931		10,513		9,454
Net interest income		26,562		26,905			25,116		24,608		24,326
Provision for loan losses		136		570			573		1,295		590
Noninterest income		3,442		4,147			3,456		3,264		3,569
Noninterest expense		18,251		18,050			15,488		15,987		15,278
Net income before taxes		11,617		12,432			12,511		10,590		12,027
Income tax expense		1,068		2,263			2,459		8,188		3,138
Net income		10,549		10,169			10,052		2,402		8,889
Earnings before interest and taxes		28,722		27,663			25,442		21,103		21,481
Net income available to common shareholders		10,549		10,161			10,052		2,394		8,889
Weighted average diluted common shares		15,077,291		14,981,440			13,766,394		13,767,949		13,773,539
Earnings per share, basic		0.73		0.71			0.76		0.18		0.67
Earnings per share, diluted		0.70		0.68			0.73		0.17		0.65
Profitability (%)
Return on average assets		1.01		0.98			1.03		0.26		1.03
Return on average equity		11.91		11.99			13.60		3.13		11.83
Return on average tangible common equity(3)		12.61		12.72			14.07		3.22		12.26
Efficiency ratio(3)		60.83		58.13			54.21		57.36		54.77
Net interest margin(1)		2.70		2.74			2.71		2.92		3.05
Balance Sheet Data ($):
Loans (including HFS)		2,564,684		2,488,862			2,322,889		2,268,632		2,127,753
Loan loss reserve		22,479		22,341			21,738		21,247		19,944
Cash		144,660		176,870			246,164		251,543		155,842
Securities		1,319,774		1,357,918			1,399,801		1,214,737		1,198,049
Goodwill		18,176		18,176			9,124		9,124		9,124
Intangible assets (Sum of core deposit intangible and    SBA servicing rights)		1,151		1,323			950		1,057		1,170
Assets		4,167,813		4,165,238			4,083,663		3,843,526		3,565,278
Deposits		3,371,550		3,398,025			3,355,153		3,167,228		2,824,825
Liabilities		3,811,636		3,817,076			3,778,798		3,538,873		3,261,581
Total equity		356,177		348,162			304,865		304,653		303,697
Common equity		356,074		348,059			304,762		304,550		303,594
Tangible common equity(3)		336,747		328,560			294,688		294,369		293,300
Asset Quality (%)
Nonperforming loans/ total loans(2)		0.16		0.14			0.15		0.13		0.14
Nonperforming assets / (total loans(2) + foreclosed assets)		0.23		0.21			0.22		0.20		0.21
Loan loss reserve / total loans(2)		0.88		0.90			0.94		0.94		0.94
Net charge-offs (recoveries) / average loans		0.00		(0.01	)		0.01		0.00		(0.13	)
Capital (%)
Tangible common equity to tangible assets(3)		8.12		7.93			7.23		7.68		8.25
Leverage ratio		8.70		8.31			7.80		8.25		8.58
Common Equity Tier 1 ratio		12.24		12.14			11.45		11.37		11.58
Tier 1 risk-based capital ratio		12.24		12.14			11.45		11.37		11.58
Total risk-based capital ratio		15.02		14.98			14.42		14.40		14.68

⁽¹⁾ Net interest margins shown in the table above include tax-equivalent adjustments to adjust interest income on tax-exempt loans and tax-exempt investment securities to a fully taxable basis.

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

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

47

Emerging Growth Company Status

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under our Registration Statement on Form S-4, which was declared effective by the SEC on May 14, 2014; (2) the last day of the fiscal year in which we have $1.07 billion or more in annual revenues; (3) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”); or (4) the date on which we have, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.

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

48

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

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

Management believes interest rate risk is best measured by earnings simulation modeling. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 and 200 basis points. All rates are increased or decreased parallel to the change in prime rate. As a result of the simulation, over a 12-month time period ended September 30, 2018, net interest income was estimated to decrease 1.09% and 2.50% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to increase 0.89% and 0.65% in a 100 basis points and 200 basis points declining rate assumption, respectively. These results are in line with the Company’s guidelines for rate sensitivity.

The following chart reflects the Company’s sensitivity to changes in interest rates as indicated as of September 30, 2018.

Projected Interest Rate Change	Net Interest Income		Net Interest Income $ Change from Base			% Change from Base
-200		106,162		687			0.65	%
-100		106,415		940			0.89	%
Base		105,475		—			0.00	%
+100		104,324		(1,151	)		(1.09	%)
+200		102,839		(2,636	)		(2.50	%)
+300		102,133		(3,342	)		(3.17	%)
+400		100,376		(5,099	)		(4.83	%)

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

ITEM 4. CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, have evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2018, the end of the fiscal quarter covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are effective.

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

49

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

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

ITEM 1A. RISK FACTORS.

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2018.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS

Exhibit No.	Description
10.1	Triple Net Office Lease Agreement, by and between South Royal Oaks Partners, LLC and Franklin Synergy Bank (incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K filed with the Securities and Exchange Commission on August 30, 2018).
31.1*	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).
31.2*	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (Section 302 Certification).
32**	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 (Section 906 Certification).
101*	Interactive Data Files.

* Filed herewith

** Furnished herewith

50

SIGNATURES

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

	Franklin Financial Network, INC.
November 9, 2018	By:	/s/ Sarah Meyerrose
		Sarah Meyerrose
		On behalf of the registrant and as Chief Financial Officer (Principal Financial Officer)