Company Quick10K Filing
Quick10K
Franklin Financial Network
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$28.16 15 $410
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
8-K 2019-04-08 Regulation FD
8-K 2019-03-08 Officers, Regulation FD, Exhibits
8-K 2019-02-08 Regulation FD, Exhibits
8-K 2019-01-23 Regulation FD, Exhibits
8-K 2019-01-23 Regulation FD, Exhibits
8-K 2019-01-23 Earnings, Regulation FD, Exhibits
8-K 2019-01-14 Other Events, Exhibits
8-K 2018-12-12 Officers, Regulation FD, Exhibits
8-K 2018-10-24 Earnings, Regulation FD, Exhibits
8-K 2018-08-28 Enter Agreement, Exhibits
8-K 2018-07-25 Earnings, Regulation FD, Exhibits
8-K 2018-06-05 Regulation FD, Exhibits
8-K 2018-05-25 Shareholder Vote
8-K 2018-05-24 Regulation FD, Exhibits
8-K 2018-04-25 Earnings, Regulation FD, Exhibits
8-K 2018-04-12 Officers, Exhibits
8-K 2018-04-01 Officers
8-K 2018-03-28 Enter Agreement, Exhibits
8-K 2018-01-24 Earnings, Regulation FD, Exhibits
8-K 2018-01-09 Earnings, Other Events
MMP Magellan Midstream Partners 14,290
PII Polaris Industries 6,030
PHI PLDT 4,990
MRUS Merus 385
GAIA Gaia 165
KINS Kingstone Companies 146
NK Nantkwest 104
FPAY Flexshopper 15
CLOW Cloudweb 0
OXF Westmoreland Resource Partners 0
FSB 2018-12-31
Part I
Item 1. Business.
Item 1A. Risk Factors.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
Item 3. Legal Proceedings.
Item 4. Mine Safety Disclosures.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Item 6.Selected Financial Data.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. (All Dollar Values in This Section Are in Thousands.)
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplementary Data.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A. Controls and Procedures.
Item 9B. Other Information.
Part III
Item 10. Directors, Executive Officers and Corporate Governance.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Item 14. Principal Accounting Fees and Services.
Part IV
Item 15. Exhibits, Financial Statement Schedules.
Item 16. Form 10-K Summary.
Note 1 - Summary of Significant Accounting Policies
Note 2-Business Combinations
Note 3 - Securities
Note 4 - Loans
Note 5 - Loan Servicing
Note 6 - Premises and Equipment and Leases
Note 7 - Goodwill and Intangible Assets
Note 8 - Deposits
Note 9 - Federal Funds Purchased and Repurchase Agreements
Note 10 - Federal Home Loan Bank Advances
Note 11 - Subordinated Notes
Note 12 - Benefit Plans
Note 13 - Income Taxes
Note 14 - Related Party Transactions
Note 15 - Share-Based Payments
Note 16 - Regulatory Capital Matters
Note 17 - Fair Value
Note 18 - Mortgage Banking Derivatives
Note 19 - Loan Commitments and Other Related Activities
Note 20 - Parent Company Only Condensed Financial Information
Note 21 - Earnings per Share
Note 22 - Capital Offering
Note 23 - Quarterly Financial Results (Unaudited)
EX-10.42 fsb-ex1042_279.htm
EX-10.43 fsb-ex1043_280.htm
EX-10.44 exhibit10_44.htm
EX-10.45 exhibit10_45.htm
EX-10.46 fsb-ex1046_270.htm
EX-10.47 exhibit10_47.htm
EX-10.48 exhibit10_48.htm
EX-10.49 fsb-ex1049_278.htm
EX-10.50 fsb-ex1050_403.htm
EX-10.51 fsb-ex1051_404.htm
EX-10.52 exhibit10_52.htm
EX-10.53 exhibit10_53.htm
EX-10.54 exhibit10_54.htm
EX-10.55 exhibit10_55.htm
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EX-23.1 fsb-ex231_8.htm
EX-31.1 fsb-ex311_9.htm
EX-31.2 fsb-ex312_6.htm
EX-32 fsb-ex32_7.htm

Franklin Financial Network Earnings 2018-12-31

FSB 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 fsb-10k_20181231.htm 10-K fsb-10k_20181231.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

For the fiscal year ended December 31, 2018

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

For the transition period from                      to                     

Commission file number 001-36895

 

FRANKLIN FINANCIAL NETWORK, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

 

Tennessee

 

20-8839445

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

722 Columbia Avenue, Franklin, Tennessee 37064

(Address of principal executive offices) (Zip Code)

615-236-2265

(Registrant’s telephone number, including area code)

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

Title of each class

 

Name of each exchange on which registered

Common Stock, no par value per share

 

New York Stock Exchange

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

None

(Title of class)

 

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 Act).      Yes      No

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 29, 2018 was $496,909,455.20 (computed on the basis of $37.60 per share).

The number of shares outstanding of the registrant’s common stock, no par value per share, as of February 28, 2019 was 14,572,658.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III is incorporated by reference to portions of the definitive proxy statement to be filed within 120 days after December 31, 2018, pursuant to Regulation 14A under the Securities Exchange Act of 1934 in connection with the annual meeting of stockholders to be held on May 23, 2019.

 


TABLE OF CONTENTS

 

 

 

 

PART I

3

3

 

 

ITEM 1.

BUSINESS

3

ITEM 1A.

RISK FACTORS

13

ITEM 1B.

UNRESOLVED STAFF COMMENTS

32

ITEM 2.

PROPERTIES

32

ITEM 3.

LEGAL PROCEEDINGS

33

ITEM 4.

MINE SAFETY DISCLOSURES

33

 

 

PART II

34

 

 

 

ITEM 5.

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

34

ITEM 6.

SELECTED FINANCIAL DATA

36

ITEM 7.

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

38

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

61

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

62

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

62

ITEM 9A.

CONTROLS AND PROCEDURES

62

ITEM 9B.

OTHER INFORMATION

63

 

 

PART III

64

 

 

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

64

ITEM 11.

EXECUTIVE COMPENSATION

64

ITEM 12.

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

64

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

64

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

64

 

 

PART IV

65

 

 

 

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

65

ITEM 16.

FORM 10-K SUMMARY

65

 

 

EXHIBIT INDEX

66

SIGNATURES

 

72

 

 

INDEX TO FINANCIAL STATEMENTS

F-1

 


CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

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

There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the following:

 

business and economic conditions nationally, regionally and in our target markets, particularly in Middle Tennessee and the geographic areas in which we operate;

 

the concentration of our loan portfolio in real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;

 

the concentration of our business within our geographic areas of operation in Middle Tennessee;

 

credit and lending risks associated with our commercial real estate, residential real estate, commercial and industrial, and construction and land development portfolios;

 

increased competition in the banking and mortgage banking industry, nationally, regionally and locally;

 

our ability to execute our business strategy to achieve profitable growth;

 

the dependence of our operating model on our ability to attract and retain experienced and talented bankers in each of our markets;

 

risks that our cost of funding could increase, in the event we are unable to continue to attract stable, low-cost deposits and reduce our cost of deposits;

 

our ability to increase our operating efficiency;

 

failure to keep pace with technological change or difficulties when implementing new technologies;

 

risks related to our acquisition, disposition, growth and other strategic opportunities and initiatives;

 

negative impact on our mortgage banking services, including declines in our mortgage originations or profitability due to rising interest rates and increased competition and regulation;

 

our ability to attract and maintain business banking relationships with well-qualified businesses, real estate developers and investors with proven track records in our market areas;

 

our ability to attract sufficient loans that meet prudent credit standards, including in our commercial and industrial and commercial real estate loan categories;

 

failure to maintain adequate liquidity and regulatory capital and comply with evolving federal and state banking regulations;

 

inability of our risk management framework to effectively mitigate credit risk, interest rate risk, liquidity risk, price risk, compliance risk, operational risk, strategic risk and reputational risk;

 

failure to develop new, and grow our existing, streams of non-interest income;

 

our ability to maintain expenses in line with our current projections;

 

our dependence on our management team and our ability to motivate and retain our management team;

 

risks related to management transition;

 

risks related to any future acquisitions, including failure to realize anticipated benefits from future acquisitions;

 

inability to find acquisition candidates that will be accretive to our financial condition and results of operations;

 

system failures, data security breaches (including as a result of cyber-attacks), or failures to prevent breaches of our network security;

 

data processing system failures and errors;

 

fraudulent and negligent acts by individuals and entities that are beyond our control;

 

fluctuations in our market value and its impact in the securities held in our securities portfolio;

1


 

the adequacy of our reserves (including allowance for loan losses) and the appropriateness of our methodology for calculating such reserves;

 

the makeup of our asset mix and investments;

 

our focus on small and mid-sized businesses;

 

an inability to raise necessary capital to fund our growth strategy or operations, or to meet increased minimum regulatory capital levels;

 

the sufficiency of our capital, including sources of such capital and the extent to which capital may be used or required;

 

interest rate shifts and its impact on our financial condition and results of operation;

 

the expenses that we incur to operate as a public company;

 

the institution and outcome of litigation and other legal proceeding against us or to which we become subject;

 

changes in accounting standards;

 

the impact of recent and future legislative and regulatory changes;

 

governmental monetary and fiscal policies;

 

changes in the scope and cost of Federal Deposit Insurance Corporation, or FDIC, insurance and other coverage; and

 

future equity issuances under our Amended and Restated 2017 Omnibus Equity Incentive Plan and future sales of our common stock by us or our executive officers or directors.

The foregoing factors should not be construed as exhaustive and should be read in conjunction with the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from our forward-looking statements. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us.

2


PART I

ITEM 1.

BUSINESS.

Company Overview

We are a financial holding company headquartered in Franklin, Tennessee. Through our wholly owned bank subsidiary, Franklin Synergy Bank (FSB), 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 15 branches and a loan production office in the 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 Bank), any reference to “FFN” refers to Franklin Financial Network, Inc. only and any reference to “Franklin Synergy” or the “Bank” refers to our banking subsidiary, Franklin Synergy Bank.

As of December 31, 2018, we had consolidated total assets of $4.2 billion, total loans, including loans held for sale, of $2.7 billion, total deposits of $3.4 billion and total equity of $372.8 million.

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

Our History and Growth

Franklin Financial Network, Inc. (“the Company”) was incorporated under the laws of the State of Tennessee on April 5, 2007. FSB was incorporated under the laws of the State of Tennessee and received its Certificate of Authority from the Tennessee Department of Financial Institutions (TDFI) and approval for Federal Deposit Insurance Corporation (FDIC) insurance on November 2, 2007. FSB is also a member of the Federal Reserve System.

The Bank provides financial services through its offices in Franklin, Brentwood, Spring Hill, Murfreesboro, Nashville, Nolensville, and Smyrna, Tennessee. Its primary deposit products are checking, savings, and certificate of deposit accounts, and its primary lending products are commercial and residential construction, commercial, installment loans and loans secured by home equity. Substantially all loans are secured by specific items of collateral including commercial and residential real estate, business assets, and consumer assets. Commercial loans are expected to be repaid by cash flow from operations of businesses. The Company also focuses on electronic banking products such as internet banking, remote deposit capture and lockbox services and treasury management services.

On December 28, 2015, FFN invested in a wholly-owned subsidiary, Franklin Synergy Risk Management, Inc., which provides risk management services to the Company in the form of enhanced insurance coverages.

On March 1, 2016, the Bank invested in a wholly-owned subsidiary, Franklin Synergy Investments of Tennessee, Inc. (“FSIT”), which provides investment services to the Bank. Also on March 1, 2016, FSIT invested in a wholly-owned subsidiary, Franklin Synergy Investments of Nevada, Inc. (“FSIN”), to provide investment services to FSIT related to certain municipal securities. In addition, on March 1, 2016, FSIN invested in a subsidiary, Franklin Synergy Preferred Capital, Inc., to serve as a real estate investment trust (“REIT”), to allow the Bank to sell real estate loans to obtain a tax benefit. FSIN has a controlling interest in the REIT, but the REIT also has a group of investors that own a noncontrolling interest in the preferred stock of the REIT.

Acquisitions

On July 1, 2014, the Bank completed its acquisition of MidSouth Bank (“MidSouth") for 2,766,191 shares of FFN Common Stock valued at approximately $40.1 million. We acquired net assets with a fair value of $41.1 million, which included goodwill of $9.1 million, loans with a fair value of $184.3 million and deposits with a fair value of $244.4 million. The acquisition extended our footprint into Rutherford County and increased our capacity to provide wealth management and trust-related services to our customers.

On April 1, 2018, the Bank completed its acquisition of Civic Bank and Trust (“Civic”) for 970,390 shares of FFN common stock valued at approximately $31.6 million. We acquired net assets with a fair value of $24.1 million, which included goodwill of $9.1 million, loans with a fair value of $96.4 million and deposits with a fair value of $123.2 million. The acquisition expanded our footprint into Davidson County, where we already had an established base of commercial and retail customers.

3


Our Market

The Bank operates 15 branches in Williamson, Davidson, and Rutherford counties and a loan production office within the Nashville metropolitan area. Our markets are among the most attractive, both in Tennessee, and the Southeast, and compare favorably to some of the more well-known and higher-profile markets in the U.S. We believe that our focus on, and success in, growing market share in Williamson, Davidson, and Rutherford Counties will enhance our long-term value and profitability compared to financial institutions of our size in other regions of the country. The markets in which we operate are characterized by strong demographics including income levels that are well above both regional and national median levels, increasing population, a growing workforce, and unemployment that tends to be below the national rate.

Our Business Strategy

We consider ourselves to be full-service bankers. Our core business strategy is to cultivate strong long-term customer relationships by developing an extraordinary team of officers and employees focused on the customer experience and offering our customers a full suite of financial service products. We deliver a level of personal service to our customers that we believe is superior to that of the out-of-state super-regional and national financial institutions operating in our markets, while simultaneously managing risk and profitability by remaining selective when expanding our customer base and making loans.

By continuing to offer several value-added products and services to our customers, such as mortgage lending and wealth management, by investing in technology to improve our systems and the customer experience, and by leveraging strong relationships with consumers, professionals, local governments and businesses within our community, we believe we can gain greater market share, thereby improving our operational efficiency and increase profitability. As evidence of the success of our strategy, our deposit market share in Williamson County has increased from 3.4% in 2009 to a market-leading deposit share of approximately 28.2% per the FDIC’s Summary of Deposits report as of June 30, 2018, despite the presence of more institutions competing for deposits. The Bank’s deposit market share in Rutherford County has grown to 13.4%, which ranks second.

Well Positioned in Attractive Markets

We believe that we are well positioned to grow our business profitably in the demographically attractive and growing markets within the Nashville metropolitan area in which we operate. We believe that our target market segments, small to medium size for- profit businesses and the consumer base working or living in and near our geographical footprint, demand the convenience and personal service that a smaller, independent financial institution such as ours can offer. We believe the heavy out-of-state banking presence (out-of-state super-regional and national financial institutions control approximately 50.6% of local deposits in the Nashville-Davidson-Murfreesboro-Franklin metropolitan statistical area (the “Nashville MSA”) as of June 30, 2018) provides an opportunity for a strong local bank like ours to increase market share from customers who are looking for more personal banking services and a more customer-friendly experience. Through our efforts to expand our deposit base, we currently have the largest market share of deposits in Williamson County.

Products and Services

The Bank operates as a full-service financial institution with a full line of financial products, including:

Commercial Banking

The Bank focuses on small to medium-sized businesses and self-employed professionals.

The Bank seeks to provide high quality service to its customers supported by the latest bank technology. In the credit service area, the Bank endeavors to give its commercial customers access to a highly trained team of credit and deposit service specialists who remain with the customer relationship for long periods of time. Credit decisions are made locally.

Consumer Banking

The Bank offers a broad range of financial services designed to meet the credit, savings, and transactional needs of local consumers. Mortgage loans, home equity loans, and other personal loans are the focus of consumer lending. Deposits and other transactions are provided via a dual delivery systems of traditional branches and the Internet, including mobile banking.

Mortgage Loans

Our mortgage department originates single-family, residential mortgage loans, the large majority of which are sold in the secondary market. Construction loans also are available for residential and commercial purposes.

4


Deposits

The Bank’s deposit products include demand, interest-bearing transaction accounts, money market accounts, certificates of deposit (“CDs”), municipal deposits, savings, and deposit accounts. CDs offer various maturities ranging from 30 days to five years. The Bank generates relationships by personal contacts within the conventional trading markets for such services by its officers, directors, and employees, who include persons with banking experience in these markets. The Bank also solicits local deposits through the Internet and offers Internet-only deposit accounts to supplement traditional depository accounts.

Wealth Management/Trust Services

The Bank offers retirement planning, financial planning, investment services, and insurance products through its wealth management department which had approximately $374.0 million in assets under management (AUM) as of December 31, 2018 and approximately $359.0 million AUM as of December 31, 2017.

 

Recent Trends and Developments  

As of December 31, 2018, the Bank had $2.7 billion in loans, including loans held for sale, assets of $4.2 billion, deposits of $3.4 billion, and equity of $372.8 million. As of June 30, 2018, the Bank was number one in deposit market share in Williamson County, and was number two in deposit market share in Rutherford County.

Legislative relief and regulatory changes implemented in mid-2018 allow for the reciprocation of local government deposits, eliminating the requirement for the Bank to pledge securities as collateral on such deposits. Therefore, the Bank accelerated the previously planned balance sheet rotation that will ultimately re-deploy $300 million from the securities portfolio into higher-yielding assets. The Bank reduced the bond portfolio by $246 million through sales and principal payments from the mortgage backed securities (MBS) portfolio, recognizing a pre-tax loss of $4.2 million. The majority of the realized loss generated by the securities sales had an immaterial impact on the Company’s capital since previous, unrealized securities losses had been accounted for through accumulated other comprehensive income (AOCI).

In January 2019, the Company declared an initial dividend of $0.04 per share, which was paid on February 28, 2019 to shareholders of record as of February 15, 2019.

On January 15, 2019, the Bank announced that its Memorandum of Understanding (MOU) with banking authorities had been terminated.

In January 2019, the Company’s Board of Directors authorized the repurchase of up to $30 million of the Company’s common stock, which will remain in effect until January 2020. The timing and amount of additional common share repurchases will be subject to market conditions, regulatory requirements, and other considerations, as the Company deems appropriate. The Company’s repurchases may be executed using open market purchases, privately negotiated transactions, accelerated share repurchase programs or other transactions. There have been no repurchases of stock under the program.

On March 8, 2019, Richard E. Herrington retired from his position as President, Chief Executive Officer and Chairman of FFN and as the Chairman and Chief Executive Officer of the Bank. J. Myers Jones, III, Executive Vice President and Chief Credit Officer of the Bank, has been appointed to serve as interim Chief Executive Officer of the Company while the Board conducts a search for the Company’s next Chief Executive Officer, and Lee Moss, President of the Bank, has been appointed to serve as interim President of FFN. The Board has an active search process underway to select the next chief executive officer from internal and external candidates. On March 8, 2019, we entered into an Executive Transition Agreement with Mr. Herrington, pursuant to which Mr. Herrington has agreed to remain an employee of the Company through September 8, 2019 to provide services to the Company on a transitional basis. On March 8, 2019, the Board elected James W. Cross, IV to serve as the Chairman of the Board to fill the vacancy left by Mr. Herrington’s departure. Also on March 8, 2019, Kevin A. Herrington notified the Company that he is resigning from his position as Executive Vice President and Chief Operating Officer of the Bank, effective as of March 8, 2019. Kevin Herrington has also agreed to remain an employee of the Company through September 8, 2019 to provide services to the Company on a transitional basis. On March 8, 2019, the Board appointed Terry Howell as interim Chief Operating Officer of the Bank and Eddie Maynard as Chief Credit Officer of the Bank.

Competition

The Bank is subject to intense competition from various financial institutions and other companies or firms that offer financial services. The Bank competes for deposits with other commercial banks, savings and loan associations, credit unions and issuers of commercial paper and other securities, such as money market and mutual funds. In making loans, the Bank competes with other commercial banks, savings and loan associations, consumer finance companies, credit unions, leasing companies, and other lenders. Information about specific competition in Williamson County, Davidson County, and Rutherford County is included under “RISK

5


FACTORS—Competition For Deposits And Loans Is Intense, and No Assurance Can Be Given That We Will Be Successful in Our Efforts to Compete with Other Financial Institutions.”

The Bank will continue to compete with these and other financial institutions, many of which have far greater assets and financial resources than the Bank and whose common stock may be more widely traded than that of the Company’s. See “BUSINESS—Supervision and Regulation.” No assurance can be given that the Bank will be successful in its efforts to compete with such other institutions.

Risk Management

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

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

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

Employees

As of December 31, 2018, the Company and Bank collectively have 337 full-time employees and 1 part-time employee. We are not subject to any collective bargaining agreements. We offer a typical health and disability insurance plan to our employees and those of the Bank, as well as a 401(k) plan and officer equity-based incentive awards.  

Trademarks

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

Policies and Procedures

The Board of Directors of the Bank annually reviews and approves the Loan Policy, which is the primary tool for making credit decisions when making loans. Asset quality is of utmost importance and an independent loan review process has been established to monitor the Bank’s lending function. It is imperative that the Board of Directors and management have an independent and objective evaluation of the quality of specific individual loans and of the overall quality of the total portfolio.

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

Under the Community Reinvestment Act of 1977 (the “CRA”), the Federal Reserve evaluates the Bank’s record of meeting the credit needs of its communities in which it operates, including low- and moderate-income communities. The Federal Reserve also takes this record into account when deciding on certain applications submitted by the Bank and the Company. Under the CRA, the Bank’s assessment area is Williamson County, Davidson County, and Rutherford County.

Management’s lending objectives are to make credit products available to all segments of the Bank’s market and community. Williamson County has no moderate income census tracts, Davidson County has 44 moderate income census tracts and 28 low income tracts, and Rutherford County has 13 moderate census tracts and two low census tracts.

Supervision and Regulation

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

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Bank Holding Company Regulation

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

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

According to federal law and Federal Reserve policy, bank holding companies are expected to act as a source of financial and managerial strength to their subsidiary banks and to commit resources to support such subsidiary. This support may be required at times when a bank holding company may not be able to provide such support.

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

Various federal and state statutory provisions limit the amount of dividends subsidiary banks can pay to their holding companies without regulatory approval. The payment of dividends by any bank also may be affected by other factors, such as the maintenance of adequate capital for such subsidiary bank. In addition to the foregoing restrictions, the Federal Reserve has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company experiencing earnings weaknesses should not pay cash dividends that exceed its net income or that could only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Federal Reserve may also order a bank holding company to terminate an activity or control of a non-bank subsidiary if such activity or control constitutes a significant risk to the financial safety, soundness, or stability of a subsidiary bank and is inconsistent with sound banking principles. Furthermore, the Tennessee Department of Financial Institutions (“TDFI”) also has authority to prohibit the payment of dividends by a Tennessee bank when it determines such payment to be an unsafe and unsound banking practice.

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

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

The Attorney General of the United States may, within 30 days after approval by the Federal Reserve of an acquisition, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending

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a final ruling by the courts. Failure of the Attorney General to challenge an acquisition does not, however, exempt the holding company from complying with both state and federal antitrust laws after the acquisition is consummated or immunize the acquisition from future challenge under the anti-monopolization provisions of the Sherman Act.

Capital Guidelines

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

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

Under the Basel III rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of Common Equity Tier 1 Capital above its minimum risk-based capital requirements. The buffer is measured relative to RWA. Phase-in of the capital conservation buffer requirements began on January 1, 2016 and the requirements were fully phased in on January 1, 2019. The capital conservation budget threshold for 2018 was 1.875%. A banking organization with a buffer greater than 2.5% will not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% will be subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. Effectively, the Basel III framework will require us to meet minimum capital ratios of (i) 7% for Common Equity Tier 1 Capital, (ii) 8.5% Tier 1 Capital, and (iii) 10.5% Total Capital. The eligible retained income of a banking organization is defined as its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income. Now that the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer exceed the prompt corrective action (“PCA”) well-capitalized thresholds.

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

In May of 2018, Congress passed and the President signed into law, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “EGRRCPA”). Among many important changes to the regulation of the banking industry, the EGRRCPA ordered the federal banking regulators, including the Federal Reserve and FDIC to, through notice and comment rulemaking, develop an “off-

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ramp” exempting certain banking organizations with less than $10 billion in consolidated assets and a low-risk profile from generally applicable leverage capital and risk-based capital requirements if such banking organization maintained a leverage ratio to be set by the federal banking regulators (the “Community Bank Leverage Ratio”).  The EGRRCPA requires the federal banking regulators to set the Community Bank Leverage Ratio between 8% and 10%. On November 21, 2018, the federal banking regulators proposed a rule to implement Section 201 of the EGRRCPA. The proposed rule would set the Community Bank Leverage Ratio at 9%. To date, the proposed rule implementing Section 201 of the EGRRCPA has not been finalized.

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

Tennessee Banking Act; Federal Deposit Insurance Act

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The Dodd-Frank Act

In July 2010, the Dodd-Frank Act was signed into law, incorporating numerous financial institution regulatory reforms. Many of these reforms and continue to be implemented through regulations being adopted by various federal banking and securities regulators. Many of the Dodd-Frank Act provisions only apply to larger financial institutions and do not directly impact community-based institutions like the Bank. For instance, provisions that enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of the Bank’s operations. Other provisions that have impacted or will impact the Bank:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

FDIC Insurance Premiums

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

On March 15, 2016, the FDIC adopted a rule in accordance with provisions of the Dodd-Frank Act that requires large institutions to bear the burden of raising the Reserve Ratio from 1.15% to 1.35%. Since the Reserve Ratio has reached 1.15%, the FDIC will collect assessment surcharges from large institutions. Once the reserve ratio reaches 1.38%, small institutions will receive credits to offset their contribution to raising the Reserve Ratio to 1.35%. On April 26, 2016, the FDIC Board of Directors approved the final rule to improve the deposit insurance assessment system for established small insured depository institutions (generally, those banks with less than $10 billion in total assets that have been insured for at least five years). The final rule was effective July 1, 2016. Since the reserve ratio of the DIF reached 1.15 percent before that date, the final rule determined assessment rates beginning July 1, 2016. Effective July 1, 2016, the initial base assessment rates for all insured institutions were reduced from a range of 5 to 35 basis points to a range of 3 to 30 basis points. Total base assessment rates after possible adjustments were reduced from a range of 2.5 to 45 basis points to a range of 1.5 to 40 basis points. Although the base assessment rates were reduced, the assessment calculation includes pricing adjustments for certain financial ratios that relate to asset growth, loan mix, funding ratios, and nonperforming assets, which in the case of the Bank, may adversely impact the Company’s earnings due to increased premium assessments. Additional increases in premiums will impact FFN’s earnings adversely. Depending on any future losses that the FDIC insurance fund may suffer due to failed institutions, there can be no assurance that there will not be additional significant premium increases in order to replenish the fund.

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

The Community Reinvestment Act  

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

Other Regulations

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

 

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

 

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

 

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

 

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

 

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

 

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

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

Effects of Governmental Policies

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

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

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

From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial institutions. The nature and extent of the

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future legislative and regulatory changes affecting financial institutions and the resulting impact on those institutions is very unpredictable at this time. Bills are currently pending which may have the effect of changing the way the Bank conducts its business.

Recent Developments

New Offices and Branches

During 2018, the Bank opened a new branch in Williamson County at 5040 Carothers Parkway, Suite 109, Franklin, Tennessee, moved a branch in Rutherford County from 1 East College Street to 310 West Main Street, Murfreesboro, Tennessee, began operations at 3325 West End Avenue, Nashville, Tennessee, as part of Civic acquisition, and leased additional office space at 231 South Royal Oaks Boulevard in Franklin, Tennessee and 204 9th Avenue, Franklin, Tennessee. During 2017, the Bank relocated its Spring Hill branch in Williamson County to 4824 Main Street, Suite A, Spring Hill, Tennessee 37174, and opened a new branch in Murfreesboro, Tennessee in Rutherford County, located at 1605 Medical Center Parkway, Murfreesboro, Tennessee 37129.

Available Information

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

The SEC also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC as we do. The website is http://www.sec.gov.

We use our website as a channel of distribution for important company information. Important information, including press releases, analyst presentations and financial information regarding our Company, is routinely posted on and accessible on the Investor Relations subpage of our website, which is accessible by clicking on the tab labeled “Investor Relations” on our website home page.

ITEM 1A.

RISK FACTORS.

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

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Risks Related to Our Business

A Lack of Liquidity Could Adversely Affect Our Operations and Jeopardize Our Liquidity, Business, Financial Condition or Results of Operations

We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities to ensure that we have adequate liquidity to fund our operations. In addition to our traditional funding sources, we also may borrow funds from third-party lenders or issue equity or debt securities to investors. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Our liquidity may also be adversely impacted if there is a decline in our mortgage revenues from higher prevailing interest rates. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our shareholders, or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition or results of operations.

We May Be Materially and Adversely Affected by the Creditworthiness and Liquidity of Other Financial Institutions

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions expose us to credit risk in the event of a default by, or questions or concerns about the creditworthiness of, a counterparty or client, or concerns about the financial services industry generally. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on us.

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

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

The Bank Depends on Its Ability to Attract Deposits

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

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

Although we are increasing our effort to decrease our use of non-core funding sources, we can offer no assurance that we will be able to increase our market share of core-deposit funding in our highly competitive service areas. If we are unable to do so, we may be forced to accept increased amounts of out-of-market or brokered deposits. As of December 31, 2018, we had approximately $797.8 million in out-of-market brokered deposits, which represented approximately 23.2% of our total deposits. The cost of out-of-market and brokered deposits typically exceeds the cost of deposits in our local markets which will decrease our net income. In addition, the cost of out-of-market and brokered deposits can be volatile, and if we are unable to access these types of deposits or if our costs related to out-of-market and brokered deposits increases, our cost of funds will be higher and liquidity and ability to support

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demand for loans could be adversely affected. Out-of-market and brokered deposits and other secondary sources may not be sufficient to meet our liquidity needs.

We Have Extended Off-Balance Sheet Commitments to Borrowers Which Expose Us to Credit and Interest Rate Risk, and We May Not Be Able to Meet Our Unfunded Credit Commitments

We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. These off-balance sheet arrangements include commitments to make loans, credit lines and standby letters of credit which would impact our liquidity and capital resources to the extent customers accept or use these commitments. A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our customers under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Actual borrowing needs of our customers may exceed our expected funding requirements, especially during a challenging economic environment when our client companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from other sources. Any failure to meet our unfunded credit commitments in accordance with the actual borrowing needs of our customers may have a material adverse effect on our business, financial condition, results of operations or reputation.

Commitments to make loans, credit lines and standby letters of credit involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

We May Not Be Able to Implement Our Growth Strategy Effectively

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

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

The commercial banking industry in Williamson County, Tennessee consists of 32 banks and two savings and loan institutions, with 101 total offices and total deposits of $9.6 billion as of June 30, 2018. The commercial banking industry in Davidson County, Tennessee consists of 33 banks, with 203 total offices and total deposits of $35.6 billion as of June 30, 2018. The commercial banking industry in Rutherford County, Tennessee consists of 21 banks, with 72 total offices and total deposits of $4.6 billion as of June 30, 2018. June 30, 2018 is the most recent date such information has been released by the FDIC. Offices affiliated with out-of-state financial institutions have entered Tennessee in recent years to offer all financial services, including lending and deposit gathering activities. Also, changes to laws on interstate banking and branching now permit banks and bank holding companies headquartered outside Tennessee to move into Williamson County, Davidson County, and Rutherford County more easily. In addition, there are credit unions, finance companies, securities brokerage firms, and other types of businesses offering financial services. Technological advances and the growth of e-commerce have made it possible for non-financial institutions to offer products and services that traditionally have been offered by banking institutions. Competition for deposit and loan opportunities in our market area is expected to be intense because of existing competitors and the geographic expansion into the market area by other institutions. See “BUSINESS—Supervision and Regulation.” No assurance can be given that we will be successful in our efforts to compete with other such institutions.

We Face Risks Related to Our Commercial Real Estate Loan Concentrations

Commercial real estate (“CRE”) is cyclical and poses risks of possible loss due to concentration levels and similar risks of the asset class. As of December 31, 2018, approximately 52% of our loan portfolio consisted of CRE loans, including 22% of construction and land development (“CLD”) loans, which present additional risks including underwriting risks, project risks and market risks. The banking regulators give CRE lending greater scrutiny, and have required us to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly requiring a re-assessment of allowances for possible loan losses and capital levels as a result of CRE lending growth and exposures. In addition, while we believe we have appropriate systems in place to underwrite and monitor the risks associated with CLD loans, if these systems do not adequately protect us from these risks, we could incur losses that exceed our reserves for such losses, which could adversely impact our earnings.

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We Are Exposed to Higher Credit Risk Due to Relationship Exposure With a Number of Large Borrowers

As of December 31, 2018, we had $499.8 million borrowing relationships in excess of $10 million which accounted for approximately 18.7% of our loan portfolio. While we are not overly dependent on any one of these relationships and while none of these large relationships have directly impacted our allowance for loan losses in the past, a deterioration of any of these large credits could require us to increase our allowance for loan losses or result in significant losses to us, which could have a material adverse effect on our financial condition, results of operations or cash flows

We Make Loans to Small-to-Medium Sized Businesses That May Not Have the Resources to Weather a Downturn in the Economy

We make loans to privately-owned businesses, many of which are considered to be small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small- to medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns, a sustained decline in commodity prices and other events that negatively impact small businesses in our market areas could cause us to incur substantial loan losses that could negatively affect our results of operations or financial condition.

There Can Be No Assurance That the Bank Will Not Incur Loan Losses In Excess of Our Allowance for Loan Losses

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

We make various assumptions and judgments about the collectability of our loan portfolio and utilize these assumptions and judgments when determining the provision and allowance for loan losses. The determination of the appropriate level of the provision for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the amount reserved in the allowance for credit losses. Any increases in the provision or allowance for loan losses will result in a decrease in our net income and, potentially, capital, and may have a material adverse effect on our financial condition or results of operations.

A New Accounting Standard Will Likely Require Us to Increase Our Allowance for Loan Losses and May Have a Material Adverse Effect on Our Financial Condition and Results of Operations

The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company and the Bank beginning with our first full fiscal year after December 15, 2019. This standard, referred to as Current Expected Credit Loss (“CECL”), will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This standard will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.

Changes in Interest Rates May Reduce the Bank’s Profitability

The Bank’s profitability is dependent, to a large extent, upon net interest income, which is the difference between its interest income on interest-earning assets, such as loans and investment securities and interest expense on interest-bearing liabilities, such as deposits and borrowings. The Bank will continue to be affected by changes in interest rates and other economic factors beyond its control, particularly to the extent that such factors affect the overall volume of our lending and deposit activities. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time

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period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income. Furthermore, an increase in interest rates may negatively affect the market value of securities in our investment portfolio. A reduction in the market value of our portfolio will increase the unrealized loss position of our available-for-sale investments. Any of these events could materially adversely affect our results of operations or financial condition

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

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

If We Are Unable to Grow Our Non-Interest Income, Our Growth Prospects Will Be Impaired

Taking advantage of opportunities to develop new, and expand existing, streams of non-interest income, including our mortgage and wealth management business, is a part of our long-term growth strategy. If we are unsuccessful in our attempts to grow our non-interest income, especially in light of the expected decline in mortgage revenues, our long-term growth will be impaired. Further, focusing on these non-interest income streams may divert management’s attention and resources away from our core banking business, which could impair our core business, financial condition and operating results. We also derive a meaningful amount of our non-interest income from non-sufficient funds and overdraft fees, and such fees are subject to increased regulatory scrutiny, which could result in an erosion of such fees, and as a result, materially impair our future non-interest income.

Income From Mortgage-Banking Operations Is Volatile and We May Incur Losses With Respect to Our Mortgage-Banking Operations That Could Negatively Affect Our Earnings

A component of our business strategy is to sell a portion of residential mortgage loans originated into the secondary market, earning non-interest income in the form of gains on sale. Changes in interest rates may impact our mortgage banking revenues, which could negatively impact our non-interest income. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans we can originate for sale. Weak or deteriorating economic conditions also tend to reduce loan demand. If the residential mortgage loan demand decreases or we are unable to sell such loans for an adequate profit, then our non-interest income will likely decline which would adversely affect our earnings.

Decreased Residential Mortgage Origination Volume and Pricing Decisions of Competitors May Adversely Affect Our Profitability

Our mortgage operation originates and sells residential mortgage loans, services residential mortgage loans, and provides third-party origination services to other community banks and mortgage companies. Changes in interest rates, housing prices, applicable government regulations and pricing decisions by our loan competitors may adversely affect demand for our residential mortgage loan products, the revenue realized on the sale of loans, the revenues received from servicing such loans for others and, ultimately, reduce our net income. New regulations, increased regulatory reviews, and/or changes in the structure of the secondary mortgage markets which we utilize to sell mortgage loans may increase costs and make it more difficult to operate a residential mortgage origination business.

Our Mortgage Banking Profitability Could Significantly Decline If We Are Not Able to Originate and Resell a High Volume of Mortgage Loans and Securities

Mortgage production, especially refinancing activity, declines in rising interest rate environments. Our mortgage origination volume could be materially and adversely affected by rising interest rates. We expect to see declining origination volume in 2019 across the industry. Moreover, when interest rates increase further, there can be no assurance that our mortgage production will continue at current levels. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking business also depends in large part on our ability to aggregate a high volume of loans and sell them in the secondary market at

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a gain. In fact, as rates rise, we expect increasing industry-wide competitive pressures related to changing market conditions to reduce our pricing margins and mortgage revenues generally. If our level of mortgage production declines, our continued profitability will depend upon our ability to reduce our costs commensurate with the reduction of revenue from our mortgage operations. If we are unable to do so, our continued profitability may be materially and adversely affected.

We May Incur Costs, Liabilities, Fines and Other Sanctions If We Fail to Satisfy Our Mortgage Loan Servicing Obligations

We act as servicer for mortgage loans owned by third parties. As a servicer for those loans, we have certain contractual obligations to third parties. If we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period of time following notice, causing us to lose servicing income. For certain investors and/or transactions, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit losses incurred on the loan as a remedy for origination errors with respect to the loan. If we have increased repurchase obligations because of claims that we did not satisfy our obligations as a servicer, or if we have increased loss severity on such repurchases, we may have a significant reduction to net servicing income within our mortgage banking noninterest income. In addition, we may be subject to fines and other sanctions imposed by federal or state regulators as a result of actual or perceived deficiencies in our foreclosure practices. Any of these actions may harm our reputation or negatively affect our residential lending or servicing business and, as a result, our profitability.

We May Be Required to Repurchase Mortgage Loans or Indemnify Buyers Against Losses in Some Circumstances

We sell certain mortgage loans that we originated and purchased. When mortgage loans are sold, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to purchasers, guarantors and insurers about the mortgage loans and the manner in which they were originated. We may be required to repurchase or substitute mortgage loans, or indemnify buyers against losses, in the event we breach certain representations or warranties in connection with the sale of such loans. If repurchase and indemnity demands increase, are valid claims, and are in excess of our provision for potential losses, our liquidity, results of operations, or financial condition may be materially and adversely affected.

The Performance of Our Investment Securities Portfolio is Subject to Fluctuation Due to Changes in Interest Rates and Market Conditions, Including Credit Deterioration of the Issuers of Individual Securities

Our investment portfolio constitutes approximately 25% of our balance sheet as of December 31, 2018. Changes in interest rates may negatively affect both the returns on and market value of our investment securities. Interest rate volatility can reduce unrealized gains or increase unrealized losses in our portfolio. Interest rates are highly sensitive to many factors including monetary policies, domestic and international economic and political issues, and other factors beyond our control. Additionally, actual investment income and cash flows from investment securities that carry prepayment risk, such as mortgage-backed securities and callable securities, may materially differ from those anticipated at the time of investment or subsequently as a result of changes in interest rates and market conditions. These occurrences could have a material adverse effect on our book value, net interest income or results of operations.

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

We conduct our banking operations in Middle Tennessee, in particular Williamson, Rutherford and Davidson Counties within the Nashville metropolitan area. During 2018, the majority of our loans and our deposits were made to borrowers or received from depositors who live and/or primarily conduct business in Middle Tennessee. Therefore, our success will depend in large part upon the general economic conditions in this area, which we cannot predict with certainty.

This geographic concentration imposes risks from lack of geographic diversification, as adverse economic conditions to the extent they develop in our primary market area, which currently is limited to Williamson County, Rutherford County and Davidson County, Tennessee and the surrounding areas, could reduce our growth rate, affect the ability of our customers to repay their loans, and generally affect our financial condition and results of operations. Any regional or local economic downturn that affects Tennessee or existing or prospective borrowers, depositors or property values in this area may affect us and our profitability more significantly and more adversely than our competitors whose operations are less geographically concentrated.

If the communities in which we operate do not grow or if prevailing local or national economic conditions are unfavorable, our business may not succeed. Moreover, management cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market area if they do occur. Continued adverse market or economic conditions may increase the risk that the Bank’s borrowers will be unable to timely make their loan payments. Furthermore, even if the Bank’s borrowers continue to make timely loan payments, a deterioration in the real estate market could cause a decline in the appraised

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values of such mortgaged properties. In the event of such a deterioration, the Bank may be forced to write down the value of the loans, which could have a negative effect on the Bank’s capital ratios and earnings. A sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market or economic conditions in the state of Tennessee, or more specifically the Bank’s market area in Williamson County, Rutherford County and Davidson County in Middle Tennessee, could adversely affect the value of our assets, revenues, results of operations, and financial condition.

The Bank’s loan portfolio is significantly real-estate focused. As of December 31, 2018, approximately 77.6% of the Bank’s total loans were real-estate secured. One-to-four family residential properties accounted for 26% of the Bank’s portfolio, owner-occupied commercial real estate was 9% and other commercial real estate was 19% of the total loan portfolio. Total construction and land development lending accounted for 22% of total loans with residential construction lending totaling 14%, commercial construction lending totaling 4% and land development lending totaling 4%. Other real estate lending, including multi-family and farmland, accounted for 2% of the total loan portfolio. While real estate lending is the expertise of our lending staff and management, risks associated with this type of lending are heavily influenced by the economic environment. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions.

A portion of our loan portfolio is comprised of participation and syndicated transaction interests, which could have an adverse effect on our ability to monitor the lending relationships and lead to an increased risk of loss

We have entered into certain credit transactions, primarily syndicated credit transactions including shared national credits, and we participate in loans originated by other institutions in which other lenders serve as the agent or lead bank. Our reduced control over the monitoring and management of these relationships, particularly participations in large bank groups, could lead to increased risk of loss, which could have a material adverse effect on our business, financial condition, results of operations and future prospects.

A significant portion of our loans are located outside of our primary market area where our ability to oversee such loans directly is limited

Because approximately 25% of our loans are located outside of our Tennessee market area, our senior management’s ability to oversee these loans directly is limited. We may also be unable to properly understand local market conditions or promptly react to local market pressures. Any failure on our part to properly supervise these out-of-market loans could have a material adverse effect on our business, financial condition and results of operations.

We currently invest in bank owned life insurance (“BOLI”) and may continue to do so in the future

We had approximately $120 million in BOLI contracts at December 31, 2018. BOLI is an illiquid long-term asset that provides tax savings because cash value growth and life insurance proceeds are not taxable. However, if we needed additional liquidity and converted the BOLI to cash, such transaction would be subject to ordinary income tax and applicable penalties. We are also exposed to the credit risk of the underlying securities in the investment portfolio and to the insurance carrier’s credit risk (in a general account contract). If BOLI was exchanged to another carrier, additional fees would be incurred and a tax-free exchange could only be done for insureds that were still actively employed by us at that time. There is interest rate risk relating to the market value of the underlying investment securities associated with the BOLI in that there is no assurance that the market value of these securities will not decline. Investing in BOLI exposes us to liquidity, credit and interest rate risk, which could adversely affect our results of operations, financial condition and liquidity.

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

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

 

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

 

Development of Offices: There are considerable costs involved in opening branches, and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly,

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de novo branches may be expected to negatively impact earnings during this period of time until the branches reach certain economies of scale.

 

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

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

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

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

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

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

As a public company, we are required to file periodic reports containing our consolidated financial statements with the SEC within a specified time following the completion of quarterly and annual periods. As a public company, we also incur significant legal, accounting, insurance and other expenses. Compliance with these reporting requirements and other rules of the SEC and the rules of the New York Stock Exchange (“NYSE”) or any exchange on which our common stock may be listed in the future could increase our legal and financial compliance costs and make some activities more time consuming and costly. Furthermore, the need to maintain the corporate infrastructure demanded of a public company may divert management’s attention from implementing our growth strategy, which could prevent us from successfully implementing our strategic initiatives and improving our business, results of operations and financial condition. We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations as a public company. However, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements. We anticipate that these costs will materially increase our general and administrative expenses.

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

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

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companies, our independent registered public accounting firm will be required to report on the effectiveness of our internal control over financial reporting, beginning as of the first annual report after ceasing to be an emerging growth company.

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

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

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

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

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

 

The Failure to Protect Our Customers’ Confidential Information and Privacy Could Adversely Affect Our Business

 

We are subject to federal and state privacy regulations and confidentiality obligations that, among other things restrict the use and dissemination of, and access to, certain information that we produce, store or maintain in the course of our business. We also have contractual obligations to protect certain confidential information we obtain from our existing vendors and customers. These obligations generally include protecting such confidential information in the same manner and to the same extent as we protect our

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own confidential information, and in some instances may impose indemnity obligations on us relating to unlawful or unauthorized disclosure of any such information.

 

Recently passed legislation in the European Union (the General Data Protection Regulation, or GDPR) and in California (the California Privacy Act) may increase the burden and cost of compliance specifically in the realm of consumer data privacy. We are still evaluating the potential impact of these new regulations on our business and do not yet know exactly what the impact may be, but anticipate that there will be at least some added cost and burden as a result of these measures. In addition, other federal, state or local governments may try to implement similar legislation, which could result in different privacy standards for different geographical regions, which could require significantly more resources for compliance.

 

If we do not properly comply with privacy regulations and contractual obligations that require us to protect confidential information, or if we experience a security breach or network compromise, we could experience adverse consequences, including regulatory sanctions, penalties or fines, increased compliance costs, remedial costs such as providing credit monitoring or other services to affected customers, litigation and damage to our reputation, which in turn could result in decreased revenues and loss of customers, all of which would have a material adverse effect on our business, financial condition and results of operations.

The Financial Services Industry Is Undergoing Rapid Technological Changes, and We May Not Have the Resources to Implement New Technology to Stay Current with These Changes

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy client demands for convenience as well as to provide secure electronic environments as we continue to grow and expand our market area. Many of our larger competitors have substantially greater resources to invest, and have invested significantly more than us, in technological improvements. As a result, they may be able to offer additional or more convenient products compared to those that we will be able to provide, which would put us at a competitive disadvantage. Accordingly, we may not be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers, which could impair our growth and profitability.

We Are Subject to Certain Operational Risks, Including, But Not Limited to, Fraud Committed by Employees and Customers

Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence. We maintain a system of internal controls and insurance coverage to mitigate against these operational risks. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition or results of operations.

In addition, we rely heavily upon information supplied by third parties, including the information contained in credit applications, property appraisals, title information, equipment pricing and valuation and employment and income documentation, in deciding which loans we will originate, as well as the terms of those loans. If any of the information upon which we rely is misrepresented, either fraudulently or inadvertently, and the misrepresentation is not detected prior to asset funding, the value of the asset may be significantly lower than expected, or we may fund a loan that we would not have funded or on terms we would not have extended.

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

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

 

general or local economic conditions;

 

environmental cleanup liability;

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neighborhood values;

 

interest rates;

 

real estate tax rates;

 

operating expenses of the mortgaged properties;

 

supply of and demand for rental units or properties;

 

ability to obtain and maintain adequate occupancy of the properties;

 

zoning laws;

 

governmental rules, regulations and fiscal policies; and

 

tornadoes or other natural or man-made disasters and hazard losses.

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

We May Be Subject to Claims and Litigation Asserting Lender Liability

From time to time, and particularly during periods of economic stress, customers, including real estate developers and consumer borrowers, may make claims or otherwise take legal action pertaining to performance of our responsibilities. These claims are often referred to as “lender liability” claims and are sometimes brought in an effort to produce or increase leverage against us in workout negotiations or debt collection proceedings. Lender liability claims frequently assert one or more of the following allegations: breach of fiduciary duties, fraud, economic duress, breach of contract, breach of the implied covenant of good faith and fair dealing, and similar claims. Whether customer claims and legal action related to the performance of our responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a favorable manner, they may result in significant financial liability and/or adversely affect our market reputation, products, and services, as well as potentially affecting customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition, results of operation, and liquidity.

We Are Subject to Environmental Liability Risk Associated with Lending Activities

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

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

The percentage of loans in real estate construction and development in our portfolio was approximately 21.9% of total loans at December 31, 2018. This type of lending is currently robust in Middle Tennessee, but it could slow down and, generally, is considered to have relatively high credit risks because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and operation of the related real estate project. Weakness in residential real estate market prices in the Middle Tennessee area as well as demand could result in price reductions in home and land values adversely affecting the value of collateral securing the construction and development loans that we hold. Should we experience the return of these adverse economic and real estate market conditions we may experience increases in non-performing loans and other real estate owned, increased losses and expenses from the management and disposition of non-performing assets (“NPAs”), increases in provision for loan losses, and increases in operating expenses as a result of the allocation of management time and resources to the collection and work out of loans, all of which would negatively impact our financial condition and results of operations.

We Are Dependent on Key Personnel

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

If We Do Not Successfully Manage the Transition Associated with the Retirement of Our Former Chief Executive Officer and the Appointment of a New Chief Executive Officer, It Could Be Viewed Negatively by Our Customers and Shareholders and Could Have an Adverse Impact on Our Business

On March 8, 2019, Richard E. Herrington retired from his position as President, Chief Executive Officer and Chairman of the Company and as the Chairman and Chief Executive Officer of the Bank. J. Myers Jones, III, Executive Vice President and Chief Credit Officer of the Bank, has been appointed to serve as interim Chief Executive Officer of the Company while the Board conducts a search for the Company’s next Chief Executive Officer, and Lee Moss, President of the Bank, has been appointed to serve as interim President of the Company. The Board has an active search process underway to select the next chief executive officer from internal and external candidates. Such leadership transitions can be inherently difficult to manage, and an inadequate transition of our chief executive officer may cause disruption to our business, including to our relationships with customers, vendors and employees. In addition, if we are unable to attract and retain a qualified candidate to become our permanent chief executive officer in a timely manner, our ability to meet our financial and operational goals and strategic plans may be adversely impacted, as well as our financial performance. It may also make it more difficult to retain and hire key employees.

The Amount of Interest Payable on the March 2016 and June 2016 Notes Will Vary Beginning in 2021

On March 31, 2016, we completed the public offering of $40,000,000 aggregate principal amount of fixed-to-floating rate subordinated Notes due 2026 (the “March 2016 Notes”). On June 30, 2016, we completed the private offering of $20,000,000 aggregate principal amount of fixed-to-floating rate subordinated Notes due 2026 (the “June 2016 Notes”).

The interest rate on the March 2016 Notes and June 2016 Notes will vary beginning in 2021. The March 2016 Notes will bear interest at an initial rate of 6.875% per annum until March 30, 2021, at which time the March 2016 Notes will bear interest at a floating rate equal to three-month LIBOR as calculated on each applicable date of determination, plus a spread of 5.636%. The June 2016 Notes will bear interest at an initial rate of 7.00% per annum until June 30, 2021, at which time the June 2016 Notes will bear interest at a floating rate equal to three-month LIBOR as calculated on each applicable date of determination, plus a spread of 6.04%. If interest rates rise, the cost of the March 2016 Notes and June 2016 Notes may increase, thereby negatively affecting our net income.

We May Fail to Realize All of the Anticipated Benefits from Previously Acquired Financial Institutions or Institutions that We May Acquire in the Future, or Those Benefits May Take Longer to Realize Than Expected; We May Also Encounter Significant Difficulties in Integrating Financial Institutions That We Acquire

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Our ability to realize the anticipated benefits of any acquisition of other financial institutions, bank branches and/or mortgage operations in target markets will depend, to a large extent, on our ability to successfully integrate the acquired businesses. Such an acquisition strategy will involve significant risks, including the following:

 

finding suitable markets for expansion;

 

finding suitable candidates for acquisition;

 

finding suitable financing sources to fund acquisitions;

 

attracting and retaining qualified management;

 

maintaining adequate regulatory capital;

 

obtaining federal and state regulatory approvals; and

 

closing on suitable acquisitions on terms that are favorable to us.

The integration and combination of the acquired businesses is a complex, costly and time-consuming process. As a result, we may be required to devote significant management attention and resources to integrating business practices and operations. The integration process may disrupt our business and the business of the acquired bank and, if implemented ineffectively, would restrict the full realization of the anticipated benefits of the acquisition. The failure to meet the challenges involved in integrating acquired businesses and to fully realize the anticipated benefits of acquisitions could adversely impact our business, financial condition or results of operations.

Risks Related to the Regulation of Our Business

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

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

 

The effect of the acquisition on competition;

 

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

 

The quantity and complexity of previously consummated acquisitions;

 

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

 

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

 

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

 

The applicant’s regulatory compliance record; and

 

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

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

We Are Subject to Extensive Regulation

We are subject to extensive governmental regulation and control. Compliance with state and federal banking laws has a material effect on our business and operations. Our operations is subject to state and federal banking laws, regulations, and procedures. The laws and regulations applicable to the banking industry could change at any time and are subject to interpretation, and management cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the

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business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably. Non-banking financial institutions, such as securities brokerage firms, insurance companies, and money market funds now offer services, which compete directly with services offered by banks. See “BUSINESS—Supervision and Regulation.”

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

The Dodd-Frank Act contains comprehensive provisions governing the practices and oversight of financial institutions and other participants in the financial markets. See “BUSINESS—Supervision and Regulation.” The Dodd-Frank Act established, among other requirements, a new financial industry regulator, the CFPB, to centralize responsibility for consumer financial protection with broad rulemaking authority to administer and carry out the purposes and objectives of the “Federal consumer financial laws and to prevent evasions thereof,” with respect to all financial institutions that offer financial products and services to consumers, including deposit products, residential mortgages, home-equity loans and credit cards and contains provisions on mortgage-related matters, such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider, identifying and prohibiting “unfair, deceptive, or abusive acts or practices” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service (“UDAAP authority”). The ongoing broad rulemaking powers of the CFPB and its UDAAP authority have the potential to have a significant impact on the operations of financial institutions offering consumer financial products or services. The CFPB has indicated that they are examining proposing new rules on overdrafts and other consumer financial products or services and if any such rule limits our ability to provide such financial products or services it may have an adverse effect on our business. Additional legislative or regulatory action that may impact our business may result from the multiple studies mandated under the Dodd-Frank Act. Although the applicability of certain elements of the Dodd-Frank Act is limited to institutions with more than $10 billion in assets, there can be no guarantee that such applicability will not be extended in the future or that regulators or other third parties will not seek to impose such requirements on institutions with less than $10 billion in assets. Finally, President Donald Trump and the Congressional majority have indicated that the Dodd-Frank Act will be under further scrutiny and some of the provisions of the Dodd-Frank Act rules promulgated thereunder may be revised, repealed or amended. We cannot predict with any degree of certainty what impact, if any, these or future reforms will have on our business, financial condition, or results of operations.

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

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

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

We Are Affected by Governmental Monetary Policies

Like all regulated financial institutions, we are affected by monetary policies implemented by the Federal Reserve and other federal instrumentalities. A primary instrument of monetary policy employed by the Federal Reserve is the restriction or expansion of the money supply through open market operations. This instrument of monetary policy frequently causes volatile fluctuations in interest rates, and it can have a direct, adverse effect on the operating results of financial institutions. Borrowings by the United States

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government to finance the government debt may also cause fluctuations in interest rates and have similar effects on the operating results of such institutions. See “BUSINESS—Supervision and Regulation.”

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

Under rules adopted by the Federal Reserve and FDIC, the leverage and risk-based capital ratios of bank holding companies may not be lower than the leverage and risk-based capital ratios for insured depository institutions. These rules became effective on January 1, 2015 and include new minimum risk-based capital and leverage ratios. Moreover, these rules refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements now applicable to bank holding companies and banks subject to the rules are: (i) a Common Equity Tier 1 Capital ratio of 4.5%; (ii) a Tier 1 Risk-Based Capital ratio of 6%; (iii) a total Risk-Based Capital ratio of 8%; and (iv) a Tier 1 Leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% (which was phased in over three years) above the new regulatory minimum capital ratios, and resulted in the following minimum ratios now that the capital conservation buffer is fully phased in: (i) a Common Equity Tier 1 Risk-Based Capital ratio of 7.0%, (ii) a Tier 1 Risk-Based Capital ratio of 8.5%, and (iii) a total Risk-Based Capital ratio of 10.5%. The capital conservation buffer requirement began to be phased in beginning in January 2017 at 1.25% of risk-weighted assets and increased each year until fully implemented in January 2019 at 2.5%. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital levels fall below the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

In May of 2018, Congress passed and the President signed into law, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “EGRRCPA”). Among many important changes to the regulation of the banking industry, the EGRRCPA ordered the federal banking regulators, including the Federal Reserve and FDIC to, through notice and comment rulemaking, develop an “off-ramp” exempting certain banking organizations with less than $10 billion in consolidated assets and a low-risk profile from generally applicable leverage capital and risk-based capital requirements if such banking organization maintained a leverage ratio to be set by the federal banking regulators (the “Community Bank Leverage Ratio”).  The EGRRCPA requires the federal banking regulators to be set the Community Bank Leverage Ratio between 8% and 10%. On November 21, 2018, the federal banking regulators proposed a rule to implement Section 201 of the EGRRCPA. The proposed rule would set the Community Bank Leverage Ratio at 9%. To date, the proposed rule implementing Section 201 of the EGRRCPA has not been finalized. It is difficult at this time to predict when or how any new standards under the EGRRCPA will ultimately be applied to us or what specific impact the EGRRCPA and the yet-to-be-written implementing rules and regulations implementing the EGRRCPA will have.

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

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

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

We Are Subject to Numerous Fair Lending Laws Designed to Protect Consumers and Failure to Comply with These Laws Could Lead to a Wide Variety of Sanctions

The Equal Credit Opportunity Act, the Fair Housing Act, and the Fair Credit Reporting Act, together with  accompanying and / or supplemental regulations, together with other fair lending laws and regulations prohibit discriminatory lending practices, require certain consumer disclosures, and require certain other actions to be taken or refrained from being taken. The U.S. Department of

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Justice, federal banking agencies and other Federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s compliance with fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions, restrictions on dividends, and restrictions on expansion and new lines of business. Private parties may also have the ability to challenge an institution’s performance under fair lending lawns in private class action litigation. Such actions could have a material adverse effect on our assets, business, cash flow, condition (financial or otherwise), liquidity, prospects, reputation or results of operation.

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

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

The Bank had previously entered into a Memorandum of Understanding with its bank regulators, pursuant to which the Bank agreed, among other things, to enhance its policies, practices and processes to reflect the Bank’s increasingly complex business model and risk profile. The MOU was terminated effective as of January 14, 2019, but, in the future, we may become subject to additional supervisory actions and/or enhanced regulation that could have a material negative effect on our business, operating flexibility, financial condition, and the value of our common stock.

Our FDIC Deposit Insurance Premiums and Assessments May Increase

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

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

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

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

The Bank Secrecy Act (the “BSA”), the USA PATRIOT Act of 2001 (the “Patriot Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the Office of Foreign

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Assets Control. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have an adverse effect on our business, financial condition and results of operations.

 

 

Increased Regulatory Oversight, Uncertainty Relating to the LIBOR Calculation Process and Potential Phasing Out of LIBOR After 2021 May Adversely Affect Our Results of Our Operations

 

On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates the London Interbank Offering Rate (“LIBOR”), announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published or supported before or after 2021 or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Effort in the United States to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee of the Federal Reserve Board and the Federal Reserve Bank of New York. Uncertainty as to the nature of alternative reference rates and as to potential changes in other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, any successor or replacement interest rates may perform differently and we may incur significant costs to transition both our borrowing arrangements and the loan agreements with our customers from LIBOR, which may have an adverse effect on our results of operations.

We May Be Adversely Affected By Changes in U.S. Tax Laws and Regulations

On December 22, 2017, the Tax Cuts and Jobs Act, was enacted resulting in significant changes from previous law. The most notable change was a reduction of the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. This legislation required that we revalue our deferred tax items in the fourth quarter of 2017. New legislation or regulation which could affect our tax burden could be enacted by any governmental authority. We cannot predict the timing or extent of such tax-related developments which could materially and adversely affect our results of operations. For additional information see Note 13, “Income Taxes,” in the Notes to Consolidated Financial Statements and in Item 8, Financial Statements and Supplementary Data.

Risks Related to an Investment in Our Common Stock

Shares of Our Common Stock Are Not Insured

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

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

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

If Securities or Industry Analysts Do Not Publish Research or Publish Unfavorable Research About our Business, Our Stock Price and Trading Volume Could Decline

As a smaller company, it may be difficult for us to attract or retain the interest of equity research analysts. A lack of research coverage may adversely affect the liquidity of and market price of our common stock. We will not have any control over the equity research analysts or the content and opinions included in their reports. The price of our stock could decline if one or more equity research analysts downgrade our stock or issue other unfavorable commentary or research. If one or more equity research analysts

29


ceases coverage of the Company, or fails to publish reports on us regularly, demand for our stock could decrease, which in turn could cause our stock price or trading volume to decline.

The Market Price of Our Common Stock May Fluctuate Significantly

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

 

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

 

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

 

changes in economic or business conditions;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

the trading volume of our common stock;

 

future sales of our common stock;

 

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

 

additions or departures of key personnel;

 

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

 

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

 

rapidly changing technology; and

 

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

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

Future Sales of Our Common Stock or Other Securities May Dilute the Value of Our Common Stock

In many situations, our Board of Directors has the authority, without the approval of our shareholders, to issue shares of our authorized but unissued common stock or preferred stock, including shares authorized and unissued under our equity incentive plans. In the future, we may issue additional securities, through public or private offerings, in order to raise additional capital. Any such issuance would dilute the percentage of ownership interest of existing shareholders and may dilute the per share book value of the common stock.

The Issuance of Any of Our Equity Securities Pursuant to Any Equity Compensation Plan We Have Adopted or May Adopt May Dilute the Value of Our Common Stock and May Affect the Market Price of Our Common Stock

Under our existing equity compensation plans, as of December 31, 2018, we had outstanding options to purchase 1,807,922 shares of our common stock and 176,516 non-vested restricted share awards to our officers, employees and non-employee directors. In the future, we may issue to our officers, directors, employees and/or other persons equity based compensation under our Amended and Restated 2017 Omnibus Equity Incentive Plan or any equity compensation plan we may adopt to attract and retain key employees,

30


directors and consultants in order to advance the interests of the Company and its subsidiaries. The award of any such incentives could result in an immediate and potentially substantial dilution to our existing shareholders and could result in a decline in the value of our stock price. The exercise of these options and the sale of the underlying shares of common stock and the sale of common stock issued pursuant to restricted share awards may have an adverse effect upon the price of our common stock.

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

Shares of our common stock are equity interests and do not constitute indebtedness. As such, shares of our common stock rank junior to all of our outstanding indebtedness, including our outstanding March 2016 Notes and our June 2016 Notes, and to other non-equity claims against us and our assets available to satisfy claims against us, including in our liquidation. Additionally, our Board of Directors has the authority to issue in the aggregate up to 1,000,000 shares of preferred stock and to determine the terms of each issue of preferred stock without shareholder approval. Accordingly, you should assume that any shares of preferred stock that we may issue in the future will also be senior to our common stock and could have a preference on liquidating distributions or a preference on dividends that could limit our ability to pay dividends to the holders of our common stock. Upon our voluntary or involuntary dissolution, liquidation, or winding up of affairs, holders of shares of our common stock will not receive a distribution, if any, until after the payment in full of our debts and other liabilities, and the payment of any accrued but unpaid dividends and any liquidation preference on outstanding shares of preferred stock. Because our decision to issue debt or equity securities or incur other borrowings in the future will depend on market conditions and other factors beyond our control, the amount, timing, nature or success of our future capital-raising efforts is uncertain. Thus, common shareholders bear the risk that our future issuances of debt or equity securities or our incurrence of other borrowings will negatively affect the market price of our common stock.

There Is No Certainty of Return on Investment

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

We Cannot Ensure That We Will Continue to Pay Dividends

Our ability to pay dividends is highly dependent on the Bank’s ability to pay dividends and may be limited based upon regulatory restrictions and based upon our earnings and capital needs. The Bank is subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us. On January 23, 2019, our Board of Directors announced its intention to pay a quarterly dividend. Any payment of future dividends will be at the discretion of our Board of Directors and will depend on our earnings, financial condition, capital requirements, regulatory restrictions, statutory and contractual restrictions applying to the payment of dividends, and other considerations that our Board of Directors deems relevant. Accordingly, there can be no assurance that we will continue to pay dividends to our shareholders in the future.  

We May Require Additional Capital

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

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

We are an emerging growth company. For as long as we continue to be an emerging growth company, among other things, we may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and

31


proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if we comply with the greater obligations of public companies that are not emerging growth companies, we may avail ourselves of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We became an emerging growth company effective and approved by the SEC on May 14, 2014, and will retain the emerging growth company status until the end of the fiscal year ending December 31, 2019 and all subsequent filings. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

Anti-Takeover Provisions and Contractual Obligations Could Adversely Affect Our Shareholders

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

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

We have entered into change of control agreements which provide for certain payments to these executives in connection with a change of control of the Company. The change of control agreements would increase the acquisition costs to a company purchasing us. As a result, the change of control agreements may delay or prevent a sale or change of control of the Company.

ITEM 1B.

UNRESOLVED STAFF COMMENTS.

None.

ITEM 2.

PROPERTIES.

FFN’s and the Bank’s main office and headquarter’s operation is leased and located at 722 Columbia Avenue, Franklin, Tennessee 37064. In addition, the Company leases and operates at the following locations: 3359 Aspen Grove Drive, Suite 100, Franklin, Tennessee 37067; 134 Pewitt Drive, Suite 100, Brentwood, Tennessee 37027; 1015 Westhaven Blvd., Suite 150, Franklin, Tennessee 37064; 40 Moss Lane, Suite 100, Franklin, Tennessee 37064; 4824 Main Street, Suite A, Spring Hill, Tennessee 37174; 7177 Nolensville Road, Suite A3, Nolensville, Tennessee 37135; 310 W Main Street, Murfreesboro, Tennessee 37130; 724 President Place, Smyrna, Tennessee 37167; 2415 Memorial Boulevard, Murfreesboro, Tennessee 37129; 2782 South Church Street, Murfreesboro, Tennessee 37127; 2610 Old Fort Parkway, Murfreesboro, Tennessee 37128; and 1605 Medical Center Parkway, Murfreesboro, Tennessee 37129, 3325 West End Avenue, Nashville, Tennessee 37203, and 5040 Carothers Parkway, Suite 109, Franklin, Tennessee 37067. The Bank also operates a loan production office at 33 Music Square West, Nashville, Tennessee 37203. In addition, the Bank has part of its operations in an office located at 101 Southeast Parkway, Suite 100, Franklin, TN 37064, and has additional office space at 231 South Royal Oaks Boulevard, Franklin, Tennessee 37064 and 204 9th Avenue, Franklin, Tennessee 37064.

32


ITEM 3.

LEGAL PROCEEDINGS.

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

ITEM 4.

MINE SAFETY DISCLOSURES.

Not applicable.

33


PART II

ITEM 5.

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

Market Information and Holders

Our common stock is traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “FSB”.  

 

As of February 28, 2019, we had 1,581 shareholders of record of our common stock.

Dividend Policy

Prior to 2019, the Company had not declared nor paid dividends on our common stock. In January 2019, the Company’s Board of Directors declared a quarterly dividend of $0.04 per share which was paid on February 28, 2019 to shareholders of record on February 15, 2019.  

As a bank holding company, our ability to pay dividends is affected by the policies and enforcement powers of the Federal Reserve. In addition, because we are a holding company, we are dependent upon the payment of dividends by the Bank as our principal source of funds to pay dividends in the future and to make other payments. The Bank is also subject to various legal, regulatory and other restrictions on its ability to pay dividends and make other distributions and payments to us.

Recent Sales of Unregistered Securities

There were no unregistered sales of our equity securities during the year ended December 31, 2018.

Performance Graph

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

The following graph shows a comparison from March 26, 2015 (the date our common stock commenced trading on the NYSE) through December 31, 2018 of the cumulative total return for our common stock, the NYSE Composite Index and the KBW Regional Banks Index. The graph assumes that $100 was invested at the market close on March 26, 2015 in the common stock of Franklin Financial Network, Inc., the NYSE Composite Index and the KBW Regional Banks Index and data assumes reinvestments of dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance.

 

 

Comparison of 34 Month Cumulative Total Return

Assumes Initial Investment of $100

December 2018

34


 

35


ITEM 6.SELECTED FINANCIAL DATA.

The following selected historical consolidated financial data as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014, is derived, in some cases, from the audited consolidated financial statements of FFN.

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

 

 

 

Year ended December 31,

 

 

 

2018

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

SUMMARY OF OPERATIONS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

$

169,945

 

 

$

132,453

 

 

$

99,907

 

 

$

68,721

 

 

$

43,432

 

Total interest expense

 

 

64,442

 

 

 

35,407

 

 

 

18,323

 

 

 

9,306

 

 

 

5,739

 

Net interest income

 

 

105,503

 

 

 

97,046

 

 

 

81,584

 

 

 

59,415

 

 

 

37,693

 

Provision for loan losses

 

 

2,254

 

 

 

4,313

 

 

 

5,240

 

 

 

5,030

 

 

 

2,374

 

Net interest income after provision for loan losses

 

 

103,249

 

 

 

92,733

 

 

 

76,344

 

 

 

54,385

 

 

 

35,319

 

Non-interest income

 

 

10,662

 

 

 

14,721

 

 

 

15,140

 

 

 

12,830

 

 

 

10,051

 

Non-interest expense

 

 

73,478

 

 

 

60,824

 

 

 

51,681

 

 

 

42,114

 

 

 

31,822

 

Income before income taxes

 

 

40,433

 

 

 

46,630

 

 

 

39,803

 

 

 

25,101

 

 

 

13,548

 

Income tax expense

 

 

5,912

 

 

 

18,531

 

 

 

11,746

 

 

 

9,021

 

 

 

5,134

 

Net income

 

 

34,521

 

 

 

28,099

 

 

 

28,057

 

 

 

16,080

 

 

 

8,414

 

Preferred stock dividend requirement

 

 

 

 

 

 

 

 

(23

)

 

 

(100

)

 

 

(100

)

Earnings attributable to noncontrolling interest

 

 

(16

)

 

 

(16

)

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

34,505

 

 

$

28,083

 

 

$

28,034

 

 

$

15,980

 

 

$

8,314

 

PER COMMON SHARE DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

2.44

 

 

$

2.14

 

 

$

2.56

 

 

$

1.62

 

 

$

1.32

 

Diluted earnings per share

 

$

2.34

 

 

$

2.04

 

 

$

2.42

 

 

$

1.54

 

 

$

1.27

 

Common equity per common share outstanding

 

$

25.65

 

 

$

23.01

 

 

$

20.73

 

 

$

16.92

 

 

$

14.41

 

Dividends per common share

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Preferred shares outstanding

 

 

 

 

 

 

 

 

-

 

 

 

10

 

 

 

10

 

Actual common shares outstanding

 

 

14,538

 

 

 

13,237

 

 

 

13,037

 

 

 

10,571

 

 

 

7,756

 

Weighted average common shares outstanding, including

   participating securities

 

 

14,169

 

 

 

13,145

 

 

 

10,933

 

 

 

9,885

 

 

 

6,320

 

Diluted weighted average common shares outstanding,

   including participating securities

 

 

14,710

 

 

 

13,780

 

 

 

11,608

 

 

 

10,390

 

 

 

6,557

 

BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

4,249,439

 

 

$

3,843,526

 

 

$

2,943,189

 

 

$

2,167,792

 

 

$

1,355,827

 

Loans held for sale

 

 

11,103

 

 

 

12,024

 

 

 

23,699

 

 

 

14,079

 

 

 

18,462

 

Loans, net of unearned income

 

 

2,665,399

 

 

 

2,256,608

 

 

 

1,773,592

 

 

 

1,303,826

 

 

 

787,188

 

Allowance for loan losses

 

 

23,451

 

 

 

21,247

 

 

 

16,553

 

 

 

11,587

 

 

 

6,680

 

Total securities

 

 

1,152,285

 

 

 

1,214,737

 

 

 

983,649

 

 

 

734,038

 

 

 

449,037

 

Total deposits

 

 

3,431,807

 

 

 

3,167,228

 

 

 

2,391,818

 

 

 

1,814,039

 

 

 

1,172,233

 

Federal Home Loan Bank advances

 

 

368,500

 

 

 

272,000

 

 

 

132,000

 

 

 

57,000

 

 

 

19,000

 

Other borrowed funds

 

 

58,693

 

 

 

89,519

 

 

 

141,638

 

 

 

101,086

 

 

 

39,078

 

Preferred shareholders’ equity

 

 

 

 

 

 

 

 

-

 

 

 

10,000

 

 

 

10,000

 

Common equity

 

 

372,740

 

 

 

304,550

 

 

 

270,258

 

 

 

178,816

 

 

 

111,799

 

Total shareholders’ equity

 

 

372,740

 

 

 

304,550

 

 

 

270,258

 

 

 

188,816

 

 

 

121,799

 

Noncontrolling interest in consolidated subsidiary

 

 

93

 

 

 

103

 

 

 

103

 

 

 

 

 

 

 

Total equity

 

 

372,833

 

 

 

304,653

 

 

 

270,361

 

 

 

188,816

 

 

 

121,799

 

Average total assets

 

 

4,112,436

 

 

 

3,445,654

 

 

 

2,557,268

 

 

 

1,750,697

 

 

 

1,049,689

 

Average loans(1)

 

 

2,482,353

 

 

 

2,031,883

 

 

 

1,554,482

 

 

 

1,009,130

 

 

 

609,714

 

Average interest-earning assets

 

 

3,995,592

 

 

 

3,361,320

 

 

 

2,496,361

 

 

 

1,685,073

 

 

 

1,008,156

 

Average deposits

 

 

3,343,732

 

 

 

2,787,656

 

 

 

2,153,712

 

 

 

1,478,801

 

 

 

896,674

 

Average interest-bearing deposits

 

 

3,046,506

 

 

 

2,535,380

 

 

 

1,942,932

 

 

 

1,314,517

 

 

 

796,569

 

Average interest-bearing liabilities

 

 

3,465,110

 

 

 

2,891,943

 

 

 

2,125,986

 

 

 

1,409,753

 

 

 

848,993

 

Average total shareholders’ equity

 

 

337,378

 

 

 

290,436

 

 

 

207,763

 

 

 

168,933

 

 

 

97,567

 

SELECTED FINANCIAL RATIOS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

 

0.84

%

 

 

0.82

%

 

 

1.10

%

 

 

0.92

%

 

 

0.80

%

Return on average equity

 

 

10.23

%

 

 

9.67

%

 

 

13.50

%

 

 

9.52

%

 

 

8.62

%

Average equity to average total assets

 

 

8.20

%

 

 

8.43

%

 

 

8.12

%

 

 

9.65

%

 

 

9.29

%

Dividend payout

 

 

%

 

 

%

 

 

%

 

 

%

 

 

%

Efficiency ratio(2)

 

 

63.25

%

 

 

54.42

%

 

 

53.43

%

 

 

58.29

%

 

 

66.65

%

Net interest margin(3)(5)

 

 

2.71

%

 

 

3.06

%

 

 

3.42

%

 

 

3.62

%

 

 

3.74

%

Net interest spread(4)(5)

 

 

2.46

%

 

 

2.89

%

 

 

3.29

%

 

 

3.51

%

 

 

3.63

%

CAPITAL RATIOS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity Tier 1 ratio

 

 

12.18

%

 

 

11.37

%

 

 

11.75

%

 

 

10.08

%

 

N/A

 

Tier 1 leverage ratio

 

 

8.76

%

 

 

8.25

%

 

 

9.28

%

 

 

8.48

%

 

 

8.57

%

Tier 1 risk-based capital

 

 

12.18

%

 

 

11.37

%

 

 

11.75

%

 

 

10.51

%

 

 

11.58

%

Total risk-based capital

 

 

14.91

%

 

 

14.40

%

 

 

15.09

%

 

 

11.21

%

 

 

12.30

%

ASSET QUALITY RATIOS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net charge-offs (recoveries) to average loans

 

 

0.00

%

 

 

(0.02

)%

 

 

0.02

%

 

 

0.01

%

 

 

0.10

%

Allowance to period end loans(6)

 

 

0.88

%

 

 

0.94

%

 

 

0.93

%

 

 

0.89

%

 

 

0.85

%

Allowance for loan losses to non-performing loans

 

 

411.71

%

 

 

698.45

%

 

 

267.76

%

 

 

352.62

%

 

 

580.36

%

Non-performing assets to total assets

 

 

0.13

%

 

 

0.12

%

 

 

0.21

%

 

 

0.16

%

 

 

0.14

%

OTHER DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Banking locations

 

 

15

 

 

 

13

 

 

 

12

 

 

 

11

 

 

 

11

 

Full-time equivalent employees

 

 

338

 

 

 

284

 

 

 

268

 

 

 

225

 

 

 

216

 

 

(1)

Average loans include both loans held in the Bank’s portfolio and mortgage loans held for sale and are net of deferred origination fees and costs.

36


(2)

Efficiency ratio is non-interest expense divided by the sum of net interest income before the provision for loan losses plus non-interest income.

(3)

Net interest margin is net interest income (annualized for interim periods) divided by total average earning assets.

(4)

Net interest spread is the difference between the average yield on interest-earning assets and the average yield on interest-bearing liabilities.

(5)

Interest income and rates for 2018, 2017 and 2016 include the effects of tax-equivalent adjustments, which adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis. Due to immateriality, interest income and rates for 2015 and prior exclude the effects of tax-equivalent adjustments.

(6)

Period end loans exclude loans held for sale and exclude deferred fees and costs.

 

37


ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. (All dollar values in this section are in thousands.)

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with Item 8 “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” as well as other information included in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth in Item 1A. “Risk Factors” of this report.

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 (GAAP) and conform to general practices within the banking industry. To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

The Company’s accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the notes to the consolidated financial statements included elsewhere in this report. The critical accounting policies require judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. Management has established policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief summary of the more significant policies:

Allowance for Loan Losses

The allowance for loan losses is a reserve for probable incurred credit losses. Loan losses are charged against the allowance when management believes a loan has become uncollectable. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Bank 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 (TDR) 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 as substandard or worse are individually evaluated for potential designation as impaired. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

TDRs 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 TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, the Bank determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank’s loss history and loss history from the Bank’s peer group. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk

38


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.

Overview  

The Company reported net income of $34,521 for the year ended December 31, 2018, compared to $28,099 for the year ended December 31, 2017, and $28,057 for the year ended December 31, 2016. After earnings attributable to noncontrolling interest in 2018 and 2017 and the payment of preferred dividends on the senior preferred stock issued to the Treasury pursuant to Small Business Lending Fund (“SBLF”) in 2016, the Company’s net earnings available to common shareholders for the years ended December 31, 2018, 2017 and 2016 were $34,505, $28,083, and $28,034, respectively. Net earnings available to shareholders increased by $6,422 when comparing 2018 with 2017, primarily due to the decrease in the effective tax rate for 2018 attributed to the Tax Act reducing the federal income tax rate from 35% to 21%, the Bank’s participation in Tennessee’s Community Investment Tax Credit (CITC) program which provided $660 of state tax credits, and an increase in net interest income after provision for loan losses of $8,457. That was offset by a decrease of $4,059 in non-interest income, of which $4,160 is related to a loss on sale of securities during the fourth quarter of 2018. Net earnings available to common shareholders for 2017 of $28,083 was relatively consistent when compared with 2016 net earnings available to common shareholders of $28,034.  

Net Interest Income/Margin

Net interest income consists of interest income generated by earning assets, less interest expense. Net interest income for the years ended December 31, 2018, 2017 and 2016 totaled $105,503, $97,046, and $81,584, respectively, which are increases of $8,457, or 8.7%, and $15,462, or 19.0%, respectively.

For the years ended December 31, 2018 and 2017, interest income increased $37,492 and $32,546 primarily due to growth in the loan and securities portfolio. These were partially offset by increases of $29,035 and $17,084 in interest expense, which totaled $64,442, $35,407 and $18,323, respectively, for the years ended December 31, 2018, 2017 and 2016, primarily due to increases in interest rates during 2018 which drove up the cost of funds for the Bank.  

Interest-earning assets averaged $3,995,592, $3,361,320, and $2,496,361 during the years ended December 31, 2018, 2017 and 2016, which are increases of $634,272, or 18.9%, and $864,959, or 34.6%, respectively, primarily due to significant growth in loans and investment securities.

For the years ended December 31, 2018 and 2017, average loans increased 22.2% and 30.7%, respectively, and investment securities increased 9.9% and 38.9%, respectively. The yield on average interest-earning assets increased 21 basis points to 4.32% during the year ended December 31, 2018, and decreased 4 basis points to 4.11% during the year ended December 31, 2017, compared to 4.15% for the year ended December 31, 2016. The yield on average loans increased 37 basis points during the year ended December 31, 2018 and decreased 9 basis points during the year ended December 31, 2017. The increase in yields for 2018 is primarily due to increased contractual interest rates, which increased loan yields by 42 basis points in 2018, and the decrease in 2017 was due to the reduced origination and other fee income recognized and due to reduced accretion of discounts on purchased loans recognized during 2017.

For the years ended December 31, 2018, 2017 and 2016, the yield on available for sale (AFS) securities was 2.58%, 2.65% and 2.49%, respectively. The decrease in yield in 2018 is primarily attributable to the Company’s reduced tax-equivalent yield on tax-exempt municipal securities due to a lower tax rate resulting from the Tax Cuts and Jobs Act (the “Tax Act”), which was signed into law on December 22, 2017. The increase in yields in 2017 and 2016 is due to the increased volume of tax-exempt municipal securities that were purchased in 2017 and 2016 combined with the slowing of prepayment amortization for mortgage-backed securities (MBS) during 2017.

For the years ended December 31, 2018, 2017 and 2016, the yield on held to maturity (HTM) securities was 3.69%, 4.17% and 3.90%, respectively. The decrease in yield in 2018 is primarily due to a lower tax-equivalent yield on tax exempt bonds due to a lower tax rate due to the Tax Act., and additionally, the company transferred 40 bonds from the HTM intention to the AFS intention during the fourth quarter. The increase in yields in 2017 and in 2016 was attributable to the increased volume of tax-exempt municipal securities purchased over the two-year period, generating significant tax-exempt income, combined with the slowing of prepayment amortization for the MBS portfolio.

 

39


Interest-bearing liabilities averaged $3,465,110, $2,891,943, and $2,125,986, respectively, during the years ended December 31, 2018, 2017 and 2016, which are increases of $573,167, or 19.8%, during 2018 and $765,957, or 36.0%, during 2017. The increases for 2018 and 2017 were due to growth in interest checking, money market deposits, time deposits and FHLB advances during these two years.  

During 2018, total average interest-bearing deposits grew $511,126, which included increases in average interest checking of $205,366, average money market accounts of $141,863, and average time deposits outstanding of $171,574. During 2017, total average interest-bearing deposits grew $592,448, which included increases in average interest checking of $292,327, average money market accounts of $10,104 and average time deposits outstanding of $284,590. 

Growth in the loan portfolio also resulted in an increase in average FHLB advances of $81,578 and $159,803, respectively in 2018 and 2017. Subordinated notes and other borrowings increased by $178 and $19,145, in 2018 and 2017, respectively. The growth in 2018 was due to the amortization of borrowing costs, and the growth in 2017 was due to having a full year of subordinated notes outstanding compared with a partial year in 2016 when the Company had two subordinated note issuances in March and June of 2016.  

The cost of average interest-bearing liabilities increased 64 basis points to 1.86% during 2018 and increased 36 basis points to 1.22% during 2017. The increase in 2018 cost of interest-bearing liabilities was due to increases in rates on interest checking, money market accounts, time deposits, FHLB advances and Federal funds purchased. The increase in 2017 cost of interest-bearing liabilities was due to increases in rates on interest checking, money market accounts, FHLB advances and the subordinated notes that were added during 2016.

40


The tables below summarize average balances, yields, cost of funds, and the analysis of changes in interest income and interest expense for the years ended December 31, 2018, 2017, and 2016:

Average Balances(7)—Yields & Rates

(Dollars in thousands)

 

 

 

Year Ended December 31,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

Average

Balance

 

 

Interest

Inc/Exp

 

 

Average

Yield/Rate

 

 

Average

Balance

 

 

Interest

Inc/Exp

 

 

Average

Yield/Rate