SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|☒||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the fiscal year ended December 31, 2019
|☐||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)
(State or other jurisdiction of
incorporation or organization)
722 Columbia Avenue, Franklin, Tennessee 37064
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
|Common Stock, no par value per share||FSB||New York Stock Exchange|
Securities registered pursuant to Section 12(g) of the Act:
(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 x 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 x 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. x 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). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
|Large accelerated filer||¨||Accelerated filer||x|
|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 x 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 28, 2019 was $431,382,862 (computed on the basis of $27.86 per share).
The number of shares outstanding of the registrant’s common stock, no par value per share, as of March 6, 2020 was 14,859,704.
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
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:
•the risk that the cost savings and any revenue synergies from the proposed merger with FB Financial Corporation may not be realized or may take longer than anticipated to be realized;
•disruption from the proposed merger with customer, supplier, or employee relationships;
•the occurrence of any event, change, or other circumstances that could give rise to the termination of the merger agreement with FB Financial Corporation;
•the failure to obtain necessary regulatory approvals for the proposed merger with FB Financial Corporation;
•the failure to obtain the approval of the Company’s and FB Financial Corporation’s shareholders in connection with the proposed merger;
•the possibility that the costs, fees, expenses, and charges related to the proposed merger with FB Financial Corporation may be greater than anticipated, including as a result of unexpected or unknown factors, events, or liabilities;
•the failure of the conditions to the proposed merger to be satisfied;
•the risks related to the integration of the combined businesses (as well as FB Financial Corporation’s acquisition of FNB Financial Corp completed February 14, 2020, and any future acquisitions), including the risk that the integration will be materially delayed or will be more costly or difficult than expected;
•the diversion of management time on merger-related issues;
•the ability of FB Financial Corporation to effectively manage the larger and more complex operations of the combined company following the proposed merger with the Company;
•reputational risk and the reaction of the Company’s and FB Financial Corporation’s customers to the proposed merger;
•the risk of potential litigation or regulatory action related to the proposed merger;
•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;
•adverse trends or events affecting business industry groups, reduction in real estate values or markets, business closings or layoffs, inclement weather, natural disasters, pandemic crises, and international instability;
•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 on the securities held in our securities portfolio;
•changes in the level of nonperforming assets and other credit quality measures, and their impact on the adequacy of our allowance for loan losses;
•further deterioration in the credits that we are presently monitoring could result in future losses;
•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.
ITEM 1. BUSINESS.
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 in the growing Williamson, Rutherford and Davidson Counties, and a loan production / deposit production office in Wilson County, all 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, 2019, we had consolidated total assets of $3.9 billion, total loans, including loans held for sale, of $2.8 billion, total deposits of $3.2 billion and total equity of $410.4 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, Mt. Juliet, 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.
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.
The Bank operates 15 branches in Williamson, Davidson, and Rutherford counties in Tennessee. 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. We have expanded our footprint into Wilson County, Tennessee with opening a loan and deposit operations facility in February 2020.
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 24.99% per the FDIC’s Summary of Deposits report as of June 30, 2019, despite the presence of more institutions competing for deposits. The Bank’s deposit market share in Rutherford County is 10.5%, which ranks fifth in that market.
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 49.2% of local deposits in the Nashville-Davidson-Murfreesboro-Franklin metropolitan statistical area (the “Nashville MSA”) as of June 30, 2019) 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:
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.
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 dual delivery systems of traditional branches and the Internet, including mobile banking.
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.
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 $460.0 million in assets under management (AUM) as of December 31, 2019 and approximately $374.0 million AUM as of December 31, 2018.
Recent Trends and Developments
In January 2020, the Company declared a dividend of $0.06 per share, which was paid on February 28, 2020 to shareholders of record as of February 14, 2020.
On January 21, 2020, FFN, FB Financial Corporation, a Tennessee corporation (“FB Financial”), and Paisley Acquisition Corporation, a Tennessee corporation and a direct, wholly-owned subsidiary of FB Financial (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which, on the terms and subject to the conditions set forth therein, Merger Sub will merge with and into FFN, with FFN continuing as the surviving corporation (the “Merger”). Immediately following the Merger, FFN will merge with and into FB Financial, with FB Financial continuing as the surviving corporation (the “Upstream Merger”). Immediately following the Upstream Merger, FSB will merge with and into FirstBank, a Tennessee state-chartered bank and a wholly owned subsidiary of FB Financial (“FirstBank”), with FirstBank continuing as the surviving bank (the “Bank Merger,” and, together with the Merger and the Upstream Merger, the “Mergers”).
Under the terms and subject to the conditions of the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of our common stock, no par value (the “FFN Common Stock”), issued and outstanding immediately prior to the Effective Time (except for certain shares of FFN Common Stock owned by FFN as treasury stock or by FB Financial, as provided in the Merger Agreement) will be converted, in accordance with the procedures set forth in the Merger Agreement, into the right to receive, without interest, (1) 0.9650 shares (the “Exchange Ratio”) of common stock, par value $1.00 per share, of FB Financial (“FB Financial Common Stock”) and (2) $2.00 in cash (the “Per Share Cash Consideration” and, collectively with the FB Financial Common Stock to be issued pursuant to the preceding clause (1), the “Merger Consideration”).
The completion of the Mergers is subject to customary conditions, including (i) receipt of the approval of FFN's shareholders and FB Financial's shareholders, (ii) authorization for listing on the New York Stock Exchange of the shares of FB Financial Common Stock to be issued in the Merger, (iii) the receipt of required regulatory approvals, including the approval of the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Tennessee Department of Financial Institutions, (iv) effectiveness of the registration statement on Form S-4 for the FB Financial Common Stock to be issued in the Merger, and (v) the absence of any order, injunction or other legal restraint preventing or making illegal the completion of the Merger or any of the other transactions contemplated by the Merger Agreement.
On February 5, 2020, the Company purchased the properties at the Columbia Avenue and 120 9th Ave locations in Franklin, Tennessee, therefore ending the lease agreements for these properties.
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 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. No assurance can be given that the Bank will be successful in its efforts to compete with such other institutions.
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.
As of December 31, 2019, the Company and Bank collectively have 339 employees. We are not subject to any collective bargaining agreements.
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 or low income census tracts, Davidson County has 44 moderate income census tracts and 28 low income census tracts, Wilson County has 4 moderate income census tracts and 1 low income census tract, and Rutherford County has 13 moderate income census tracts and two low income 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.
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 the Federal Reserve's Regulation Y ("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 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.
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 at 2.5% on January 1, 2019. 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 requires 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-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 October 29, 2019, the federal banking regulators adopted a rule to implement Section 201 of the EGRRCPA. The rule sets the Community Bank Leverage Ratio at 9%. The rule regarding community bank leverage ratios became effective for us January 1, 2020.
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).
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.
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.
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.
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 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.
New Offices and Branches
During 2019, the Bank signed two leases with plans to relocate the Nolensville, Tennessee branch in 2020 and to open a loan production and deposit production office in Mt Juliet, Tennessee in 2020.
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.
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, pandemic crises 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 offers 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, 2019, we had approximately $632.2 million in out-of-market brokered deposits, which represented approximately 19.7% 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 our liquidity and ability to support 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 on 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 Business Strategy Effectively
Historically, our Company's business strategy relied heavily upon growth, which was primarily driven by organic asset growth and was supplemented by opportunistic acquisitions. During the course of the last year, our Board of Directors and senior management team undertook an intensive strategic evaluation, which resulted in a fundamental change to our overall business strategy, focusing on balancing growth with profitability. However, we may not be able to execute aspects of our overall strategy, and in particular, may not be able to effectively implement our growth initiatives or may not be able to appropriately balance growth and profitability. 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 35 banks and two savings and loan institutions, with 106 total offices and total deposits of $10.2 billion as of June 30, 2019. The commercial banking industry in Davidson County, Tennessee consists of 34 banks, with 200 total offices and total deposits of $36.9 billion as of June 30, 2019. The commercial banking industry in Rutherford County, Tennessee consists of 22 banks, with 73 total offices and total deposits of $4.8 billion as of June 30, 2019. June 30, 2019 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, 2019, approximately 56% of our loan portfolio consisted of CRE loans, including 21% 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.
We Are Exposed to Higher Credit Risk Due to Relationship Exposure With a Number of Large Borrowers
As of December 31, 2019, we had $646.8 million borrowing relationships in excess of $10 million which accounted for approximately 23.1% 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 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. Given the decline in interest rates recently, we expect to see an increase in origination volume in 2020 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 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 17% of our balance sheet as of December 31, 2019. 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.
We could be required to write down goodwill and other intangible assets.
As of December 31, 2019, our goodwill and other identifiable intangible assets were $18,624. A significant and sustained decline in our stock price and market capitalization below book value, a significant decline in our expected future cash flows, a significant adverse change in the business climate, slower growth rates or other factors could result in impairment of our goodwill. If we were to conclude that a write-down of our goodwill is necessary, then the appropriate charge would likely cause a material loss. Any impairment charge would have an adverse effect on our shareholders' equity and financial results and could cause a decline in our stock price. We conduct a review at least annually to determine whether goodwill is impaired. Our goodwill impairment evaluation indicated no impairment of goodwill for our reporting segments. We cannot provide assurance, however, that we will not be required to take an impairment charge in the future.
Weather-Related Events, Other Natural Disasters, or Health Emergencies May Adversely Affect Our Business, Financial Condition or Results of Operations.
We operate in Williamson, Rutherford and Davidson Counties within the Nashville metropolitan area. This region has experienced weather events including floods, tornadoes, fires and other natural disasters. The nature and level of these events and their frequency and severity cannot be predicted. If large scale events occur, they may significantly impact our loan portfolios by damaging properties pledged as collateral as well as impairing our borrowers’ ability to repay their loans.
Additionally, the impact of widespread health emergencies may adversely impact our results of operations, such as the potential impact from the recent outbreak of the coronavirus (COVID-19), which originated in Wuhan, Hubei Province, China but has now spread to other countries, including the United States. On March 5, 2020, Tennessee state health officials identified the first confirmed case of COVID-19 in Williamson County. Recent developments and reports relating to the coronavirus have coincided with heightened volatility in financial markets in the U.S. and worldwide. If COVID-19 adversely affects our own operations or adversely affects the ability of our borrowers to satisfy their obligations, the demand for our loans, or our business operations, or leads to a significant or prolonged impact on global markets or economic growth, our financial conditions and results of operations could be adversely affected.
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 2019, 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 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, 2019, approximately 79.1% of the Bank’s total loans were real-estate secured. One-to-four family residential properties accounted for 23% of the Bank’s portfolio, owner-occupied commercial real estate was 10% and other commercial real estate was 24% of the total loan portfolio. Total construction and land development lending accounted for 21% of total loans with residential construction lending totaling 11%, commercial construction lending totaling 7% and land development lending totaling 3%. Other real estate lending, including multi-family and farmland, accounted for 1% 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 less access to borrower 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 24% 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 $57 million in cash surrender value of BOLI contracts at December 31, 2019. 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.
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, including workplace violence 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 continue to increase our general and administrative expenses.
We identified a material weakness in our internal control over financial reporting and determined that our control related to the Company’s precision of review regarding the valuation of impaired loans was not effective. If we are unable to successfully implement remedial action to address this material weakness, we may be unable to maintain effective internal control over financial reporting.
The Sarbanes-Oxley Act and related rules and regulations require that management report annually on the effectiveness of our internal control over financial reporting and assess the effectiveness of our disclosure controls and procedures on a quarterly basis. Among other things, management must conduct an assessment of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act and related rules and regulations. Maintaining and adapting our internal controls is expensive and requires significant management attention. Failure to maintain effective controls or implement required new or improved controls or difficulties encountered in the process may harm our results of operations and financial condition or cause us to fail to meet our reporting obligations.
Based on management’s assessment, we concluded that our control related to the Company’s precision of review regarding the valuation of impaired loans was not effective as of December 31, 2019, and that we had as of such date, a material weakness in our internal control over financial reporting. The specific issues leading to these conclusions are described in Part II - Item 9A. “Controls and Procedures” of this Form 10-K and in “Management’s Report on Internal Control over Financial Reporting” appearing elsewhere in this Form 10-K. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected on a timely basis. The material weakness identified in Item 9A did not result in any material misstatement in our consolidated financial statements and we have implemented remedial measures intended to address the material weaknesses and related disclosure controls. However, if the remedial measures we have implemented are insufficient, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting or in our disclosure controls occur in the future, our future consolidated financial statements or other information filed with the SEC may contain material misstatements. Any material misstatements could
require a restatement of our consolidated financial statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information, leading to a decline in the market value of our securities.
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, our independent registered public accounting firm is required to report on the effectiveness of our internal control over financial reporting, beginning with this Annual Report on Form 10-K for the year ended December 31, 2019, which is when we ceased to be an emerging growth company.
We identified a material weakness as described above, which did not require a restatement of our consolidated financial statements or cause us to fail to met our reporting obligations. However, 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, 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 increased in recent years and can result in significant losses, 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. For example, we provide customers the ability to bank remotely, including over the Internet or through a mobile device, and the secure transmission of confidential information is a critical element of mobile banking.
As customer, public, and regulatory expectations regarding operational and information security practices 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 workplace violence; economic fraudulent activity, and cyber attacks and data security incidents, including ransomware, malware, phishing, social engineering, and other security events, including some that target commercial financial accounts. These incidents can range from individual attempts to gain unauthorized access to information technology systems to more sophisticated security threats involving cyber criminals, hacktivists, cyber terrorists, nation state actors, and the targeting of commercial financial accounts. These events can also result from internal compromises, such as human error or malicious internal actors, of our workforce or our vendors’ personnel.
Our business relies on its digital technologies, computer and email systems, software and networks to conduct its operations, and our risk and exposure for security incidents and breaches is heightened by our online banking activities. Although we have information security procedures and controls in place, our technologies, systems and networks as well as our customers’ devices may become the target of cyber attacks or information security breaches that could result in theft of financial resources, the unauthorized release, gathering, monitoring, misuse, loss, or destruction of personal information or
confidential information, including trade secrets, belonging to us, our employees, our customers or other third parties. Third parties with whom we do business or who facilitate our business activities, including financial intermediaries, 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, security incidents, 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, increased regulatory enforcement, the expansion of consumer rights under data privacy and security laws, and the use of third-party vendors with access to our systems and data. 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, and additional guidance, regulations, and laws come into effect 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 our networks, systems or devices or those that our clients or vendors use to access our products and services, could result in client attrition, financial loss, regulatory fines, penalties or intervention, reputational 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 or events 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, including the Gramm-Leach-Bliley Act, 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. In addition, state and federal banking regulators have issued various policy statements and, in some cases, regulations, emphasizing the importance of technology risk management and supervision. 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 own confidential information, and in some instances may impose indemnity obligations on us relating to unlawful or unauthorized disclosure of any such information.
Legislation in the European Union (the General Data Protection Regulation, or GDPR) and in California (the California Consumer Privacy Act) as well as existing and proposed legislation in other states in which we do business may increase the burden and cost of compliance as well as our exposure to regulatory penalties and private litigation in the realm of consumer data privacy. Although these laws do not apply to all aspects of our business, we anticipate that there will be some added cost, burden and risk as a result of these laws and pending legislative efforts in other jurisdictions. For example, certain states’ privacy, security, and data breach laws, including, for example, the California Consumer Privacy Act, include a private right of action that may expose us to private litigation regarding our privacy practices and significant damages awards or settlements in civil litigation. In addition, other federal, state or local governments are trying to implement similar legislation, which could result in different privacy standards for different geographical regions, which could require significantly more resources for compliance, and increase the risk of regulatory enforcement and private litigation with respect to our privacy and security practices.
If we do not properly comply with privacy regulations and contractual obligations that require us to protect personal data and 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;
•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;
•governmental rules, regulations and fiscal policies; and
•tornadoes, floods 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 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.
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 affect customer demand for those products and services. Any financial liability or reputational 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 May Be Subject To Claims and Litigation Pertaining to Fiduciary Responsibility.
From time to time as part of our normal course of business, customers may make claims and take legal action against us based on actions or inactions related to the fiduciary responsibilities of our trust and wealth management associates. If such claims and legal actions are not resolved in a manner favorable to us, they may result in financial liability and/or adversely affect our market reputation or our products and services. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
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 21.0% of total loans at December 31, 2019. 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.
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
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 are 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 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 and rules promulgated thereunder already have been revised, repealed, or amended, and may be revised, repealed or amended further. 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 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 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 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 October 29, 2019, the federal banking regulators adopted a rule to implement Section 201 of the EGRRCPA. The rule sets the Community Bank Leverage Ratio at 9%. 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. 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 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 laws 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 Bank's deposits are insured by the FDIC up to the legal limits, and accordingly, subject the Bank 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 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
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the London Interbank Offered Rate (“LIBOR”). This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments.
In particular, regulators, industry groups and certain committees (e.g., the Alternative Reference Rates Committee) have, among other things, published recommended fall-back language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., the Secured Overnight Financing Rate as the recommended alternative to U.S. Dollar LIBOR), and proposed implementations of the recommended alternatives in floating rate instruments. At this time, it is not possible to predict whether these specific recommendations and proposals will be broadly
accepted, whether they will continue to evolve, and what the effect of their implementation may be on the markets for floating-rate financial instruments.
We have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The transition from LIBOR could create considerable costs and additional risk. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition will change our market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to the FB Financial Merger
Because the Market Price of FB Financial Common Stock May Fluctuate, Holders of Our Common Stock Cannot Be Certain of the Market Value of the Merger Consideration They Will Receive
In the merger, each share of our common stock issued and outstanding immediately prior to the effective time (other than certain shares held by FB Financial or us) will be converted into 0.9650 (the “exchange ratio”) shares of FB Financial common stock and $2.00 in cash per share. This exchange ratio is fixed and will not be adjusted for changes in the market price of either FB Financial common stock or our common stock. Changes in the price of FB Financial common stock prior to the merger will affect the value that holders of our common stock will receive in the merger. Neither we nor FB Financial is permitted to terminate the merger agreement as a result, in and of itself, of any increase or decrease in the market price of FB Financial common stock or our common stock.
Stock price changes may result from a variety of factors, including general market and economic conditions, changes in FB Financial’s or our business, operations and prospects and regulatory considerations, many of which factors are beyond FB Financial’s or our control. Therefore, at the time of the FB Financial special meeting and our special meeting, holders of FB Financial common stock and holders of our common stock will not know the market value of the consideration to be received by holders of our common stock at the effective time. You should obtain current market quotations for shares of FB Financial common stock and for shares of our common stock.
The Market Price of FB Financial Common Stock After the Merger May Be Affected by Factors Different from Those Affecting the Shares of Our Common Stock or FB Financial Common Stock Currently
In the merger, holders of our common stock will become holders of FB Financial common stock. FB Financial’s business differs from that of FFN and the Bank. Accordingly, the results of operations of the combined company and the market price of FB Financial common stock after the completion of the merger may be affected by factors different from those currently affecting the independent results of operations of each of FB Financial and FFN.
FB Financial and FFN are Expected to Incur Substantial Costs Related to the Merger and Integration
FB Financial and FFN have incurred and expect to incur a number of non-recurring costs associated with the merger. These costs include legal, financial advisory, accounting, consulting and other advisory fees, severance/employee benefit-related costs, public company filing fees and other regulatory fees, financial printing and other printing costs and other related costs. In addition, FB Financial and FFN may incur significant losses resulting from the planned reduction of approximately $430 million of FFN’s Shared National Credits and non-strategic healthcare and corporate loan portfolio, which planned reduction was previously disclosed in connection with the merger announcement. Some of these costs are payable by either FB Financial or FFN regardless of whether or not the merger is completed.
The combined company is expected to incur substantial costs in connection with the related integration. There are a large number of processes, policies, procedures, operations, technologies and systems that may need to be integrated, including purchasing, accounting and finance, payroll, compliance, treasury management, branch operations, vendor management, risk management, lines of business, pricing and benefits. While FB Financial and FFN have assumed that a certain level of costs will be incurred, there are many factors beyond their control that could affect the total amount or the timing of the integration costs. Moreover, many of the costs that will be incurred are, by their nature, difficult to estimate accurately. These integration costs may result in the combined company taking charges against earnings following the completion of the merger, and the amount and timing of such charges are uncertain at present.
Combining FB Financial and FFN May be More Difficult, Costly or Time Consuming Than Expected and FB Financial and FFN May Fail to Realize the Anticipated Benefits of the Merger
The success of the merger will depend, in part, on the ability to realize the anticipated cost savings from combining the businesses of FB Financial and FFN. To realize the anticipated benefits and cost savings from the merger, FB Financial and FFN must successfully integrate and combine their businesses in a manner that permits those cost savings to be realized. If FB Financial and FFN are not able to successfully achieve these objectives, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected. In addition, the actual cost savings and anticipated benefits of the merger could be less than anticipated, and integration may result in additional unforeseen expenses.
FB Financial and FFN have operated and, until the completion of the merger, must continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the companies’ ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. Integration efforts between the two companies may also divert management attention and resources. These integration matters could have an adverse effect on each of FB Financial and FFN during this transition period and for an undetermined period after completion of the merger on the combined company.
The Future Results of the Combined Company Following the Merger May Suffer if the Combined Company Does Not Effectively Manage its Expanded Operations
Following the merger, the size of the business of the combined company will increase significantly beyond the current size of either FB Financial’s and FFN’s business. The combined company’s future success will depend, in part, upon its ability to manage this expanded business, which may pose challenges for management, including challenges related to the management and monitoring of new operations and associated increased costs and complexity. The combined company may also face increased scrutiny from governmental authorities as a result of the significant increase in the size of its business. There can be no assurances that the combined company will be successful or that it will realize the expected operating efficiencies, cost savings, revenue enhancements or other benefits currently anticipated from the merger.
The Combined Company May be Unable to Retain FB Financial or FFN Personnel Successfully After the Merger is Completed
The success of the merger will depend in part on the combined company’s ability to retain the talents and dedication of key employees currently employed by FB Financial and FFN. It is possible that these employees may decide not to remain with FB Financial or FFN, as applicable, while the merger is pending or with the combined company after the merger is consummated. If FB Financial and FFN are unable to retain key employees, including management, who are critical to the successful integration and future operations of the companies, FB Financial and FFN could face disruptions in their operations, loss of existing customers, loss of key information, expertise or know-how and unanticipated additional recruitment costs. In addition, if key employees terminate their employment, the combined company’s business activities may be adversely affected and management’s attention may be diverted from successfully integrating FB Financial and FFN to hiring suitable replacements, all of which may cause the combined company’s business to suffer. In addition, FB Financial and FFN may not be able to locate or retain suitable replacements for any key employees who leave either company.
Regulatory Approvals May Not be Received, May Take Longer Than Expected or May Impose Conditions That are Not Presently Anticipated or That Could Have an Adverse Effect on the Combined Company Following the Merger
Before the merger and the bank merger may be completed, various approvals, consents and non-objections must be obtained from the Federal Reserve Board, the FDIC, the Tennessee Department of Financial Institutions (TDFI) and other authorities in the United States. In determining whether to grant these approvals, the regulators consider a variety of factors, including the regulatory standing of each party among other factors. These approvals could be delayed or not obtained at all, including due to: an adverse development in either party’s regulatory standing, or any other factors considered by regulators in granting such approvals; governmental, political or community group inquiries, investigations or opposition; or changes in legislation or the political environment.
The approvals that are granted may impose terms and conditions, limitations, obligations or costs, or place restrictions on the conduct of the combined company’s business or require changes to the terms of the transactions contemplated by the merger agreement. There can be no assurance that regulators will not impose any such conditions, limitations, obligations or restrictions and that such conditions, limitations, obligations or restrictions will not have the effect of delaying the completion of any of the transactions contemplated by the merger agreement, imposing additional material costs on or materially limiting the revenues of the combined company following the merger or otherwise reduce the
anticipated benefits of the merger if the merger were consummated successfully within the expected time frame. In addition, there can be no assurance that any such conditions, limitations, obligations or restrictions will not result in the delay or abandonment of the merger. Additionally, the completion of the merger is conditioned on the absence of certain orders, injunctions or decrees by any court or regulatory agency of competent jurisdiction that would prohibit or make illegal the completion of any of the transactions contemplated by the merger agreement.
Despite the parties’ commitments to use their reasonable best efforts to respond to any request for information and resolve any objection that may be asserted by any governmental entity with respect to the merger agreement, under the terms of the merger agreement, neither FB Financial nor FFN is required to take any action or agree to any condition or restriction in connection with obtaining these approvals that would reasonably be expected to have a material adverse effect on the combined company and its subsidiaries, taken as a whole, after giving effect to the merger.
Certain of Our Directors and Executive Officers May Have Interests in the Merger That May Differ from the Interests of Holders of Our Common Stock
Holders of our common stock should be aware that some of our directors and executive officers may have interests in the merger and have arrangements that are different from, or in addition to, those of holders of our common stock generally. These interests and arrangements may create potential conflicts of interest. The FFN board of directors was aware of these respective interests and considered these interests, among other matters, when making their decisions to approve the merger agreement, and in recommending that shareholders vote to approve the merger agreement.
Termination of the Merger Agreement Could Negatively Affect FFN
If the merger agreement is not completed for any reason, including as a result of FB Financial shareholders failing to approve the FB Financial share issuance to our shareholders or our shareholders failing to approve the merger, there may be various adverse consequences and we may experience negative reactions from the financial markets and from our customers and employees. For example, our business may have been affected adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. Additionally, if the merger agreement is terminated, the market price of our common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed. If the merger agreement is terminated under certain circumstances, we may be required to pay a termination fee of $21.4 million to FB Financial.
Additionally, we have incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement, including certain outside costs relating to integration preparation, as well as the costs and expenses of filing, printing and mailing the joint proxy statement/prospectus being sent to our shareholders and FB Financial’s shareholders, and all filing and other fees paid to the SEC in connection with the merger. If the merger is not completed, we would have to pay these expenses without realizing the expected benefits of the merger. Furthermore, any credit losses, including losses suffered by us in connection with the planned exit of FFN's Shared National Credits and non-strategic healthcare and corporate loan portfolio, may have a more material and adverse effect on our stock price in the event the merger is not consummated than if the merger is consummated given the intended loan mark that FB Financial has indicated to us that it intends to take on our loan portfolio in connection with its purchase accounting for the merger.
FB Financial and FFN Will be Subject to Business Uncertainties and Contractual Restrictions While the Merger is Pending
Uncertainty about the effect of the merger on employees and customers may have an adverse effect on FB Financial or FFN. These uncertainties may impair FB Financial’s or our ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers and others that deal with FB Financial or us to seek to change existing business relationships with FB Financial or us. In addition, subject to certain exceptions, FB Financial and FFN have agreed to operate their respective businesses in the ordinary course prior to closing, which could cause FB Financial or FFN to be unable to pursue other beneficial opportunities that may arise prior to the completion of the merger.
The Shares of FB Financial Common Stock to be Received by Holders of Our Common Stock as a Result of the Merger Will Have Different Rights from the Shares of FFN Common Stock
In the merger, holders of our common stock will become holders of FB Financial common stock and their rights as shareholders will be governed by Tennessee law and the governing documents of the combined company. The rights associated with FB Financial common stock are different from the rights associated with our common stock.
Holders of FB Financial Common Stock and FFN Common Stock Will Have a Reduced Ownership and Voting Interest in the Combined Company After the Merger and Will Exercise Less Influence Over Management
Holders of FB Financial common stock and our common stock currently have the right to vote in the election of the board of directors and on other matters affecting FB Financial and us, respectively. When the merger is completed, each holder of our common stock who receives shares of FB Financial common stock will become a holder of common stock of the combined company, with a percentage ownership of the combined company that is smaller than the holder’s percentage ownership of FFN. Based on the number of shares of FB Financial and our common stock currently outstanding, and based on the number of shares of FB Financial common stock expected to be issued in the merger, the former holders of our common stock, as a group, are estimated to own approximately thirty-two percent (32%) of the fully diluted shares of the combined company immediately after the merger and current holders of FB Financial common stock as a group are estimated to own approximately sixty-eight percent (68%) of the fully diluted shares of the combined company immediately after the merger. Because of this, holders of our common stock may have less influence on the management and policies of the combined company than they now have on the management and policies of FFN.
Shareholder Litigation Could Prevent or Delay the Closing of the Merger or Otherwise Negatively Affect the Business and Operations of FB Financial and FFN
FB Financial and FFN may incur costs in connection with the defense or settlement of any shareholder lawsuits filed in connection with the merger. Such litigation could have an adverse effect on the financial condition and results of operations of FB Financial and FFN and could prevent or delay the consummation of the merger.
The Merger Agreement Limits Our Ability to Pursue Alternatives to the Merger and May Discourage Other Companies from Trying to Acquire Us
The merger agreement contains “no shop” covenants that restrict our ability to, directly or indirectly, initiate, solicit, knowingly encourage or knowingly facilitate any inquiries or proposals with respect to any acquisition proposal, engage or participate in any negotiations with any person concerning any acquisition proposal, provide any confidential or nonpublic information or data to, or have or participate in any discussions with, any person relating to any acquisition proposal, subject to certain exceptions, or, unless the merger agreement has been terminated in accordance with its terms, approve or enter into any term sheet, letter of intent, commitment, memorandum of understanding, agreement in principle, acquisition agreement, merger agreement or other agreement in connection with or relating to any acquisition proposal.
The merger agreement further provides that, during the 12-month period following the termination of the merger agreement under specified circumstances, including the entry into a definitive agreement or consummation of a transaction with respect to an alternative acquisition proposal, we may be required to pay FB Financial a cash termination fee equal to $21.4 million.
These provisions could discourage a potential third-party acquirer that might have an interest in acquiring all or a significant portion of FFN from considering or proposing that acquisition.
The Combined Company Will Have Over $10 Billion in Total Consolidated Assets as a Result of the Merger, Which Will Lead to Increased Regulation
Upon consummation of the merger, and as of September 30, 2019 on a pro forma basis giving effect to the merger, the combined company will have approximately $10 billion in total consolidated assets. Accordingly, the combined company will become subject to certain regulations that apply only to depository institution holding companies or depository institutions with total consolidated assets of $10 billion or more.
Debit card interchange fee restrictions set forth in Section 1075 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is known as the Durbin Amendment, as implemented by regulations of the Federal Reserve Board, cap the maximum debit interchange fee that a debit card issuer may receive per transaction at the sum of $0.21 plus five basis points. A debit card issuer that adopts certain fraud prevention procedures may charge an additional $0.01 per transaction. Debit card issuers with total consolidated assets of less than $10 billion, which currently includes FB Financial and FFN, are exempt from these interchange fee restrictions. The exemption for small issuers ceases to apply as of July 1st of the year following the calendar year in which the debit card issuer has total consolidated assets of $10 billion or more at calendar year-end. As a result, if the bank merger is consummated in 2020, the combined company will become subject to the interchange restrictions of the Durbin Amendment beginning July 1, 2021.
In addition, an insured depository institution with total assets of $10 billion or more is subject to supervision, examination, and enforcement with respect to consumer protection laws by the Consumer Financial Protection Bureau, which we refer to as the CFPB. Under its current policies, the CFPB will assert jurisdiction in the first quarter after the call reports of merging insured depository institutions, on a combined basis, show total consolidated assets of $10 billion or more for four consecutive quarters, including quarters ended prior to the merger. As a result, the combined company will become subject to CFPB supervision, examination and enforcement at the beginning of the quarter following consummation of the bank merger.
There are other regulatory requirements that apply to insured depository institution holding companies and insured depository institutions with total consolidated assets of $10 billion or more. These include, but are not limited to, (1) the establishment by publicly traded depository institution holding companies with $10 billion or more in assets of a risk committee responsible for oversight of enterprise-wide risk management practices that are commensurate with the entity’s structure, risk profile, complexity, activities and size and (2) an institution with total consolidated assets of $10 billion or more no longer being entitled to benefit from the FDIC’s offset of the effect of the increase in the statutory minimum DIF reserve ratio to 1.35% from the former statutory minimum of 1.15% that is required for institutions with assets of less than $10 billion by the Dodd-Frank Act.
In addition, Congress and/or regulatory agencies may impose new requirements or surcharges on these institutions in the future. The EGRRCPA which was enacted on May 24, 2018, includes provisions that, as they are implemented, relieve banking organizations with total consolidated assets of less than $10 billion (and that satisfy certain other conditions) from risk-based capital requirements, restrictions on proprietary trading and investment and sponsorship in hedge funds and private equity funds known as the Volcker Rule, and certain other regulatory requirements. Once the combined company has total consolidated assets of $10 billion or more, the combined company will no longer qualify for any of the foregoing relief.
There can be no assurance that the benefits of the merger will outweigh the regulatory costs resulting from the combined company having total consolidated assets of $10 billion or more.
The Merger May Fail to Qualify as a “Reorganization” Within the Meaning of Section 368(a) of the Code
FFN intends and expects the merger to qualify as a “reorganization” within the meaning of Section 368(a) of the Code and the obligation of each of FB Financial and FFN to complete the merger is conditioned upon the receipt, by each company, of a U.S. federal income tax opinion to that effect from FB Financial’s and FFN’s respective tax counsels. These tax opinions represent the legal judgment of counsel rendering the opinion and are not binding on the Internal Revenue Service (“IRS”) or the courts. If the merger were to fail to qualify as a reorganization within the meaning of Section 368(a) of the Code, then the merger would be treated as a taxable sale of the assets of FFN to FB Financial followed by a taxable liquidation of FFN. Generally, the deemed sale of the assets of FFN would result in the gain or loss equal to the difference between (1) the fair market value of the merger consideration and (2) the adjusted tax basis in such assets held by FFN. Such gain or loss, as applicable, would be allocated to, and recognized by, the holders of FFN common stock and would increase (in the case of gain) and decease (in the case of loss) the adjusted tax basis in such holder’s FFN common stock. Generally, the deemed distribution of the merger consideration distributed in respect of each share of FFN common stock would result in gain or loss equal to the difference between (1) the fair market value of the merger consideration distributed in respect of each share of FFN common stock and (2) the adjusted tax basis in the shares of such FFN common stock surrendered in exchange therefor. The consequences of the merger to any particular shareholder will depend on that shareholder’s individual situation. We strongly urge you to consult your own tax advisor to determine the particular tax consequences of the merger to you.
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 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;
•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, including, without limitation, announcements and disclosures regarding the pending merger with FB Financial.
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, 2019, we had outstanding options to purchase 1,499,570 shares of our common stock, 90,992 non-vested restricted stock awards and 160,251 restricted stock units were issued during 2019 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, 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. In the first quarter of 2019, we began paying quarterly dividends. 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.
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 with certain of our executive officers 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.
ITEM 2. PROPERTIES.
At December 31, 2019, 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 . In addition, the Bank has its deposit operations located at 101 Southeast Parkway, Suite 100, Franklin, TN 37064, offices at 204 9th Avenue, Franklin, Tennessee 37064, and has additional office space at 231 South Royal Oaks Boulevard, Franklin, Tennessee 37064, Nolensville Road, Suite 100, Nolensville, TN 37216 in Williamson County, and a loan production and deposit production office located at 105 Industrial Drive, Suite 7, Mt. Juliet, Tennessee, in Wilson County.
We lease these properties under operating leases except for one finance lease located at 231 South Royal Oaks Boulevard, Franklin, Tennessee 37064, in Williamson County.
On February 5, 2020, the Company purchased the properties at Columbia Avenue and 120 9th Ave locations in Franklin, Tennessee, therefore ending the lease agreements.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of their respective businesses or operations, the Company or one of its subsidiaries may be named as a plaintiff, a defendant, or a party to a legal proceeding or any of their respective properties may be subject to various pending and threatened legal proceedings and various actual and potential claims. In view of the inherent difficulty of predicting the outcome of such matters, the Company cannot state what the eventual outcome of any such matters will be; however, based on current knowledge and after consultation with legal counsel, the Company's management believes these proceedings will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company.
ITEM 4. MINE SAFETY DISCLOSURES
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 March 6, 2020, there were 14,859,704 shares of common stock outstanding held by 1,382 shareholders of record.
Issuer Purchases of Equity Securities and Recent Sales of Unregistered Securities
The following table discloses shares of our common stock repurchased during the three months ended December 31, 2019:
Total Number of Shares Purchased (1)
|Average Price Paid Per Share|
Total Number of Shares Purchased as part of Publicly Announced Plans or Programs (1)
|Maximum Number (or Approximate Dollar Value) of Shares That May Yet Be Purchased Under the Plans or Programs|
|October 1, 2019 to October 31, 2019||200||$||29.01||200||23,488|
|November 1, 2019 to November 30, 2019||0||0||0||23,488|
|December 1, 2019 to December 31, 2019||0||0||0||23,488|
(1) On January 23, 2019, we announced that our board of directors had authorized a share repurchase program for up to $30 million of our outstanding common stock. The repurchase program expired on January 23, 2020, and no additional shares were purchased after December 31, 2019.
There were no unregistered sales of our equity securities during the year ended December 31, 2019.
In 2019, the Company’s Board of Directors declared dividends of $0.18 per share. Prior to 2019, the Company had not declared or paid dividends on our common stock.
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. Therefore, while we currently expect to continue to pay dividends, there can be no assurance that we will be able to do so.
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, 2019 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 $100
ITEM 6. SELECTED FINANCIAL DATA.
The following selected historical consolidated financial data as of and for the years ended December 31, 2019, 2018, 2017, 2016 and 2015, is derived, in some cases, from the audited consolidated financial statements of FFN.
(Amounts are in thousands, except ratios, per share data, banking locations and full time equivalent employees.)
|Year ended December 31,|
|SUMMARY OF OPERATIONS:|
|Total interest income||$||184,692||$||169,945||$||132,453||$||99,907||$||68,721|
|Total interest expense||73,532||64,442||35,407||18,323||9,306|
|Net interest income||111,160||105,503||97,046||81,584||59,415|
|Provision for loan losses||32,047||2,254||4,313||5,240||5,030|
|Net interest income after provision for loan losses||79,113||103,249||92,733||76,344||54,385|
|Income before income taxes||15,009||40,433||46,630||39,803||25,101|
|Income tax expense||187||5,912||18,531||11,746||9,021|
|Preferred stock dividend requirement||—||—||—||(23)||(100)|
|Earnings attributable to noncontrolling interest||(16)||(16)||(16)||—||—|
|Net income available to common shareholders||$||14,806||$||34,505||$||28,083||$||28,034||$||15,980|
|PER COMMON SHARE DATA:|
|Basic earnings per share||$||1.01||$||2.44||$||2.14||$||2.56||$||1.62|
|Diluted earnings per share||$||0.98||$||2.34||$||2.04||$||2.42||$||1.54|
|Common equity per common share outstanding||$||27.68||$||25.65||$||23.01||$||20.73||$||16.92|
|Dividends per common share||$||0.18||$||—||$||—||$||—||$||—|
|Preferred shares outstanding||—||—||—||—||10|
|Actual common shares outstanding||14,822||14,538||13,237||13,037||10,571|
|Weighted average common shares outstanding, including participating securities||14,633||14,169||13,145||10,933||9,885|
|Diluted weighted average common shares outstanding, including participating securities||14,962||14,710||13,780||11,608||10,390|
|BALANCE SHEET DATA:|
|Loans held for sale||43,162||11,103||12,024||23,699||14,079|
|Loans, net of unearned income||2,812,444||2,665,399||2,256,608||1,773,592||1,303,826|
|Allowance for loan losses||45,436||23,451||21,247||16,553||11,587|
|Federal Home Loan Bank advances||155,000||368,500||272,000||132,000||57,000|
|Other borrowed funds||58,872||58,693||89,519||141,638||101,086|
|Preferred shareholders’ equity||—||—||—||—||10,000|
|Total shareholders’ equity||410,333||372,740||304,550||270,258||188,816|
|Noncontrolling interest in consolidated subsidiary||93||93||103||103||—|
|Average total assets||4,031,993||4,112,436||3,445,654||2,557,268||1,750,697|
Average gross loans(1)
|Average interest-earning assets||3,867,484||3,995,592||3,361,320||2,496,361||1,685,073|
|Average interest-bearing deposits||2,864,326||3,046,506||2,535,380||1,942,932||1,314,517|
|Average interest-bearing liabilities||3,255,747||3,465,110||2,891,943||2,125,986||1,409,753|
|Average total shareholders’ equity||394,860||337,378||290,436||207,763||168,933|
|SELECTED FINANCIAL RATIOS:|
|Return on average assets||0.37||%||0.84||%||0.82||%||1.10||%||0.92||%|
|Return on average equity||3.8||%||10.2||%||9.7||%||13.5||%||9.5||%|
|Average equity to average total assets||9.8||%||8.2||%||8.4||%||8.1||%||9.7||%|
Net interest margin(3)(5)
Net interest spread(4)(5)
|Common equity Tier 1 ratio||11.9||%||12.2||%||11.4||%||11.8||%||10.1||%|
|Tier 1 leverage ratio||10.3||%||8.8||%||8.3||%||9.3||%||8.5||%|
|Tier 1 risk-based capital||11.9||%||12.2||%||11.4||%||11.8||%||10.5||%|
|Total risk-based capital||15.0||%||14.9||%||14.4||%||15.1||%||11.2||%|
|ASSET QUALITY RATIOS:|
|Net charge-offs (recoveries) to average loans||0.35||%||—||%||(0.02)||%||0.02||%||0.01||%|
Allowance to period end loans(6)
|Allowance for loan losses to non-performing loans||164.09||%||411.71||%||698.45||%||267.76||%||352.62||%|
Nonperforming assets to total assets(7)
|Full-time equivalent employees||339||338||284||268||225|
(1)Average gross loans exclude loans held for sale.
(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 2019, 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 exclude the effects of tax-equivalent adjustments.
(6)Period end loans exclude loans held for sale and exclude deferred fees and costs.
(7)Nonperforming loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest.
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 is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of the Corporation. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report. The detailed financial discussion that follows focuses on 2019 results compared to 2018. For a discussion of 2018 results compared to 2017 see the Corporation's Annual Report on Form 10-K for the year ended December 31, 2018.
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 noncollectable. 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 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.
The Company's net income for the year ended December 31, 2019 was $14,822, compared to $34,521 for the year ended December 31, 2018, and $28,099 for the year ended December 31, 2017. After earnings attributable to noncontrolling interest, the Company’s net earnings available to common shareholders for the years ended December 31, 2019, 2018 and 2017 were $14,806, $34,505, and $28,083, respectively. Net earnings available to shareholders decreased by $19,699 when comparing 2019 with 2018, primarily driven by specific reserves of $9,759 related to a Shared National Credit (“SNC”) relationship, and $20,657 related to two lending relationships in our healthcare and corporate loan portfolios discussed below, along with $4,301 related to post-employment and retirement expense recorded during 2019. Interest income increased $14,747 for the year ended December 31, 2019, compared to the year ended December 31, 2018 mainly due to an increased volume of loans and fluctuating rates during 2019.
In connection with our year-end audit process, and subsequent to our January 21, 2020 earnings release related to the fourth quarter of 2019, we have determined the need to record an additional loan loss provision of $18,761 to provide specific reserves for two lending relationships, which were both on nonaccrual status as of December 31, 2019 and comprised a material portion of our classified assets, in our healthcare and corporate loan portfolios. Our determination to record this additional provision was primarily the result of certain developments and circumstances regarding the collectability of these two relationships that arose following our earnings release, and have been amplified by various macroeconomic developments. Under GAAP we are required to reflect the additional provision during the fourth quarter of 2019, and the specific reserves as of December 31, 2019. Accordingly, this Form 10-K reflects the updated provision and reserves and, as a result, contains financial information that is different than the information previously presented in our January 21, 2020 earnings release related to the fourth quarter of 2019.
Furthermore at this time, we expect to experience certain ongoing lending and depository losses occurring during the first quarter of 2020 related to at least one of these relationships, which would be reflected in our financial statements for the first quarter of 2020. We continue to monitor these two relationships, and we could experience additional losses attributed to these relationships in future periods.
Planned Reduction of Non-Strategic Loan Portfolio
As previously announced, on January 21, 2020, the Company entered into an Agreement and Plan of Merger with FB Financial Corporation (“FB Financial”), pursuant to which the Company will merge into FB Financial, with FB Financial continuing as the surviving corporation (the “merger”). In connection with the announcement of the merger, FB Financial identified a group of nonstrategic loans that would be liquidated in connection with the consummation of the merger. As disclosed in FB Financials’ merger investor presentation, the nonstrategic loans were comprised of shared national credits, corporate and healthcare lending relationships totaling approximately $429,500 at December 31, 2019, including criticized and classified loans totaling approximately $39,100, of which the two lending relationships identified above were included.
The Company has been in communication with FB Financial regarding its determination to record the additional 2019 provision for loan losses and specific reserves described above. The specific reserves discussed above are consistent with the overall anticipated impact of the liquidation of the nonstrategic loans and FB Financials’ aggregate estimated credit marks associated with the acquired loan portfolio as disclosed in their merger investor presentation. Additionally, as a result of subsequent loans sales, payoffs and other ordinary course changes, the nonstrategic loans totaled approximately $412,600 as of February 28, 2020, reflecting a decrease of approximately $16,900 from December 31, 2019, which represents a 23.5% annualized decrease. The Company expects to continue to experience loan payoffs, customer migration and other ordinary course changes in this portfolio during the coming periods. On an ongoing basis, the Company evaluates the presentation of loans and other assets as held for sale when the criteria for such classification are met.
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, 2019, 2018 and 2017 totaled $111,160, $105,503, and $97,046, respectively, which is an increase of $5,657, or 5.4%, comparing 2019 and 2018, and an increase of $8,457, or 8.7%, comparing 2018 and 2017.
For the years ended December 31, 2019 and 2018, interest income increased $14,747 and $37,492 primarily due to an asset rotation away from lower-yielding securities combined with growth in the loan portfolio. These were partially offset by increases of $9,090 and $29,035 in interest expense, which totaled $73,532, $64,442, and $35,407, respectively, for the years ended December 31, 2019, 2018 and 2017 primarily due to increases in interest-bearing deposits combined with increases in interest rates for money market deposits and Federal Home Loan Bank (“FHLB”) advances during 2019 and 2018 which had an impact on the cost of funds for the Bank.
Interest-earning assets averaged $3,867,484, $3,995,592, and $3,361,320 during the years ended December 31, 2019, 2018 and 2017, which is a decrease of $128,108, or 3.2%, and an increase of $634,272, or 18.9%, respectively, primarily due to significant growth in loans.
For the years ended December 31, 2019 and 2018, average loans held for investment increased 14.3% and 22.5%, respectively, and investment securities decreased 36.3% during 2019 and increased 9.9% during 2018. During the year ended December 31, 2019, our earning asset yield increased by 51 basis points and 21 basis points from the years ended December 31, 2018 and 2017, respectively, while the total funding rates increased by 40 basis points and 64 basis points compared to the years ended December 31, 2018 and 2017, respectively. The increase in yields throughout all three periods presented is primarily caused by fluctuations in the rate environment, intense competition, and our continued balance sheet rotation strategy.
For the years ended December 31, 2019, 2018 and 2017, the yield on taxable securities were 2.69%, 2.39% and 2.27%, respectively. The increase in yield in 2019 is primarily due to an increase in interest rates and a reduction in lower-yielding securities.
For the years ended December 31, 2019, 2018 and 2017, the yield on tax exempt securities were 3.82%, 4.53% and 5.24%, respectively. The decrease in yield in 2019 is primarily due to the strategically-planned balance sheet rotation focused on core loan growth.
Interest-bearing liabilities averaged $3,255,747, $3,465,110, and $2,891,943, respectively, during the years ended December 31, 2019, 2018 and 2017, which is a decrease of $209,363 or 6.0%, during 2019 compared to an increase of $573,167, or 19.8%, during 2018. The decrease for 2019 was due primarily to reduction in time deposits. 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 2019, total average interest-bearing deposits decreased by $182,180, which included a decrease in average interest checking of $64,760, an increase of average money market accounts of $316,616, and a decrease in average time deposits outstanding of $426,060. 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.
With the decrease in the average loan portfolio during 2019, the average FHLB advances decreased by $15,173. Average FHLB advances increased $81,578 in 2018 as the average loans grew. Subordinated notes and other borrowings increased by $177 and $178, in 2019 and 2018, respectively. The increases in 2019 and 2018 were due to the amortization of borrowing costs.
The cost of average interest-bearing liabilities increased 40 basis points to 2.26% during 2019 and increased 64 basis points to 1.86% during 2018. The increase in cost of interest-bearing liabilities for 2019 and 2018 was due to increases in rates on interest checking, money market accounts, time deposits, FHLB advances and Federal funds purchased.
The tables below summarize average balances, yields, cost of funds, and the analysis of changes in interest income and interest expense for the years ended December 31, 2019, 2018, and 2017:
Average Balances(7)—Yields & Rates
(Dollars in thousands)
|Year Ended December 31,|
|Loans held for sale||20,581||799||3.88||10,588||474||4.48||10,031||426||4.25|
|Restricted equity securities||23,986||1,213||5.06||20,549||1,250||6.08||16,498||928||5.62|
|Certificates of deposit at other financial institutions||3,642||85||2.33||3,128||62||1.98||2,229||33||1.48|
Federal funds sold and other(2)
|TOTAL INTEREST EARNING ASSETS||$||3,867,484||$||186,793||4.83||%||$||3,995,592||$||172,642||4.32||%||$||3,361,320||$||138,098||4.11||%|
|Allowance for loan losses||(26,580)||(22,596)||(18,729)|
|All other assets||191,089||139,440||103,063|
|LIABILITIES AND EQUITY|
Federal funds purchased and other(3)
Federal Home Loan Bank advances and other (8)
|TOTAL INTEREST BEARING LIABILITIES||$||3,255,747||$||73,532||2.26||%||$||3,465,110||$||64,443||1.86||%||$||2,891,943||$||35,407||1.22||%|
|TOTAL LIABILITIES AND EQUITY||$||4,031,993||$||4,112,436||$||3,445,654|
NET INTEREST SPREAD(4)
|NET INTEREST INCOME||$||113,261||$||108,199||$||102,691|
NET INTEREST MARGIN(5)
(1)Loan balances include loans held in the Bank’s portfolio and are net of deferred origination fees and costs. Non-accrual loans are included in total loan balances.
(2)Includes federal funds sold and interest-bearing deposits at the Federal Reserve Bank, the Federal Home Loan Bank and other financial institutions.
(3)Includes repurchase agreements.
(4)Represents the average rate earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(5)Represents net interest income (annualized) divided by total average earning assets.
(6)Interest income and rates include the effects of tax-equivalent adjustments to adjust tax-exempt interest income on tax-exempt loans and investment securities to a fully taxable basis.
(7)Average balances are average daily balances.
(8)Includes finance lease.
The tables below detail the components of the changes in net interest income for the periods indicated. For each major category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes due to average volume and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category. The changes noted in the table below include tax equivalent adjustments, and as a result, will not agree to the amounts reflected on the Company’s consolidated statements of income for the categories that have been adjusted to reflect tax equivalent income.
Analysis of Changes in Interest Income and Expenses
|Net change year ended|
December 31, 2019 versus
December 31, 2018
|Net change year ended|
December 31, 2018 versus
December 31, 2017
|Volume||Rate||Net Change||Volume||Rate||Net Change|
|Loans held for sale||447||(122)||325||24||24||48|
|Restricted equity securities||209||(246)||(37)||228||94||322|
|Certificates of deposit at other financial institutions||10||13||23||13||16||29|
|Federal funds sold and other||(256)||606||350||591||1,087||1,678|
|TOTAL INTEREST INCOME||$||7,186||$||6,965||$||14,151||$||24,680||$||9,864||$||34,544|
|Money market accounts||5,614||3,952||9,566||1,475||5,619||7,094|
Federal funds purchased and other(2)
Federal Home Loan Bank advances and other(1)
|TOTAL INTEREST EXPENSE||$||(3,888)||$||12,977||$||9,089||$||6,146||$||22,890||$||29,036|
|NET INTEREST INCOME||$||11,074||$||(6,012)||$||5,062||$||18,534||$||(13,026)||$||5,508|
(1) Includes finance lease.
(2) Includes repurchase agreements.
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, should be adequate to provide coverage for probable losses incurred in the loan portfolio. The allowance is increased by the provision for loan losses and is decreased by charge-offs, net of recoveries on prior loan charge-offs.
The provision for loan losses was $32,047, $2,254 and $4,313 for the years ended December 31, 2019, 2018 and 2017, respectively. The $29,793 increase in the provision during 2019 was driven by a combination of both loan growth and specific reserves of $9,759 related to a SNC relationship and $20,657 related to two commercial and industrial lending relationships. The decrease in the provision in 2018 was driven by a strong local economy and improvements to other qualitative factors specific to the Bank resulting in the ALLL reserve of 88 basis points in 2018.
In connection with our year-end audit process, and subsequent to our January 21, 2020 earnings release related to the fourth quarter of 2019, we determined to record an additional provision of $18,761 to fund a specific reserve in respect of two lending relationships in our healthcare and corporate loan portfolios. Our determination to record this additional provision was primarily the result of certain developments and circumstances regarding the collectability from these two relationships that arose following our earnings release. Under GAAP we are required to reflect the additional provision during the fourth quarter of 2019, and the specific reserve as of December 31, 2019. Accordingly, this Form 10-K contains financial information that reflects the updated provision and reserve that is different than the information previously presented in our January 21, 2020 earnings release related to the fourth quarter of 2019.
Non-interest income for the years ended December 31, 2019, 2018, and 2017 was $17,775, $10,662 and $14,721, respectively. The following is a summary of the components of non-interest income (in thousands):
|Years Ended December 31,||2019-2018|
|Year Ended December 31,||2018-2017|
|Service charges on deposit accounts||$||317||$||217||46.1||%||$||154||40.9||%|
|Other service charges and fees||3,724||3,183||17.0||%||3,039||4.7||%|
|Mortgage Banking revenue||9,154||6,696||36.7||%||6,892||(2.8)||%|
|Gain (loss) on sales and calls of securities||2,043||(4,160)||149.1||%||896||(564.3)||%|
|Net (loss) gain on sale of loans held for investment||(2,003)||—||—||%||226||(100.0)||%|
|Net gain (loss) on foreclosed assets||7||91||(92.3)||%||(7)||(1,400.0)||%|
|Total non-interest income||$||17,775||$||10,662||66.7||%||$||14,721||(27.6)||%|
Service charges on deposit accounts increased 46.1% in 2019 and 40.9% in 2018. The increase was mainly due to an increase in business analysis fees of $88 and $55 in 2019 and 2018, respectively. Other service charges and fees for the year ended December 31, 2019 increased 17.0% when compared to 2018. The increase was due to an increase of $126 in ATM (Automated Teller Machine) fees, $98 in application fees, $88 in tax service fees, and $80 in unused commitment fees. Other service charges and fees for the year ended December 31, 2018 increased 4.7% when compared to 2017. The increase for 2018 was mainly due to an increase of $118 in ATM fees.
Mortgage banking revenue consists primarily of net gains on mortgage loans sold, and mortgage servicing rights amortization. Gains on mortgage loans sold were $9,217 and $6,286, respectively, for the years ended December 31, 2019 and 2018. The year-over-year increase in 2019 was attributable to an increase in production when compared to 2018. Mortgage servicing amortization was $1,289 and $867, respectively, for the years ended December 31, 2019 and 2018. The increase in amortization was a result of the decrease in rates causing higher prepayments leading to mortgage servicing rights being amortized over a shorter period when compared to 2018.
Wealth management income experienced a slight decrease of 3.0% for 2019 relative to 2018, mainly due to a decrease in overall commission's income. Wealth management income for 2018 was $2,969, an increase of 13.6% when compared with
2017. The increase in wealth management income for 2018 is attributable to the growth in AUM and the growth in the investment markets during 2018. AUM was approximately $460, $374, and $359 million as of year-end 2019, 2018, and 2017, respectively.
Gains (losses) on sales and calls of securities for the year ended December 31, 2019 amounted to $2,043, an increase of $6,203, when compared with the same period in 2018. The increase was due to the Company’s election to sell certain securities to take advantage of the market conditions that existed during 2019, consistent with the strategic securities reduction. The Company evaluated its securities held-to-maturity and determined that certain securities no longer adhered to the Company’s strategic focus and could be sold or reinvested to potentially improve the Company’s liquidity position, duration profile and net interest margin. Accordingly, the Company was no longer able to assert that it had the intent to hold these securities until maturity and, as a result, the Company transferred all of its securities held-to-maturity to securities available-for-sale. Once the securities were transferred to available-for-sale, certain securities were sold as part of the Company’s balance sheet management initiatives. For the year ended December 31, 2018, the loss on sales and calls of securities was $4,160, a compared to a gain of $896 the year ended December 31, 2017. The large loss on sale in 2018 can be attributed to a balance sheet rotation strategy implemented during the fourth quarter of 2018 to ultimately re-purpose approximately $300,000 from lower-yielding securities into higher-yielding assets.
Net loss on sale of loans held for investment for the year ended December 31, 2019 was $2,003, a decrease of $2,003, or 100%, when compared to year ended December 31, 2018. The losses during the year ended December 31, 2019 were attributed to the sales of several SNC relationships during the year compared to no sales occurring during 2018. Net gain for the year ended December 31, 2018 was $0, a decrease of $226, or 100%, from the year ended December 31, 2017.
Other non-interest income decreased $13, or 0.8%, when comparing the years ended December 31, 2019 and 2018, and it increased $758, or 83.5%, when comparing the years ended December 31, 2018 and 2017. The decrease in other non-interest income from 2019 is primarily attributable to a decrease in ceded premiums of $328. The increase in other non-interest income for 2018 is primarily attributable to increases in the cash surrender value of the bank owned life insurance (BOLI).
Non-interest expense for the years ended December 31, 2019, 2018 and 2017 was $81,879, $73,478 and $60,824, respectively. This increase was the result of the following components listed in the table below (in thousands):
|Years Ended December 31,||2019-2018|
|Year Ended December 31,||2018-2017|
|Salaries and employee benefits||$||50,813||$||43,837||15.9||%||$||35,268||24.3||%|
|Occupancy and equipment||13,069||11,628||12.4||9,219||26.1|
|FDIC assessment expense||1,843||3,448||(46.5)||3,680||(6.3)|
|Amortization of core deposit intangible||504||612||(17.6)||473||29.4|
|Total non-interest expense||$||81,879||$||73,478||11.4||%||$||60,824||20.8||%|
During 2019 and 2018, salaries and employee benefits expense increased 15.9% and 24.3%, respectively, and total employees increased by 1 in 2019 and 54 in 2018. The expense increases for December 31, 2019, and 2018, were mainly due to general salary increases and certain post-employment and retirement benefits of $4.1 million and $3.2 million, respectively.
The increase in occupancy and equipment expense during 2019 and 2018 is attributable to the Company entering into various leases for new branch and office locations. Occupancy and equipment expenses increased in 2019 by 12.4% and in 2018 by 26.1%. Building rent expense increased $376 and $1,073 and software maintenance fees increased $737 and $658 in 2019 and 2018, respectively.
The FDIC deposit insurance fund assessment decreased in 2019 by $1,605, or 46.5%, mainly due to a credit of approximately $900 that was received from the FDIC for a Small Bank Assessment Credit issued in 2019. The FDIC assessment expense also decreased due to the Company’s decline in average assets, improved Leverage Ratio and other financial ratios considered in the FDIC’s calculation for insurance assessments. The FDIC deposit insurance fund assessment
decreased 6.3% in 2018 due to improvements in demographics of loan portfolio and improvements in the Bank’s risk profile in regulatory standing.
Marketing expenses increased by 8.9% in 2019, and by 13.2% in 2018 due to efforts to gain a larger market share in Davidson County and the opening of two new branches during 2018.
Professional fee expenses remained steady during 2019 with a decrease of 1.3%. Professional fees increased by 29.1% during 2018 primarily due to increases in other professional fees $326, audit and accounting fees $125, merger expenses $334, and legal fees $213. A significant portion of the increase is related to expenses related to the acquisition of Civic.
Other noninterest expense increased $1,657, or 19.6%, during 2019 and $648, or 8.3%, during 2018. The increase in 2019 can be attributed to ATM network expense $206; CDARS fee expense $367; captive insurance expense $134; and correspondent bank charges $130. The increase in 2018 was due to captive insurance expense $369; loan servicing expense $295; and board of director fees $108. Amortization of core deposit intangibles decreased $108 or 17.6%, during 2019 and increased $139, or 29.4%, during 2018.
Return on Equity and Assets
The following schedule details selected key ratios for the years ended December 31, 2019, 2018 and 2017:
|Return on assets (Net income divided by average total assets)||0.37||%||0.84||%||0.82||%|
|Return on equity (Net income divided by average equity)||3.8||%||10.2||%||9.7||%|
|Dividend payout ratio (Dividends declared per share divided by net income per share)||17.8||%||—||%||—||%|
|Equity to asset ratio (Average equity divided by average total assets)||9.8||%||8.2||%||8.4||%|
|Leverage capital ratio (Equity divided by fourth quarter average total assets, excluding accumulated other comprehensive income)||10.3||%||8.8||%||8.3||%|
The minimum leverage capital ratio required by the regulatory agencies is 4.00%.
Under guidelines developed by regulatory agencies a “risk weight” is assigned to various categories of assets and commitments ranging from 0% to 300% based on the risk associated with the asset. The following schedule details the Company’s risk-based capital at December 31, 2019 excluding the net unrealized gain on available-for-sale securities which is shown as an addition in stockholders’ equity in the consolidated financial statements:
|Common Equity Tier 1 capital:|
|Stockholders’ equity, excluding accumulated other comprehensive income, disallowed goodwill, other disallowed intangible assets and disallowed servicing assets||$||388,199|
|Tier 1 capital:|
|Common Equity Tier 1 capital plus additional tier 1 capital instruments and related surplus, less additional tier 1 capital deductions||$||388,199|
|Tier 2 capital:|
|Tier 2 capital instruments plus related surplus||58,872|
|Total capital minority interest that is not included in tier 1 capital||84|
|Allowable allowance for loan losses (limited to 1.25% of gross risk-weighted assets)||40,811|
|Total risk-based capital||$||487,966|
|Risk-weighted assets, gross||$||3,264,861|
|Less: Excess allowance for loan and lease losses||4,625|
|Risk-weighted assets, net||$||3,260,236|
|Risk-based capital ratios:|
|Common Equity Tier 1 risk-based capital ratio||11.9||%|
|Tier 1 risk-based capital ratio||11.9||%|
|Total risk-based capital ratio||15.0||%|
The minimum Common Equity Tier 1 risk-based capital ratio required by the regulatory agencies is 4.50%. Tier 1 risk-based capital ratio required by the regulatory agencies is 6.00%, and the minimum total risk-based capital ratio required is 8.00%. At December 31, 2019, the Company was in compliance with these requirements.
COMPARISON OF BALANCE SHEETS AT DECEMBER 31, 2019 AND DECEMBER 31, 2018
Total assets decreased by $353,277, or 8.3%, from December 31, 2018 to December 31, 2019 driven primarily by strategic balance sheet actions geared toward unlocking the value of the core bank through a reduction in non-core assets and liabilities.
The following table compares selected balance sheet totals from December 31, 2019 and 2018:
|In Thousands||December 31, 2019||December 31, 2018||Growth||Growth|
|Total loans held for investments, net of deferred fees||$||2,812,444||$||2,672,399||$||140,045||5.2||%|
Loans Held For Sale
During 2019, the Company originated $655,546 of mortgage loans to sell in the secondary market, compared to originations of $278,559 during 2018. For the years ended December 31, 2019, 2018, 2017, the Company recorded gains from sales of mortgage loans totaling $9,217, $6,286, and $6,779, respectively, which is included in mortgage banking revenue on the Company's Consolidated Statements of Income.
Loans Held For Investment
Total loans, net of deferred fees, at December 31, 2019 and 2018 were $2,812,444 and $2,672,399, respectively, an increase of $140,045, or 5.2%. This growth in the loan portfolio is due to increased market penetration and a healthy local economy, as well as the addition of several experienced loan officers.
The table below provides a summary of the loans held for investment portfolio composition for the periods noted.
|As of December 31,|
|Types of Loans||2019||2018||2017||2016||2015|
|Total loans held for investment|
|Construction and land development||$||591,541||$||584,440||$||494,818||$||489,562||$||372,845|
|Commercial and industrial||582,641||596,793||503,914||378,445||285,700|
|Consumer and other||4,769||5,568||3,781||3,359||6,577|
|Loans before net deferred loan fees||2,816,464||2,674,943||2,258,571||1,774,385||1,306,302|
|Deferred loan fees, net||(4,020)||(2,544)||(1,963)||(793)||(2,476)|
|Allowance for loan losses||(45,436)||(23,451)||(21,247)||(16,553)||(11,587)|
|Total loans, net allowance for loan losses||$||2,767,008||$||2,648,948||$||2,235,361||$||1,757,039||$||1,292,239|
Gross loans increased $141,521, or 5.3%, during 2019 with real estate loans growing by 7.5%, primarily in commercial real estate, which grew 23.5% and was offset by a 5.8% decrease in residential real estate. The commercial and industrial segment also decreased by 2.4% during 2019.
Real estate loans comprised 79.1% of the loan portfolio at December 31, 2019. The largest portion of the real estate segments of the portfolio as of December 31, 2019, was commercial real estate loans, which totaled $993,912 and comprised 44.6% of real estate loans and 35.3% of the total loan portfolio. The commercial real estate loan classification primarily includes
commercial-based mortgage loans secured by nonfarm, nonresidential real estate properties and multi-family residential properties.
Construction and land development loans totaled, $591,541, or 26.5% of real estate loans, and comprised 21.0% of gross loans at December 31, 2019. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development.
The residential real estate classification primarily includes 1-4 family residential loans, which are typically conventional first-lien home mortgages or junior lien mortgages, not including loans held-for-sale in the secondary market. Residential real estate loans totaled $643,601 and comprised 28.9% of real estate loans and 22.9% of total loans at December 31, 2019.
Commercial and industrial loans consist of commercial loans, including healthcare loans, to various sized businesses primarily secured by commercial assets, such as inventories, business equipment, receivables and other commercial assets. At December 31, 2019, commercial and industrial loans made up 20.7% of the total loan portfolio, and healthcare loans comprised 49.7% of commercial and industrial loans.
The banking agencies define a “Shared National Credit” (“SNC”) as any loan extended to a borrower which aggregates $100 million or more and is shared by three or more banks. The SNC portfolio totaled $136,658 at December 31, 2019, decreasing 45.1% from $249,033 at December 31, 2018, driven by the sales and paydowns of $112,375 of SNCs during 2019. The entire outstanding balance of SNCs was included in the commercial and industrial portfolio. SNC participations are originated in the normal course of business to meet the needs of our customers and are reviewed at least quarterly for credit quality.
|SNC and Healthcare Portfolios||December 31, 2019||September 30, 2019||June 30, 2019||March 31, 2019||December 31, 2018|
QoQ (Decline) Growth (1)
|YoY (Decline) Growth|
|% of Total Loans HFI||4.9||%||5.2||%||8.0||%||8.1||%||9.3||%|
The repayment of loans is a source of liquidity. The following table sets forth the loans maturing within specific intervals at December 31, 2019, excluding unearned net fees and costs.
Loan Maturity Schedule
|December 31, 2019|
year to five
|Construction and land development||$||272,354||$||190,957||$||128,230||$||591,541|
|Commercial and industrial||70,845||420,222||91,574||582,641|
|Consumer and other||2,910||1,589||270||4,769|
|Fixed interest rate||$||102,359||$||441,005||$||403,900||$||947,264|
|Variable interest rate||332,089||621,806||915,305||1,869,200|
The information presented in the above table is based upon the contractual maturities of the individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity structure of the loan portfolio.
Allowance for Loan Losses (ALLL)
The Company maintains the ALLL at a level that management believes is adequate to absorb the probable incurred losses in the Bank’s loan portfolio. The ALLL is increased by provisions for loan losses charged to earnings and is decreased by loan charge-offs net of recoveries of prior period loan charge-offs. The ALLL is evaluated quarterly, although management is engaged in monitoring the adequacy of the allowance on a more frequent basis. In estimating the ALLL balance, the following factors are considered:
•past loan experience;
•the nature and volume of the portfolio;
•risks known about specific borrowers;
•underlying estimated values of collateral securing loans;
•current and anticipated economic conditions; and
•other factors which may affect the allowance for probable incurred losses.
The ALLL consists of two primary components: (1) a specific component that relates to loans that are individually classified as impaired, and (2) a general component which covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank’s loss history and loss history from a peer group. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.
The following loan portfolio segments have been identified: (1) Construction and land development loans, (2) Commercial real estate loans, (3) Residential real estate, (4) Commercial and industrial loans, and (5) Consumer and other loans. Management evaluates the risks associated with these segments based upon specific characteristics associated with the loan segments. These risk characteristics include, but are not limited to, the value of the underlying collateral, adverse economic conditions, and the borrower’s cash flow. While the total ALLL consists of a specific portion and a general portion, both portions of the allowance are available to provide for probable incurred loan losses in the entire portfolio.
|December 31, 2019||December 31, 2018||Increase (Decrease)|
|Non impaired loans||$||2,730,684||$||24,588||0.90||%||$||2,575,930||$||23,249||0.90||%||$||154,754||$||1,339||—||bps|
Acquired loans (1)
(1)Loans acquired pursuant to the acquisitions of MidSouth and Civic. These are performing loans recorded at estimated fair value at the respective acquisition dates. This fair value discount that was established at acquisition is accreted into interest income over the remaining lives of the related loans on a straight-line basis. The remaining fair value discount balance at December 31, 2019 related to the acquired loans was $726, or 1.2% of the outstanding aggregate loan balances. At December 31, 2019, loans identified as impaired beyond the extent of its recorded discount lead to an allowance for loan losses of $77 being recorded related to the acquired loans. The remaining fair value discount balance at December 31, 2018 related to the acquired loans was $1,210, or 1.3% of the outstanding aggregate loan balances. At December 31, 2018, loans identified as impaired beyond the extent of its recorded discount lead to an allowance for loan loss of $185 being recorded related to the acquired loans.
At December 31, 2019, the ALLL was $45,436, compared to $23,451 at December 31, 2018. ALLL as a percentage of total loans held for investment was 1.61% and 0.88% at December 31, 2019 and 2018, respectively. Loan growth and deterioration of certain commercial loan relationships during the period is the primary reason for the increase in the ALLL.
The table below sets forth the activity in the ALLL for the years presented.
|Construction & land development||(68)||(38)||—||(11)||—|
|Commercial real estate||—||—||—||—||—|
|Residential real estate||(15)||(7)||(1)||(40)||(32)|
|Commercial & industrial||(10,227)||(49)||(310)||(255)||(48)|
|Total loans charged-off||(10,457)||(121)||(360)||(348)||(215)|
|Recoveries on loans previously charged-off:|
|Construction & land development||—||1||668||—||—|
|Commercial real estate||—||—||—||—||—|
|Residential real estate||15||44||50||66||26|
|Commercial & industrial||286||11||6||1||1|
|Total loan recoveries||395||71||741||74||92|
|Net recoveries (charge-offs)||(10,062)||(50)||381||(274)||(123)|
|Provision for loan losses charged to expense||32,047||2,254||4,313||5,240||5,030|
|Total allowance at end of period||$||45,436||$||23,451||$||21,247||$||16,553||$||11,587|
Total loans, gross, at end of period(1)
Average gross loans(1)
|Allowance to total loans||1.61||%||0.88||%||0.94||%||0.93||%||0.89||%|
|Net charge-offs (recoveries) to average loans||0.35||%||0.00||%||(0.02)||%||0.02||%||0.01||%|
(1)Loan balances exclude loans held for sale.
While the total ALLL consists of a specific portion and a general portion, both portions of the allowance are available to provide for probable incurred loan losses in the entire portfolio. The following table summarizes the allocation of ALLL by loan category and loans in each category as a percentage of total loans, for the periods presented.
Loan Segment to Total Loans
Loan Segment to Total Loans
Loan Segment to Total Loans
Loan Segment to Total Loans
Loan Segment to Total Loans
|Real estate loans:|
|Construction and land development||$||4,847||21.0||%||$||4,743||21.9||%||$||3,802||21.9||%||$||3,776||27.6||%||$||3,186||28.5||%|
|Total real estate||17,422||79.0||%||16,211||77.6||%||13,617||77.5||%||10,440||78.5||%||8,193||77.6||%|
|Commercial and industrial||27,957||20.7||%||7,166||22.2||%||7,587||22.3||%||6,068||21.3||%||3,358||21.9||%|
|Consumer and other||57||0.2||%||74||0.2||%||43||0.2||%||45||0.2||%||36||0.5||%|
Fluctuations in the allocations during the periods presented are due, in part, to changes in the specific reserve factors assigned to each category of loans. The Company has relied heavily on the loss history of peer groups due to the lack of its own history of losses; therefore, reserve factors have been adjusted in accordance with the loss performance experienced by a select group of local peer banks. Allocations between categories of loans have also been affected by the change in the mix of loans among the categories.
As of December 31, 2019, the largest component of the ALLL was associated with commercial and industrial loans, followed by commercial real estate loans. The increase on these reserves as a percentage of the total allowance in these categories was primarily due to qualitative and specific risk factors in these portfolio segments, and specific reserves for impaired loans in the commercial and industrial segment. Commercial and industrial loans decreased 2.4% from $596,793, or 22.2% of total loans at the end of 2018, to $582,641, or 20.7% of total loans at year-end 2019. During 2019, construction and land development loans increased from $584,440 at December 31, 2018 to $591,541 at December 31, 2019, an increase of 1.2%. During the same period, commercial real estate loans increased 23.4%, from $805,260 at December 31, 2018 to $993,912 at December 31, 2019.
Nonperforming loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest. Nonperforming assets consist of nonperforming loans plus OREO (i.e., real estate acquired through foreclosure or deed in lieu of foreclosure). Loans are placed on non-accrual status when they are past due 90 days and management believes the borrower’s financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. When a loan is placed on nonaccrual status, interest accruals cease and uncollected interest is reversed and charged against current income. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The primary component of nonperforming loans is nonaccrual loans, which as of December 31, 2019 totaled $27,035. The other component of nonperforming loans are loans past due greater than 90 days and still accruing interest which totaled $654 at December 31, 2019. Loans past due greater than 90 days are placed on nonaccrual status unless they are both well-secured and in the process of collection.
In connection with our year-end audit process, and subsequent to our January 21, 2020 earnings release related to fourth quarter of 2019, we determined to record an additional provision of $18,761 to fund a specific reserve in respect of two lending relationships in our healthcare and corporate loan portfolios. Our determination to record this additional provision was primarily the result of certain developments and circumstances regarding the collectability from these two relationships that arose following our earnings release. Under GAAP we are required to reflect the additional provision during the fourth quarter of 2019, and the specific reserve as of December 31, 2019. Accordingly, this Form 10-K contains financial information that reflects the updated provision and reserve that is different than the information previously presented in our January 21, 2020 earnings release related to the fourth quarter of 2019.
The table below summarizes nonperforming loans and assets for the periods presented.
|Nonperforming loans and assets||2019||2018||2017||2016||2015|
|Past due loans 90 days or more and still accruing interest||654||208||205||2,552||2,378|
|Total nonperforming loans||27,689||5,696||3,042||6,182||3,286|
|Foreclosed real estate (“OREO”) and repossessed assets||—||—||1,503||—||200|
|Total nonperforming assets||$||27,689||$||5,696||$||4,545||$||6,182||$||3,486|
|Total nonperforming loans as a percentage of total loans||0.98||%||0.21||%||0.13||%||0.35||%||0.25||%|
|Total nonperforming assets as a percentage of total assets||0.71||%||0.13||%||0.12||%||0.21||%||0.16||%|
|Allowance for loan losses as a percentage of nonperforming loans||164||%||412||%||698||%||268||%||353||%|
As of December 31, 2019, there were twenty loans on nonaccrual status. Please refer to the table below for a summary of nonaccrual loans by type:
|Nonaccrual loans by type||Nonaccrual Loans||Percentage of|
|Commercial & Industrial||24,528||90.7||%||11|
|Total nonaccrual loans||$||27,035||100.0||%||20|
TDRs are modified loans in which a concession is provided to a borrower experiencing financial difficulties. Loan modifications are considered a TDR when the concession provided is not available to the borrower through either normal channels or other sources; however, not all loan modifications are TDRs. Our standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations; however, each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. TDRs can be either accruing or non-accruing loans. The Bank had one TDR for $311 at December 31, 2019, and one TDR for $167 as of December 31, 2018.
Generally, loans that are current as to principal and interest are not included in our nonperforming assets categories; however, a loan that is current may be classified as a potential problem loan if it exhibits potential weaknesses and management has information about possible credit problems of the borrower that has caused management to have doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be consistent with the Bank’s loan policy established for loans classified as special mention or worse and less than 90 days past due, but not considered nonperforming. Loans are assigned risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually when classifying the loans as to credit risk.
The following definitions are used for assigning risk ratings to loans:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above are considered to be “Pass” rated loans. All loans in all loan categories are assigned risk ratings. As of December 31, 2019, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
|Dollars in Thousands|
|Real estate loans:|
|Construction and land development||$||591,293||$||248||$||—||$||591,541|
|Total real estate||2,219,977||2,070||7,007||2,229,054|
|Commercial and industrial||539,442||943||42,256||582,641|
|Consumer and other||4,769||—||—||4,769|
At December 31, 2019, the Bank realized a $12,291 decrease in classified and criticized loans compared to December 31, 2018.
Gain (loss) on Sale of Bonds
Gains (losses) on sales and calls of securities for the year ended December 31, 2019 amounted to $2,043, an increase of $6,203, when compared with the same period in 2018. The loss from sales in 2018 is attributed to a balance sheet rotation strategy implemented during the fourth quarter of 2018 to re-purpose funds from lower yielding securities into higher yielding assets by selling those securities.
The AFS portfolio totaled $652,132 at December 31, 2019, compared to $1,030,668 at December 31, 2018, a decrease of $378,536, or 36.7%. The decrease is due to the Company's continuation of the balance sheet rotation strategy during 2019 to unlock the value of the core bank.
The HTM portfolio totaled $0 at December 31, 2019, compared to $121,617 at December 31, 2018, a decrease of $121,617, or 100%. The decrease can be attributed to the aforementioned balance sheet rotation strategy that included transferring securities from the HTM intention to the AFS intention during 2019.
The AFS securities represented 16.7% of total assets at December 31, 2019, and the combined AFS and HTM portfolios represented 27.1% of total assets at December 31, 2018. No securities were determined to be other than temporarily impaired at December 31, 2019.
The following table summarizes the fair value of the AFS securities portfolio at December 31, 2019 and 2018:
|U.S. government sponsored entities and agencies||$||—||$||21,888|
|U.S. Treasury securities||—||253,014|
|Mortgage-backed securities: residential||375,943||580,699|
|Mortgage-backed securities: commercial||17,780||—|
|State and political subdivisions||225,048||137,799|
The following table summarizes the amortized cost of the HTM securities portfolio at December 31, 2019 and 2018:
|Mortgage backed securities: residential||$||—||$||75,944|
|State and political subdivisions||—||45,673|
The table below presents the maturities and yield characteristics of the AFS securities as of December 31, 2019. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
|(Dollars in Thousands)|
Mortgage-backed securities: residential(1)
|Mortgage-backed securities: commercial||—||9,860||7,998||—||17,858||17,780|
|State and political subdivisions||3,733||3,313||177,982||37,596||222,624||225,048|
|Total available-for-sale securities||$||3,783||$||197,677||$||369,949||$||76,821||$||648,230||$||652,132|
|Percent of total||0.58||%||30.50||%||57.07||%||11.85||%||100.00||%|
Weighted average yield(2)
(1)Mortgage-backed securities are grouped into average lives based on December 31, 2019 prepayment projections.
(2)The weighted average yields are based on amortized cost, and municipal securities are calculated on a fully tax-equivalent basis.
Securities pledged at December 31, 2019 and 2018 had a carrying amount of $294,585 and $939,440, respectively, and were pledged to secure public deposits and repurchase agreements.
At December 31, 2019 and 2018, there were no holdings of securities of any one issuer, other than the U.S. government-sponsored entities and agencies, in an amount greater than 10% of shareholders’ equity.
Restricted Equity Securities
Other investments totaled $24,802 and $21,831 at December 31, 2019, and December 31, 2018, respectively, and primarily consisted of capital stock in the Federal Reserve and the FHLB (required as members of the Federal Reserve Bank System and the FHLB). The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus, not liquid, have no ready market or quoted market value, and are carried at cost.
Bank Premises and Equipment
Bank premises and equipment totaled $12,141 at December 31, 2019 compared to $12,371 at December 31, 2018, a decrease of $230, or 1.9%.
As of December 31, 2019, the cash surrender value of the BOLI portfolio totaled $56,726, compared to $55,239 at December 31, 2018. The increase is attributed to the increase in cash surrender value during 2019.
Goodwill and Intangible Assets
As of December 31, 2019 and 2018, the Company had $18,176 in goodwill related to the acquisition of MidSouth Bank in 2014 and Civic Bank & Trust in April of 2018. At December 31, 2019, there were no circumstances or significant changes that have occurred related to those acquisitions that, in management’s assessment, would necessitate recording impairment of goodwill.
As of December 31, 2019 and 2018, the Company had net core deposit intangible of $448 and $952, respectively. At the time of the acquisitions, the Bank recorded a core deposit intangible of $3,059 and $558 related to MidSouth and Civic, respectively. These core deposit intangibles are amortizing over 8.2 and 3.2 years, respectively. Through December 31, 2019, the Company has recognized amortization of $3,169 related to the core deposit intangible.
The following table represents acquired intangible assets at December 31, 2019 and 2018:
|Acquired intangible assets:|
|Core deposit intangibles||$||3,617||$||(3,169)||$||3,617||$||(2,665)|
Aggregate amortization expense was $504, $612 and $473 for 2019, 2018 and 2017, respectively.
The following table presents the estimated remaining amortization expense:
At December 31, 2019, total deposits were $3,207,584, a decrease of $224,223, or 6.5%, compared to $3,431,807 at December 31, 2018. Included in the Company’s funding strategy are brokered deposits and public funds deposits. Total brokered deposits decreased by 20.8%, to $632,241, at December 31, 2019 when compared with $797,795 at December 31, 2018. Public funds deposits decreased 50.6% from $782,890 at December 31, 2018 to $386,902 at December 31, 2019, because many of those deposits were placed in a reciprocal deposits program, providing FDIC insurance coverage to the public entities without having to pledge securities.
Time deposits, excluding brokered deposits, as of December 31, 2019, amounted to $399,258, as compared to $532,445 as of December 31, 2018.
The average amounts for deposits for 2019, 2018 and 2017 are detailed in the following schedule.
|In thousands, except percentages||Average|
|Interest-bearing checking accounts||765,218||1.98||829,978||1.62||624,612||0.80|
|Money market deposit accounts||1,085,619||2.14||769,003||1.77||627,140||1.04|
The following table shows time deposits, excluding brokered deposits, of $100 or more by category based on time remaining until maturity.
|Three months or less||$||33,327|
|Over three months through six months||61,326|
|Over six months through 12 months||83,827|
|Over one year through three years||128,630|
|Over three years through five years||15,933|
|Over five years||—|
Liquidity, Other Borrowings, and Capital Resources
Federal Funds Purchased and Repurchase Agreements
As of December 31, 2019 and 2018, the Company had no Federal funds purchased from correspondent banks and no securities sold under agreements to repurchase.
The Bank has established a line of credit with the FHLB of Cincinnati which is secured by a blanket pledge of 1-4 family residential mortgages, home equity lines of credit, multifamily real estate, and commercial real estate. At December 31, 2019, advances totaled $155,000 compared to $368,500 as of December 31, 2018. Based on this collateral, up to an additional $633,910 is eligible to borrow with this line of credit at December 31, 2019.
At December 31, 2019, the scheduled maturities of these advances and interest rates were as follows:
The Company has issued $60,000 of subordinated notes in two separate issuances. In March 2016, $40,000 of 6.875% fixed-to-floating rate subordinated notes were issued in a public offering to accredited institutional investors, and in June 2016, $20,000 of 7.00% fixed-to-floating rate subordinated notes were issued to certain accredited institutional investors in a private offering. At December 31, 2019, subordinated notes, net of issuance costs, totaled $58,872 as compared to $58,693 at December 31, 2018. For regulatory capital purposes, the subordinated notes are treated as Tier 2 capital, subject to certain limitations, and are included in total regulatory capital when calculating the Company’s total capital to risk weighted assets ratio as indicated in Note 17 of the consolidated financial statements.
The subordinated notes are unsecured and will rank at least equally with all of the Company’s other unsecured subordinated indebtedness and will be effectively subordinated to all of our secured debt to the extent of the value of the collateral securing such debt. The subordinated notes will be subordinated in right of payment to all of our existing and future senior indebtedness, and will rank structurally junior to all existing and future liabilities of our subsidiaries including, in the case of the Company’s bank subsidiary, its depositors, and any preferred equity holders of our subsidiaries. The holders of the subordinated notes may be fully subordinated to interests held by the U.S. government in the event that we enter into a receivership, insolvency, liquidation, or similar proceeding.
The following table summarizes the terms of each subordinated note offering:
|Principal amount issued||$40,000||$20,000|
|Maturity date †||March 30, 2026||July 1, 2026|
|Initial fixed interest rate||6.875%||7.00%|
|Initial interest rate period||5 years||5 years|
|First interest rate change date †||March 30, 2021||July 1, 2021|
|Interest payment frequency through year five||Semiannually||Semiannually|
|Interest payment frequency after five years||Quarterly||Quarterly|
|Interest repricing index and margin||3-month LIBOR|
† The March 2016 Subordinated Notes are redeemable at the Company’s option in whole or in part on or after March 30, 2021, and the June 2016 Subordinated Notes are redeemable at the Company’s option in whole or in part on or after July 1, 2021.
For more detail related to the subordinated notes, please see Note 12 of the consolidated financial statements.
Shareholders’ equity was $410,333 at December 31, 2019, an increase of $37,593, or 10.1%, from $372,740 at December 31, 2018. Common dividends of $2,636 were paid during 2019, and no common dividends were paid during 2018 and 2017.
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. 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 risk-weighted assets ("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 buffer threshold for 2019 was 2.5%. 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 requires 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.
PCA regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
Management believes as of December 31, 2019, the Company and Bank meet all capital adequacy requirements to which they are subject. Actual and required capital amounts and ratios are presented below as of December 31, 2019 and 2018 for the Company and Bank.
|To Be Well|
|December 31, 2019|
|Common equity Tier 1 capital to RWA||$||388,199||11.9||%||$||146,711||4.5||%||N/A||N/A|
|Total Capital to RWA||$||487,966||15.0||%||$||260,819||8.0||%||N/A||N/A|
|Tier 1 (Core) Capital to RWA||$||388,199||11.9||%||$||195,614||6.0||%||N/A||N/A|
|Tier 1 (Core) Capital to average assets||$||388,199||10.3||%||$||151,456||4.0||%||N/A||N/A|
|Common equity Tier 1 capital to RWA||$||441,348||13.6||%||$||146,491||4.5||%||$||211,599||6.5||%|
|Total Capital to RWA||$||482,183||14.8||%||$||260,429||8.0||%||$||325,536||10.0||%|
|Tier 1 (Core) Capital to RWA||$||441,348||13.6||%||$||195,322||6.0||%||$||260,429||8.0||%|
|Tier 1 (Core) Capital to average assets||$||441,348||11.7||%||$||151,255||4.0||%||$||189,069||5.0||%|
|December 31, 2018|
|Common equity Tier 1 capital to RWA||$||367,096||12.2||%||$||135,598||4.5||%||N/A||N/A|
|Total Capital to RWA||$||449,325||14.9||%||$||241,064||8.0||%||N/A||N/A|
|Tier 1 (Core) Capital to RWA||$||367,096||12.2||%||$||180,798||6.0||%||N/A||N/A|
|Tier 1 (Core) Capital to average assets||$||367,096||8.8||%||$||167,553||4.0||%||N/A||N/A|
|Common equity Tier 1 capital to RWA||$||421,335||14.0||%||$||135,613||4.5||%||$||195,886||6.5||%|
|Total Capital to RWA||$||444,871||14.8||%||$||241,090||8.0||%||$||301,363||10.0||%|
|Tier 1 (Core) Capital to RWA||$||421,335||14.0||%||$||180,818||6.0||%||$||241,090||8.0||%|
|Tier 1 (Core) Capital to average assets||$||421,335||10.1||%||$||167,420||4.0||%||$||209,275||5.0||%|
Note: Minimum ratios presented exclude the capital conservation buffer.
The following table summarizes our contractual obligations and other commitments to make minimum future payments as of December 31, 2019:
|(Dollars in Thousands)|
|One Year or|
|As of December 31, 2019|
|Minimum operating lease commitments||4,849||9,727||9,786||31,277||55,639|
|Capital lease commitment||276||564||581||2,840||4,261|
FHLB advances include arrangements under various FHLB credit programs. Long-term FHLB debt is more fully described under the caption “FHLB Advances” in Note 11 of our Consolidated Financial Statements. Subordinated notes include two issuances that occurred in the first and second quarters of 2016, respectively. The subordinated notes are more fully described in Note 12, “Subordinated Notes” of our Consolidated Financial Statements. Operating and capital lease commitments include leases for branch and office sites and are included in Note 7, “Leases”.
Interest Rate Sensitivity
The following schedule details the Company’s interest rate sensitivity at December 31, 2019:
|(In Thousands, Except Percentages)||Total||1-90 Days||3 months|
|1 to 5 years||Over 5|
|Loans, net of unearned income†||$||2,785,409||$||1,276,838||$||128,059||$||996,062||$||384,450|
|Loans held for sale||43,162||—||—||—||43,162|
|Available for sale securities||652,132||—||—||7,571||644,561|
|Interest-bearing deposits at other financial institutions||195,888||195,888||—||—||—|
|Certificates of deposit at other financial institutions||3,590||490||735||2,115||250|
|Total earning assets||3,680,181||1,473,216||128,794||1,005,748||1,072,423|
|Interest-bearing checking accounts||843,475||843,475||—||—||—|
|Money market deposit accounts||1,255,438||1,255,438||—||—||—|
|IRA’s and certificates of deposit, $250,000 and over||142,435||13,644||65,161||63,630||—|
|IRA’s and certificates of deposit, under $250,000||606,622||68,115||227,203||311,304||—|
|Total interest-bearing liabilities||3,101,453||2,310,283||357,364||433,806||—|
|Interest-sensitivity gap as % of total average assets||(20.76)||%||(5.67)||%||14.19||%||26.60||%|
|Cumulative gap as % of total average assets||(20.76)||%||(26.43)||%||(12.24)||%||14.36||%|
† Loans, net of unearned income, excludes non-accrual loans.
Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis.
Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, management focuses on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet the Company’s needs. Our source of funds to pay interest on our March 2016 Notes and June 2016 Notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. The Bank’s ability to pay a dividend may be restricted due to regulatory requirements as well as the Bank’s future earnings and capital needs.
Funds are available from a number of basic banking activity sources including the core deposit base, the repayment and maturity of loans, payments of principal and interest as well as sales of investments classified as available-for-sale, and sales of brokered deposits. As of December 31, 2019, the entire investment securities portfolio, totaling $652,132, was classified as AFS and is reported at fair value on the consolidated balance sheet. None of the portfolio was classified as HTM at December 31, 2019. Approximately $294,585 of the total $652,132 investment securities portfolio on hand at December 31, 2019, was pledged to secure public deposits and CRA investments. Other funding sources available include repurchase
agreements, federal funds purchased, and borrowings from the FHLB. For more detail regarding funding sources see Note 10 and Note 11 of the consolidated financial statements.
Effects of Inflation and Changing Prices
The accompanying consolidated financial statements have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation affects financial institutions’ increased cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and shareholders’ equity. Commercial and other loan originations and refinancing tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities.
Off Balance Sheet Arrangements
The Company generally does not have any off-balance sheet arrangements other than approved and unfunded loans and lines and letters of credit to customers in the ordinary course of business. At December 31, 2019, the Company had unfunded loan commitments outstanding of $48,999, unused lines of credit of $790,366, and outstanding standby letters of credit of $55,869.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial data included in our selected historical consolidated financial information are not measures of financial performance recognized by GAAP. Our management uses these non-GAAP financial measures in its analysis of our performance:
•“Common equity” is defined as total shareholders’ equity at end of period less the liquidation preference value of the preferred stock;
•“Tangible common equity” is common equity less goodwill and other intangible assets;
•“Total tangible assets” is defined as total assets less goodwill and other intangible assets;
•“Other intangible assets” is defined as the sum of core deposit intangible and SBA servicing rights;
•“Tangible book value per share” is defined as tangible common equity divided by total common shares outstanding. This measure is important to investors interested in changes from period-to-period in book value per share exclusive of changes in intangible assets;
•“Tangible common equity ratio” is defined as the ratio of tangible common equity divided by total tangible assets. We believe that this measure is important to many investors in the marketplace who are interested in relative changes from period-to period in common equity and total assets, each exclusive of changes in intangible assets;
•“Return on Average Tangible Common Equity” is defined as net income available to common shareholders divided by average tangible common equity;
•“Efficiency ratio” is defined as noninterest expenses divided by our operating revenue, which is equal to net interest income plus noninterest income;
•“Adjusted yield on loans” is our yield on loans after excluding loan accretion from our acquired loan portfolio. Our management uses this metric to better assess the impact of purchase accounting on our yield on loans, as the effect of loan discount accretion is expected to decrease as the acquired loans mature or roll off of our balance sheet;
•“Net interest margin” is defined as annualized net interest income divided by average interest-earning assets for the period; and
•“Adjusted net interest margin” is net interest margin after excluding loan accretion from the acquired loan portfolio and premiums for acquired time deposits. Our management uses this metric to better assess the
impact of purchase accounting on net interest margin, as the effect of loan discount accretion and accretion of net discounts and premiums related to deposits is expected to decrease as the acquired loans and deposits mature or roll off of our balance sheet.
We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use.
The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
|As of or for the Years Ended|
|December 31, 2019||December 31, 2018||December 31, 2017|
|(Amounts in thousands, except share/per share data and percentages)|
|Total shareholders’ equity||$||410,333||$||372,740||$||304,550|
|Less: Preferred stock||—||—||—|
|Total common equity||410,333||372,740||304,550|
|Less: Goodwill and other intangible assets||18,652||19,128||10,181|
|Tangible common equity||$||391,681||$||353,612||$||294,369|
|Common shares outstanding||14,821,594||14,538,085||13,237,128|
|Tangible book value per share||$||26.43||$||24.32||$||22.24|
|Net income available to common shareholders||$||14,806||$||34,505||$||28,083|
|Average tangible common equity||379,502||325,012||279,098|
|Return on average tangible common equity||3.9||%||10.6||%||10.1||%|
|Net interest income||$||111,160||$||105,503||$||97,046|
|Total noninterest expense||81,879||73,478||60,824|
Termination of Emerging Growth Company Status
Effective as of December 31, 2019, the Company no longer qualified as an emerging growth company, and therefore can no longer rely on the scaled disclosure requirements and exemptions from various reporting requirements afforded to emerging growth companies.
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, our independent registered public accounting firm is required to report on the effectiveness of our internal control over financial reporting, beginning with this Annual Report on Form 10-K for the year ended December 31, 2019,
Recently Adopted and Issued Accounting Pronouncements
See "Part II- Item 8. Financial Statements and Supplementary Data - Note 1. - Summary of Significant Accounting Policies" of this Report for further information.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Based upon the nature of our operations, we are not subject to foreign currency exchange or commodity price risk.
Management seeks to maintain profitability in both immediate and long-term earnings through funds management/interest rate risk management. Interest rate risk (sensitivity) management deals with the potential impact on earnings associated with changing interest rates using various rate change (shock) scenarios. Our rate sensitivity position has an important impact on earnings. Senior management monitors our rate sensitivity position throughout each month, and the Asset Liability Committee (“ALCO”) of the Bank meets on a quarterly basis to analyze the rate sensitivity position and other aspects of asset/liability management. These meetings cover the spread between the cost of funds and interest yields generated primarily through loans and investments, rate shock analyses, liquidity and dependency positions, and other areas necessary for proper balance sheet management.
Management believes interest rate risk is best measured by earnings simulation modeling. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 and 200 basis points. All rates are increased or decreased parallel to the change in prime rate. As a result of the simulation run as of December 31, 2019, net interest income was estimated to increase 0.96% and 1.96% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to increase 1.90% and 4.01% in a 100 basis points and 200 basis points declining rate assumption, respectively. These results are in line with the Company’s guidelines for rate sensitivity and fall within a desirably neutral interest rate risk positioning.
The following chart reflects the Company’s sensitivity to changes in interest rates as indicated as of December 31, 2019.
|Projected Interest Rate Change||Net Interest|
The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, changes in the shape of the yield curve, prepayments on loans and spreads between key market rates, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, these results do not include any management action that might be taken in responding to or anticipating changes in interest rates. The simulation results are one indicator of interest rate risk, and actual net interest income is largely impacted by the allocation of assets, liabilities, and product mix.
We utilize derivative financial instruments as part of an ongoing effort to mitigate interest rate risk exposure to interest rate fluctuations and facilitate the needs of our customers.
The Company has entered into interest rate swap contract to hedge interest rate exposure on short term liabilities, which is accounted for as a cash flow hedge, with the Company receiving a variable rate of interest and paying a fixed rate of interest. Additionally, the Company has entered into interest rate swap contracts to hedge interest rate exposure on the changes in fair value of fixed rate available-for-sale securities, which are accounted for as fair value hedges, with the Company receiving a variable rate of interest and paying a fixed rate of interest.
The Company enters into rate lock commitments and forward loan sales contracts as part of our ongoing efforts to mitigate our interest rate risk exposure inherent in our mortgage pipeline and held for sale portfolio. Under the interest rate lock
commitments, interest rates for a mortgage loan are locked in with the client for a period of time. Once an interest rate lock commitment is entered into with a client, we also enter into a forward commitment to sell the residential mortgage loan to secondary market investors. Forward loan sale contracts are contracts for delayed sale and delivery of mortgage loans to a counter party. We agree to deliver on a specified future date, a specified instrument, at a specified price or yield. The credit risk inherent to us arises from the potential inability of counterparties to meet the terms of their contracts. In the event of non-acceptance by the counterparty, we would be subject to the credit and inherent (or market) risk of the loans retained.
For more information about our derivative financial instruments, see Note 19, “Derivatives” in the notes to our consolidated financial statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required by this Item are included as a separate section of this report commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of December 31, 2019, as based on the evaluation of these controls and procedures required by Rule 13a-15(b) or 15d-15(b) of the Exchange Act. Based on that evaluation, our principal executive officer and principal financial officer have concluded that, because of the material weakness described below in Management's Report on Internal Control Over Financial Reporting, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective as of December 31, 2019 in ensuring that the information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and were not operating in an effective manner to ensure that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Notwithstanding the identified material weakness related to the Company's control environment, Franklin Financial Network, Inc. believes the consolidated financial statements included in this Form 10-K fairly represent in all material respects the Company's financial condition, results of operations and cash flows at and for the periods presented in accordance with U.S. GAAP.
Management’s Report on Internal Control Over Financial Reporting
The management of Franklin Financial Network, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Franklin Financial Network, Inc.’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
Franklin Financial Network, Inc.’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Based on the assessment of the effectiveness of the Company's internal control over financial reporting discussed above, management concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2019 due to a material weakness arising from certain control deficiencies existing during 2019 related to the
Company’s precision of review regarding the valuation of impaired loans. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The Company's internal controls are designed such that all impaired loans being assessed to determine if a specific reserve is warranted are reviewed by someone independent of the valuation function to ensure the valuation is reasonable. In the fourth quarter of 2019, management determined this control was not operating at a level sufficiently precise to adequately challenge the assumptions and inputs used in the valuation of impaired loans. No restatement of prior period financial statements and no change in previously issued financial results were required as a result of this material weakness in internal control, however, a reasonable possibility exists that material misstatements in the Company’s financial statements would not be prevented or detected on a timely basis.
The Company’s management is taking steps to remediate this material weakness by evaluating the Company's policies and procedures for and resources allocated to the review control over the valuation of impaired loans. As of December 31, 2019, the Company’s internal control over financial reporting was not effective due to this matter.
Crowe LLP, the independent registered public accounting firm that audited the Company's financial statements included in this Form 10-K, has also audited the Company's internal control over financial reporting as of December 31, 2019. Their report on the Company's internal control over financial reporting, which is included herein, expressed an adverse opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2019.
Changes in Internal Control Over Financial Reporting
Except for the foregoing, there were no changes in our internal control over financial reporting that occurred during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Information Regarding Our Directors
Included below is certain information regarding our directors. Each of our directors is elected annually to serve for a one-year term. There are no family relationships between any of the Company’s executive officers or directors, and there are no arrangements or understandings between a director and any other person pursuant to which such person was elected as director.
No director or officer of the Company has, during the last 10 years, been subject to or involved in any legal proceedings described under Item 401(f) of Regulation S-K, been convicted of any criminal proceeding (excluding traffic violations or similar misdemeanors), or been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and as a result of such proceeding was or is subject to a judgment, decree or final order enjoining future violations of, or prohibiting or mandating activities subject to, United States federal or state securities laws or finding any violations with respect to such laws.
|Jimmy E. Allen||80||Director|
|James W. Cross, IV||56||Chairman of the Board|
|Dr. David H. Kemp||61||Director|
|Dr. Anil C. Patel||62||Director|
|Paul M. Pratt, Jr.||56||Director|
|Pamela J. Stephens||61||Director|
|Melody J. Sullivan||67||Director|
|Gregory E. Waldron||57||Director|
|Benjamin P. Wynd||42||Director|
Jimmy E. Allen, age 80, is a director of FFN and the Bank. Mr. Allen is the owner of Venture Express, Inc. since 1980; Creative Transportation since 1999; Allen’s Cartage Company, LaVergne, Tennessee since 1980; and co-owner of Center Hill Marina & Yacht Club since 1994. He attended Austin Peay State University, Clarksville, Tennessee and the University of Tennessee, Nashville. Mr. Allen formerly served as a member of the board of directors of MidSouth, Rutherford Bank & Trust, Murfreesboro and Independent Bank, Gallatin, Tennessee. He served as past chairman of Tennessee Trucking Association and Nashville Motor Freight. His past accomplishments include being selected as Nashville Business Journal’s Executive of the Year. He is a supporter of Vanderbilt Children’s Hospital and Ronald McDonald House.
•Extensive Knowledge of the Financial Services Industry—Mr. Allen formerly served as a member of the board of directors of multiple banks.
•Relevant Executive/Leadership Experience—Mr. Allen is the President of three companies and the co-owner of a marina and yacht club.
•Relevant Governance Experience—Mr. Allen served as past chairman of two organizations.
James W. Cross, IV, age 56, has been a director of FFN since March 8, 2019 and a director of the Bank since July of 2009 and was previously a director of FFN from July 2009 to February 23, 2016 and from May 25, 2017 to May 24, 2018. Mr. Cross serves as President of Century Investment Partners, a site development firm also based in Franklin, Tennessee. Mr. Cross has more than 30 years of business experience in Tennessee, beginning his career at Century Construction Company, Inc., a firm started by his father, James W. Cross, III in 1958. Mr. Cross served on the board of directors of Franklin Financial Corporation, parent of Franklin National Bank and the Tennessee affiliate board of directors of Fifth Third Bank in Franklin, Tennessee. Mr. Cross is a member of the board of directors of Williamson Medical Center. He previously served on the board of directors of Franklin Tomorrow, Leadership Franklin, Youth Leadership Franklin, the Franklin-Williamson County Chamber of Commerce, the Williamson County Library, the Williamson County Library Foundation and Battle Ground Academy.
•Extensive Knowledge of Our Company—Mr. Cross has been a director of FFN since March 8, 2019 and a director of the Bank since July of 2009 and was previously a director of FFN from July 2009 to February 23, 2016 and from May 25, 2017 to May 24, 2018.
•Extensive Knowledge of the Financial Services Industry��Mr. Cross served on the board of directors of Franklin Financial Corporation, parent of Franklin National Bank and the Tennessee affiliate board of directors of Fifth Third Bank in Franklin, Tennessee.
•Relevant Executive/Leadership Experience—Mr. Cross has more than 30 years of business experience in Tennessee.
Dr. David H. Kemp, age 61, has been a director of the Bank since its inception and was previously a director of FFN from its inception until May 25, 2017 and from May 24, 2018 to the present. Dr. Kemp has more than 30 years of healthcare experience in Franklin, Tennessee. Dr. Kemp opened Kemp Orthodontics (now Kemp & Rice Orthodontics) in Franklin in 1986 and has owned and operated the business since that time. Dr. Kemp serves as an advocate speaker for 3M Oral Care and he furthers his education by participating in and lecturing to various dental study clubs, both locally and internationally. Dr. Kemp hosts in office courses to orthodontists promoting his ultra aesthetic orthodontic technique he has developed. From 1993 to April 2007, Dr. Kemp served as an Advisory Board member to First Tennessee Bank in Franklin, supporting Regional Presidents in the accomplishment of their responsibilities by assisting in contacts with community leaders. Dr. Kemp holds a Bachelor of Science from the University of Tennessee, Martin, Tennessee. Dr. Kemp is also a graduate of The University of Tennessee, Center for the Health Sciences, Memphis, Tennessee and holds both a Doctor of Dental Science and a Postdoctoral Master of Science in Orthodontics.
•Extensive Knowledge of Our Company—Dr. Kemp has been a member of the board of directors of the Bank since inception and was previously a director of FFN from FFN’s inception until May 25, 2017 and from May 24, 2018 to the present.
•Extensive Knowledge of the Financial Services Industry—In addition to his service on the boards of directors of FFN and the Bank, Dr. Kemp served on the Advisory Board for First Tennessee Bank in Franklin, Tennessee from 1993 to April 2007.
•Extensive Knowledge of the Healthcare Industry— Dr. Kemp has more than 30 years of healthcare experience in Franklin, Tennessee.
Dr. Anil C. Patel, age 62, was elected to the board of directors of FFN and the Bank effective April 1, 2018, pursuant to the requirements of the Agreement and Plan of Reorganization and Bank Merger dated December 14, 2015, by and among the Bank, Civic, and FFN, as amended by Amendment No. 1, dated May 9, 2016, Amendment No. 2, dated March 30, 2017, and Amendment No. 3, dated September 29, 2017. Dr. Patel has been providing gastroenterology services to his patients at his endoscopy center in Clarksville, Tennessee since 1993. Dr. Patel has also been involved with the construction of several Marriott hotels and retirement communities in the Middle Tennessee area, and in 2005, he helped organize Civic Bank & Trust (“Civic”). He served as Chairman of the board of directors of Civic since Civic’s organization until its merger with and into the Bank, effective April 1, 2018. He earned his bachelor’s and medical degrees from the University of Zambia in 1979 and 1982, respectively. He completed his residency in Internal Medicine at Baptist Hospital in 1988, his fellowship training in Gastroenterology at Vanderbilt University in 1990, and his Masters of Business Administration at the Vanderbilt Owen Graduate School of Business in 1998.
•Extensive Business Experience—Dr. Patel has extensive business experience and knowledge of the Nashville and broader Middle Tennessee markets. His connection to, and business experience in, both the Nashville and greater Middle Tennessee markets will provide valuable insight into those markets.
•Relevant Governance Experience—Dr. Patel previously served chairman of the board of directors of Civic.
Paul M. Pratt, Jr., age 56, has been a member of the board of directors of the Bank since inception and was previously a director of FFN from its inception until February 23, 2016 and from May 25, 2017 to May 24, 2018 and from March 8, 2019 to present. Mr. Pratt has 30 years of financial services and business experience in Franklin, Tennessee. In 1983, Mr. Pratt began his financial services career with Full Service Insurance, an independent insurance broker in Franklin, Tennessee. He rose through the ranks to become President, the position he holds today. Mr. Pratt is a 1983 graduate of Columbia State Community College with an Associate Degree in Engineering. Mr. Pratt is a Past President of the Board of Directors of the Franklin Noon Rotary Club and a former board member of Williamson Medical Foundation, a non-
profit dedicated to philanthropic community gifts to Williamson Medical Center in Franklin, Tennessee. Mr. Pratt also served on the Williamson County Advisory Board of Cumberland Bank until April 2007.
•Extensive Knowledge of Our Company—Mr. Pratt has been a member of the board of directors of the Bank since inception and was previously a director of FFN from FFN’s inception until February 23, 2016 and from May 25, 2017 to May 24, 2018.
•Extensive Knowledge of the Financial Services Industry—Mr. Pratt has 30 years of financial services and business experience in Franklin, Tennessee.
•Relevant Executive/Leadership Experience—Mr. Pratt serves as President of an independent insurance broker.
Pamela J. Stephens, age 61, has been a director of FFN and the Bank since July of 2009. Ms. Stephens is a Funeral Director and part owner and President of Williamson Memorial Funeral Home & Cremation Services in Franklin, Tennessee and joined the firm in 1995, part owner and Secretary/Treasurer of Williamson Memorial Gardens in Franklin, Tennessee and joined the firm in 1995, and part owner and Vice President of Spring Hill Memorial Park, Funeral Home and Cremation Services in Spring Hill, Tennessee and started the firm along with family in 1998. From 2003 to 2007, Ms. Stephens served on the board of directors of Cumberland Bank in Franklin, Tennessee. Ms. Stephens was the recipient of the Walk of Fame Award in 2015 presented by CABLE, a women's professional organization. Ms. Stephens is the recipient of the Paul Harris Fellow and was awarded this achievement twice. She served as charter president of the Rotary Club of Spring Hill and current member of the Franklin Downtown Rotary Club. She is a past president of the Cemetery Association of Tennessee, past president of the Tennessee Funeral Directors Association and past president of the Southern Cemetery and Funeral Association. Ms. Stephens is currently serving as a director on the Board of Directors for the Williamson Medical Center Foundation Board, and is a member of Mt. Carmel Cumberland Presbyterian Church.
•Extensive Knowledge of Our Company—Ms. Stephens has been a director of FFN and the Bank since July of 2009.
•Relevant Executive/Leadership Experience—Ms. Stephens serves in leadership positions and is the part owner of multiple businesses in the funeral services industry.
•Relevant Governance Experience—Ms. Stephens previously served on the board of directors of Cumberland Bank and is the past president of multiple organizations. She also has served on various legislative committees in the funeral industry.
Melody J. Sullivan, age 67, has been a director of FFN and the Bank since May of 2010. Ms. Sullivan founded the first woman-owned CPA firm in Franklin, Tennessee’s Historic Downtown business district in July of 1986 after working as a staff accountant for one of Nashville’s most respected business owners and CPA firms, and serving as comptroller for a local food service company. Ms. Sullivan served as Owner of Smiley CPAs (now known as Smiley, Smith, Wynd, LLC) from July 1986 through November 2014 and retired in April 2015. She served on the board of directors of Franklin National Bank for 14 years and Fifth Third Bank for five years. Ms. Sullivan is a member and past president of the Franklin Breakfast Rotary Club. She served on the board of directors for Waves in Franklin, Tennessee, an organization dedicated to enabling individuals with intellectual and developmental disabilities to progress toward their full potential. She is a past president of the board of directors of Franklin Family YMCA and has served on the board of directors of United Way of Williamson County, Franklin Tomorrow, the Williamson County-Franklin Chamber of Commerce, The March of Dimes, Williamson County CASA, and Historic Carnton Plantation. Ms. Sullivan is a graduate of Leadership Franklin. She is a past chairperson of the Small Business Development Division of the Williamson County-Franklin Chamber of Commerce.
•Extensive Knowledge of Our Company—Ms. Sullivan has been a director of FFN and the Bank since May of 2010.
•High Level of Financial Literacy—Ms. Sullivan has over 30 years of experience as a CPA. She founded the first woman-owned CPA firm in downtown Franklin, Tennessee, served as a staff accountant for one of Nashville’s most respected business owners and CPA firms, served as comptroller for a local food service company and has been designated as our “audit committee financial expert” on our audit committee.
•Extensive Knowledge of the Financial Services Industry—Ms. Sullivan served on the board of directors of Franklin National Bank for 14 years and Fifth Third Bank for five years.
Gregory E. Waldron, age 57, has been a director of FFN and the Bank since April 28, 2015. Mr. Waldron is a partner and managing member of Waldron Enterprises, LLC in Murfreesboro, Tennessee, which he joined in 1986. He received a Bachelor of Science in Engineering Science from Lipscomb University in Nashville, Tennessee in 1985. Waldron Enterprises, LLC is involved in building and selling new homes, building and managing apartments, developing residential lots, and developing commercial investment property for retail and office use. He formerly served on the board of directors of MidSouth from 2003 to 2014 and as its Vice Chairman from 2012 to 2014; on the board of directors of Middle Tennessee Christian School from 1999 to 2007 and as its Vice Chairman from 2006 to 2007; on the Community Board of Cavalry Banking from 2000 to 2003; on the board of directors of Trans Financial Bank of Tennessee from 1997 to 1999; and on the Rutherford County Home Builders Association from 1994 to 1995.
•Extensive Knowledge of Our Company—Mr. Waldron has been a director of FFN and the Bank since April of 2015.
•Relevant Executive/Leadership Experience—Mr. Waldron is a partner and managing member of a company and has served in leadership roles of various organizations.
•Extensive Knowledge of the Financial Services Industry—Mr. Waldron has served on the boards of multiple banks.
•Extensive Knowledge of the Real Estate Industry—Mr. Waldron has extensive experience in the real estate industry.
Benjamin P. Wynd, age 42, has been a director of FFN and the Bank since August 25, 2015. Mr. Wynd serves as Partner of SSW CPAs, a local Franklin, Tennessee CPA firm started in 1986, since November 2014, and as Partner of SSW Capital LLC, a locally-owned financial services and transaction advisory firm. Mr. Wynd currently serves on the board of directors for Outdoor Encounter, Inc., a Franklin, Tennessee based non-profit organization. Prior to joining SSW CPAs, Mr. Wynd was heavily involved in Nashville’s healthcare industry, serving as the Director of Financial Reporting at Tenet Healthcare/Vanguard. While at Tenet/Vanguard, he was actively engaged in working on the company’s SEC filings, including Vanguard’s initial public offering in June 2011, comprehensive debt refinancing, overseeing the financial reporting of the company’s health plans and supporting acquisition due diligence. Mr. Wynd’s experience also includes working with national accounting firms, as well as with the 2002 Olympic Winter Games in Salt Lake City, Utah. Mr. Wynd is a graduate of Transylvania University in Lexington, Kentucky. Mr. Wynd is currently a member of the Tennessee Society of Certified Public Accountants and the American Institute of Certified Public Accountants.
•Extensive Knowledge of Our Company—Mr. Wynd has been a director of FFN and the Bank since August of 2015.
•High Level of Financial Literacy—Mr. Wynd serves as partner of a CPA firm, is Partner of a financial services and transaction advisory firm, has worked with national accounting firms and is a member of the Tennessee Society of Certified Public Accountants and the American Institute of Certified Public Accountants.
•Extensive Knowledge of the Healthcare Industry—Mr. Wynd was heavily involved in Nashville’s healthcare industry.
•Extensive Public Company Experience—Mr. Wynd served as the Director of Financial Reporting at Tenet Healthcare/Vanguard and was actively engaged in working on the company’s SEC filings, including Vanguard’s initial public offering in June 2011, comprehensive debt refinancing, overseeing the financial reporting of the company’s health plans and supporting acquisition due diligence.
Committees of the Board of Directors
Our board of directors has established the following committees: an audit committee, a compensation committee and a nominating and corporate governance committee. The composition and responsibilities of each committee are described below. Members serve on these committees until their resignation or until otherwise determined by our board of directors.
The purpose of the audit committee is set forth in the audit committee charter and includes assisting the board of directors in overseeing:
•the quality and integrity of our financial statements;
•our compliance with legal and regulatory requirements;
•the independent auditor’s qualification, performance and independence; and
•the design and implementation of our internal audit function.
The audit committee consists of Jimmy E. Allen, Pamela J. Stephens, Melody J. Sullivan, Gregory E. Waldron and Benjamin P. Wynd, with Mr. Wynd serving as chairman. Our board has determined each of these members is an independent director under the applicable SEC rules and the NYSE listing standards for audit committee members, and Ms. Sullivan is an “audit committee financial expert” within the meaning of Item 407 of Regulation S-K. Each member of the audit committee has the ability to read and understand fundamental financial statements. Our board of directors has adopted a written charter under which the audit committee operates. A copy of the charter, which satisfies the applicable standards of the SEC and the NYSE, is available on our corporate website (www.franklinsynergybank.com), accessible from the “Governance Documents” link on the “Investor Relations” subpage of our website. Information from this website is not incorporated by reference into this Annual Report on Form 10-K.
Nominating and Corporate Governance Committee
The purpose of the nominating and corporate governance committee is set forth in the nominating and corporate governance committee charter and includes:
•identifying individuals qualified to become members of our board of directors, and selecting, or recommending that our board of directors select, the director nominees for each annual meeting of shareholders or to otherwise fill vacancies or newly created directorships on the board of directors;
•overseeing the evaluation of the performance of our board of directors and management;
•reviewing and recommending to our board of directors committee structure, membership and operations
•developing and recommending to our board of directors a set of corporate governance guidelines applicable to us; and;
•leading our board of directors in its annual review process.
The nominating and corporate governance committee currently consists of Jimmy E. Allen, Pamela J. Stephens, Melody J. Sullivan and Gregory E. Waldron, with Mr. Allen serving as chairman. Our board has determined each of these members is an independent director under the applicable SEC rules and NYSE listing standards. Our board of directors has adopted a written charter under which the nominating and corporate governance committee operates. A copy of the charter, which satisfies the applicable standards of the NYSE, is available on our corporate website (www.franklinsynergybank.com), accessible from the “Governance Documents” link on the “Investor Relations” subpage of our website. Information from this website is not incorporated by reference into this Annual Report on Form 10-K.
The purpose of the compensation committee is set forth in the compensation committee charter and includes:
•oversight of our executive compensation policies and practices;
•reviewing and approving, or recommending to our board of directors to review and approve, matters related to the compensation of our Chief Executive Officer and our other executive officers; and
•overseeing administration and monitoring of our incentive and equity-based compensation plans.
The compensation committee currently consists of Jimmy E. Allen, Pamela J. Stephens, Melody J. Sullivan and Benjamin P. Wynd, with Ms. Stephens serving as chair. Our board has determined each of these members is an independent director under the applicable SEC rules and NYSE listing standards. Our board of directors has adopted a written charter under which the compensation committee operates. A copy of the charter, which satisfies the applicable standards of the SEC and the NYSE, is available on our corporate website (www.franklinsynergybank.com), accessible from the “Governance Documents” link on the “Investor Relations” subpage of our website. Information from this website is not incorporated by reference into this Annual Report on Form 10-K.
Corporate Governance Guidelines and Code of Business Conduct and Ethics
Our board of directors has adopted corporate governance guidelines, which set forth a flexible framework within which our board of directors, assisted by board committees, directs the affairs of our company. The guidelines address, among other things, the composition and functions of our board of directors, director independence, compensation of directors, management succession and review, board committees and selection of new directors.
We have adopted a code of business conduct and ethics applicable to our directors, officers and employees including specific standards and guidelines applicable to our principal executive, financial and accounting officers and all persons performing similar functions. A copy of that code, and the corporate governance guidelines, is available on our corporate website (www.franklinsynergybank.com), accessible from the “Governance Documents” link on the “Investor Relations” subpage of our website. We expect that any amendments to such code and guidelines, or any waivers of their requirements, will be disclosed on our corporate website and by other means required by SEC and NYSE rules.
Our nominating and corporate governance committee has no set procedures or policy on the selection of nominees or evaluation of shareholder recommendations and will consider these issues on a case-by-case basis. Our nominating and corporate governance committee will consider shareholder recommendations for director nominees that are properly received in accordance with our bylaws and the applicable rules and regulations of the SEC. Our nominating and corporate governance committee screens all potential candidates in the same manner. Our nominating and corporate governance committee review will typically be based on all information provided with respect to the potential candidate. Our nominating and corporate governance committee has not established specific minimum qualifications that must be met by a nominee for a position on our board of directors or specific qualities and skills for a director. Our nominating and corporate governance committee may consider the diversity of qualities and skills of a nominee, but our nominating and corporate governance committee has no formal policy in this regard.
Information Regarding Our Executive Officers
Included below is certain information regarding our executive officers. Our executive officers are elected annually by our board of directors and serve at the discretion of our board of directors.
|J. Myers Jones, III||69||Chief Executive Officer|
|Christopher J. Black||45||Executive Vice President and Chief Financial Officer|
|Steven E. Groom||68||Executive Vice President, General Counsel and Chief Human Resources Officer|
|Terry R. Howell||62||Executive Vice President, Corporate Risk Officer and Interim Chief Operating Officer|
|Eddie A. Maynard, Jr.||44||Chief Credit Officer|
|David McDaniel||52||Executive Vice President, Chief Lending Officer and Williamson County President|
|Lee M. Moss||68||President|
J. Myers Jones, III, age 69, serves as Chief Executive Officer of FFN and the Bank since September 2019 and served as Interim Chief Executive Officer from March 2019 to September 2019. Mr. Jones previously served as Executive Vice President and Chief Credit Officer from 2011 to March 2019. Mr. Jones has more than 40 years of local community banking experience, most recently with Cadence Bank in Franklin, Tennessee, where he served as Executive Vice President of Commercial Lending. Prior to his service at Cadence Bank, Mr. Jones served as President and CEO of Franklin National Bank in Franklin, Tennessee, for 13 years prior to Franklin National’s acquisition by Fifth Third Bank. In addition to Franklin National Bank and Cadence Bank, Mr. Jones was instrumental in the success of several other area banks, including Sovran Bank and Commerce Union Bank. Mr. Jones is a graduate of Austin Peay State University in Clarksville, Tennessee and the Herbert V. Prochnow Graduate School of Banking at the University of Wisconsin in Madison, Wisconsin. In addition, Mr. Jones is a graduate of the ABA National Commercial Lending School at the University of Oklahoma.
Christopher J. Black, age 45, is the Executive Vice President and Chief Financial Officer of FFN and the Bank since December 12, 2018. Mr. Black previously served as the Company’s Executive Vice President, Strategy from November 16, 2018 to December 12, 2018. Prior to joining the Company, Mr. Black was at FirstBank, a bank headquartered in Downtown Nashville, serving as Senior Vice President and Chief Financial Officer, Banking from August 2017 to November 2018 and as Director of Strategic Finance from May 2016 to August 2017. From 2014 to 2016, Mr. Black served as Chief Risk Officer, Managing Director for Kingswell Capital Management, LLC, a financial services company, and from 2010 to 2013, Mr. Black served as Sr. Research Analyst, Principal for Rinehart Capital Partners, LLC, a company providing investment advisory services. Previously, Mr. Black worked in the investment management and investment research industries in New York City, specializing in the banking sector while serving as Vice President at Merrill Lynch & Co. from 2006 to 2009 and as Associate Managing Director at ISI Group, Inc. from 2009 to 2010. Prior to working in the private sector, Mr. Black served for over nine years as an Officer and pilot in the United States Air Force.
Steven E. Groom, age 68, is the Executive Vice President, General Counsel and Chief Human Resources Officer of FFN since July 2019. Mr. Groom previously served as Of Counsel at the Nashville law firm of Neal & Harwell from January 2018 to July 2019 and as Of Counsel in the Nashville office of law firm Butler Snow from April 2017 to January 2018. Prior to Butler Snow, Mr. Groom served as Executive Vice President and General Counsel for CoreCivic (formerly Corrections Corporation of America) from April 2010 to June 2016. Mr. Groom has more than 40 years of experience as an attorney and has spent more than 27 years in executive and general counsel roles with two large public companies. He earned his bachelor's degree from Lipscomb University and earned his J.D. from the University of Memphis Law School. Mr. Groom also has attended executive education programs at Harvard University, the Wharton School, and the Kellogg School of Management at Northwestern University.
Terry R. Howell, age 62, is the Interim Chief Operating Officer of the Bank since March 2019 and the Executive Vice President, Corporate Risk Officer of FFN since November 2016. Mr. Howell joined the Company in June 2016 from Civic Bank & Trust, where he served as Chief Operating Officer since 2015. Prior to that, Mr. Howell served as Chief Operating Officer for Red River Bank in central Louisiana for five years. Mr. Howell received a BSBA degree from the University of Tennessee and an Executive MBA from the Fogelman College of Business and Economics, University of Memphis. He has more than thirty years of financial industry experience.
Eddie Maynard, age 44, is the Executive Vice President, Chief Credit Officer of the Bank since March 2019. Mr. Maynard previously served as Senior Vice President and Assistant Chief Credit Officer of the Bank from February 2018 to March 2019, Senior Vice President - Division Executive from 2016 to February 2018 and Senior Vice President, Senior Commercial Lender from 2014 to 2016. Mr. Maynard joined the Company in January 2008 from Colonial Bank where he served as a Vice President, head of the Nashville LPO. Prior to that he worked for Franklin National Bank from 1998-2006 and transitioned over to Fifth Third Bank upon its acquisition. Mr. Maynard received a BSBA degree from West Virginia University. He also graduated from the Graduate School of Banking at Louisiana State University. He has more than 20 years of financial industry experience.
David J. McDaniel, age 52, is the Executive Vice President, Chief Lending Officer, and Williamson County President of the Bank since 2015. From 2011 to 2013, Mr. McDaniel was Senior Vice President, Investment Management of the Bank, and from 2013 to 2015, he was Executive Vice President and Chief Retail Officer of the Bank. Mr. McDaniel is a Brentwood native and served as Regional President at Community First Bank & Trust in Cool Springs prior to joining the Bank. In a banking career that spans more than 18 years, Mr. McDaniel has held roles at AmSouth Bank, First American Bank, Equitable Securities and Merrill Lynch. He holds a B.S. in Finance and an M.B.A. from the University of Tennessee in Knoxville, Tennessee. He is a graduate of Brentwood Academy in Brentwood. Mr. McDaniel is a graduate of Leadership Franklin, a member of the Williamson County/Franklin Chamber of Commerce, and a Health and Educational Facilities Board member of the City of Franklin.
Lee M. Moss, age 68, is President of FFN since September 2019 and President of the Bank and a director of the Bank since July 1, 2014. He served as Interim President of FFN from March 2019 to September 2019. Mr. Moss was the Chairman and Chief Executive Officer of MidSouth from its inception in 2003 until our acquisition of MidSouth effective July 1, 2014. He served on MidSouth’s Loan and Executive Committee (Executive Chairman), Trust Committee (Chairman), Executive Leadership Committee (Chairman) and the Asset/Liability Committee. In 1973, Mr. Moss graduated from the University of Tennessee with a Bachelor of Science degree, majoring in Banking. He graduated from the National Commercial Lending School in 1978 and the Graduate School of Banking of the South in 1983. Mr. Moss worked for Valley Fidelity Bank in Knoxville for one year after graduating from the University of Tennessee, and then worked 28 years with Third National Bank/SunTrust Bank in Nashville. He served in numerous leadership capacities in both the Retail and Commercial divisions of the bank, and in January 1995, he moved to Murfreesboro where he served as Regional President, overseeing Rutherford and Wilson Counties. In January 2003, Mr. Moss served as one of the organizers for MidSouth. Since moving to Murfreesboro, Mr. Moss formerly served as Chair of St. Thomas Rutherford Hospital’s Board and currently serves as Chair-Elect of Tennessee Bankers Association, member of Saint Thomas Health Services Board in Nashville, Business Education Partnership Board, and as a Sunday School teacher and Administrative board member for First United Methodist Church. Mr. Moss is a graduate of Leadership Rutherford and Leadership Middle Tennessee.
Delinquent Section 16(a) Reports
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires each director, officer, and individual beneficially owning more than 10% of a registered security to file with the SEC, within specified time frames, initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5). Based solely on such forms filed electronically with the SEC and with respect to the fiscal year ended December 31, 2019 or written representations that no additional forms were required, to the best of our knowledge, all required Section 16(a) filings were timely and correctly
made by reporting persons for 2019, except for (i) one late Form 4 for J. Myers Jones, III, filed on May 20, 2019 to report one transaction, the exercise of a stock option on May 15, 2019; (ii) one Form 4 for James W. Cross, IV, filed on April 17, 2019, reported an incorrect number of shares awarded to Mr. Cross on April 15, 2019, which was corrected in a Form 4 amendment filed on September 13, 2019 to correct the number of securities granted to Mr. Cross and to correct the number of securities beneficially owned by Mr. Cross following the transaction; and (iii) one Form 4 for Benjamin Wynd, filed on April 17, 2019, reported an incorrect number of shares awarded to Mr. Wynd on April 15, 2019, which was corrected in a Form 4 amendment filed on September 13, 2019 to correct the number of securities granted to Mr. Wynd and to correct the number of securities beneficially owned by Mr. Wynd following the transaction.
ITEM 11. EXECUTIVE COMPENSATION.
Compensation Discussion and Analysis
This Compensation Discussion and Analysis outlines the principles underlying our executive compensation policies and decisions as it relates to the Company’s “Named Executive Officers,” which under the SEC’s executive compensation disclosure rules consist of all persons who served as our principal executive officer and our principal financial officer during our last fiscal year, our next three highest-paid executive officers who were serving as executive officers at the end of our last fiscal year, as well as up to two additional individuals for whom disclosure would have been required because they were among the three highest-paid executive officers other than our principal executive and financial officers but for the fact that the individual was not serving as an executive officer at the end of the last completed fiscal year.
The Company’s Named Executive Officers for 2019 were:
• Richard E. Herrington, our former President, Chief Executive Officer and Chairman of the Board (until March 8, 2019);
• J. Myers Jones, III, our Chief Executive Officer (since September 2019) and Interim Chief Executive Officer (from March 2019 to September 2019);
• Christopher J. Black, our Chief Financial Officer;
• Kevin A. Herrington, our former Executive Vice President, Chief Operating Officer of the Bank (until March 8, 2019);
• David J. McDaniel, our Executive Vice President, Chief Lending Officer, and Williamson County President of the Bank;
• Lee M. Moss, our President (since September 2019), Interim President (from March 2019 to September 2019) and President of the Bank; and
• Eddie A. Maynard, Jr., our Executive Vice President, Chief Credit Officer of the Bank.
Determining Compensation for Named Executive Officers
Role of the Compensation Committee
The Compensation Committee of the Board of Directors is comprised entirely of independent directors and operates under a written charter. The Compensation Committee is responsible for determining compensation for all of the Company’s Named Executive Officers including evaluating compensation policies, approving compensation for executive officers and administering our equity incentive programs.
Role of Management
Our Chief Executive Officer plays an important role in setting compensation for our other executive officers by assisting the Compensation Committee in evaluating individual goals and objectives and developing compensation recommendations for Named Executive Officers other than himself. Final decisions on the design of the compensation program, including total compensation are ultimately made by the Compensation Committee.
Role of Compensation Consultants
The Compensation Committee is authorized to retain the services of a compensation consultant to be used to assist in the review and establishment of our compensation programs and related policies. In 2019, the Compensation Committee retained Pay Governance, LLC as its independent compensation consultant to advise it on executive officer and director compensation. Other than advising the Compensation Committee, Pay Governance, LLC did not provide any services to the
Company in 2019. The Company has determined that Pay Governance, LLC is independent and there was no conflict of interest between the Company and Pay Governance, LLC during 2019.
Compensation Objectives and Philosophy
The Compensation Committee believes that the Company's compensation program for executive officers should:
• Attract, retain and motivate highly-skilled executives;
• Encourage management to balance short-term goals against longer-term objectives without incentivizing excessive risk-taking; and
• Align the interests of management and shareholders through the use of equity-based compensation.
The Compensation Committee applied this philosophy in establishing each of the elements of executive compensation for the fiscal year ended December 31, 2019.
Elements of Compensation
Our executive compensation program for the Named Executive Officers consists of base salary, an annual incentive cash bonus and long-term equity incentive awards.
Base salary is intended to attract and retain executive officers and is generally based on the scope and complexity of the role and responsibilities and individual performance. The Compensation Committee seeks to target our Named Executive Officers’ base salaries at competitive levels to recognize professional growth, success and/or increased responsibilities within the Company. Base salaries are reviewed annually to assess if adjustments are necessary.
The current base salaries for Messrs. Jones, Black and Maynard were established by the Compensation Committee in connection with the employment agreements we entered into with such Named Executive Officers on August 28, 2019. See “Employment Agreements and Other Agreements with Our Named Executive Officers” for additional information regarding our employment and transition agreements with certain of our Named Executive Officers.
For 2019, base salaries for our Named Executive Officers were as follows:
|Name||2019 Base Salary|
Richard E. Herrington(1)
|J. Myers Jones, III||$453,000|
|Christopher J. Black||$362,870|
Kevin A. Herrington(1)
|David J. McDaniel||$360,133|
|Lee M. Moss||$329,040|
|Eddie A. Maynard, Jr.||$315,370|
(1) Messrs. Richard and Kevin Herrington retired from their positions as executive officers of the Company effective as of March 8, 2019.
In 2019, we awarded cash bonuses to our Named Executive Officers, other than Messrs. Richard and Kevin Herrington, as follows:
|Name||2019 Cash Bonus|
|Richard E. Herrington||$25,482|
|J. Myers Jones, III||$39,656|
|Christopher J. Black||$34,943|
|Kevin A. Herrington||$12,011|
|David J. McDaniel||$35,466|
|Lee M. Moss||$26,143|
|Eddie A. Maynard, Jr.||$29,701|
Our cash bonus program is designed to reward our Named Executive Officers for the achievement of annual operational and financial goals, as well as individual performance and significant non-financial achievements. In determining the size of cash bonus awards, the Compensation Committee thoroughly reviews the Company’s performance and individual performance of the Named Executive Officers. When calculating the awards for our incentive program, the Committee relied on previously established weighted targets identifying various measurements of profitability and corporate governance including ratios for core earnings per share growth, total book value per share growth, net interest margin, core return on average assets, non-performing assets ratios, and regulatory ratings for safety and soundness; Community Reinvestment Act; and consumer compliance.
Long-Term Incentive Program (Equity-Based Compensation)
We granted awards of restricted stock units (RSUs) to our Named Executive Officers, other than Messrs. Richard and Kevin Herrington, on August 28, 2019 to encourage retention and alignment with the long-term growth and performance of the Company, as follows:
|Name||No. of RSUs|
|J. Myers Jones, IIII||5,244||$146,150|
|Christopher J. Black||6,012||$167,554|
|David J. McDaniel||6,946||$193,585|
|Lee M. Moss||4,397||$122,544|
|Eddie A. Maynard, Jr.||4,751||$132,410|
(1) Based on the grant date fair value of the awards, based on a price per share of common stock of $27.87.
The RSUs granted to our Named Executive Officers in August 2019 vest ratably over three years beginning on the first anniversary of the date of grant, assuming the Named Executive Officer is still employed by the Company as of each such vesting date, except that the award of 2,870 RSUs to Mr. Black vest ratably over a five-year period beginning on the first anniversary of the date of grant.
In addition, on January 31, 2019, we granted an award of 1,255 shares of restricted stock to Christopher J. Black that vests ratably over five years beginning on the first anniversary of the date of grant, assuming Mr. Black is still employed by the Company as of each such vesting date.
Our executive compensation program is designed to achieve an appropriate balance between risk and reward that does not incentivize excessive risk-taking. We believe that our annual cash bonus program and equity compensation program contain appropriate risk mitigation factors, as summarized below:
• Balance of short-term and long-term incentives through annual cash bonuses and long-term equity compensation;
• Meaningful portion of total compensation is in the form of long-term equity awards;
• Three to five-year vesting based on continued service as of the vesting date;
• Anti-hedging policy contained in our Insider Trading Compliance Policy.
Other Practices, Plans and Agreements
There is standard medical and disability insurance for officers and employees similar to other banking institutions in the area. FFN may enter into other incentive compensation, bonus, and/or pension plans with its officers and employees in the future as may be decided by the board of directors. Officers and employees will receive salaries standard in the market and industry.
Omnibus Equity Incentive Plan
The Company’s 2007 Omnibus Equity Incentive Plan (the “2007 Plan”), as amended and shareholder-approved, provided for the issuance of up to 4,000,000 shares. The 2007 Plan provided that no options intended to be incentive stock options may be granted after April 9, 2017. As a result, the Company’s board of directors approved, and recommended to its shareholders for approval, a new equity incentive plan, the 2017 Omnibus Equity Incentive Plan (the “2017 Plan”). The Company’s shareholders approved the 2017 Plan at the 2017 annual meeting of shareholders. The terms of the 2017 Plan are substantially similar to the terms of the 2007 Plan it was intended to replace, except that the 2017 Plan provided for the issuance of up to 5,000,000 shares. The Company is no longer issuing awards under the 2007 Plan. On April 12, 2018, the Compensation Committee approved the Amended and Restated 2017 Omnibus Equity Incentive Plan (the “Amended and Restated 2017 Plan”) in order to make the following amendments to the 2017 Plan in response to feedback the Company received from its shareholders:
• reduce the number of shares of common stock available for issuance from 5,000,000 shares under the 2017 Plan to 3,500,000 shares under the Amended and Restated 2017 Plan;
• revise the definition of Change in Control to include only actual changes in control (and removed triggering events that represented a potential change in control);
• remove the Compensation Committee's authority to accelerate vesting (other than in cases of termination of the participant's employment);
• remove certain provisions allowing recycling of shares and to clarify that (1) shares tendered in payment of an option, (2) shares delivered or withheld to satisfy tax withholding obligations and (3) shares covered by a stock-settled SAR or other awards that were not issued upon settlement of the award will not be available for issuance under the Amended and Restated 2017 Plan; and
• remove the ability to grant reload options (automatic granting of new options at the time of exercise).
The Amended and Restated 2017 Plan did not require approval by the Company's shareholders. At December 31, 2019, there were 2,410,486 authorized shares available for issuance under the Amended and Restated 2017 Plan.
Employee, organizer and director awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant; those option awards have a vesting period of two to five years and have a ten-year contractual term. The Company assigns discretion to its Compensation Committee to make grants either as qualified incentive stock options or as non-qualified stock options. All employee grants are intended to be treated as qualified incentive stock options, if allowable. All other grants are expected to be treated as non-qualified.
Additionally, the Company’s 2007 Plan and the Amended and Restated 2017 Plan provide for the granting of restricted share awards and other performance related incentives. When restricted shares are awarded, a participant receives voting and dividend rights with respect to the shares, but is not able to transfer the shares until the restrictions have lapsed. All outstanding restricted share awards have a vesting period of two to seven years and vest in equal annual installments on the anniversary date of the grant.
Employment Agreements and Other Agreements with Our Named Executive Officers
2019 Employment Agreements
On August 28, 2019, FFN and the Bank entered into employment agreements (collectively, the “2019 Employment Agreements”) with each of J. Myers Jones, III, Christopher J. Black, David J. McDaniel, IV, Lee M. Moss and Eddie A. Maynard, Jr. In addition, on August 28, 2019, each of these Named Executive Officers also entered into non-compete and non-solicitation agreements, pursuant to which, among other things, each of such Named Executive Officers agreed, during the term
of his employment and for a period of 12 months thereafter, not to (i) solicit customers, employees or independent contractors of the Bank and (ii) engage in certain activities that would compete with the Bank.
The terms of the 2019 Employment Agreements are summarized below.
J. Myers Jones, III Employment Agreement
Pursuant to the terms of Mr. Jones’ employment agreement, Mr. Jones is entitled to, among other things:
• An annual base salary of not less than $453,000 for the 12-month period ending August 28, 2020 and not less than $498,000 for the remainder of the term, subject to annual review for increase (but not decrease);
• Be eligible to receive (but not entitled to) discretionary cash bonuses or other incentive compensation, including equity compensation;
• Participate in the Company’s equity compensation plans and any employee benefit plans available to similarly situated employees;
• If Mr. Jones’ employment is terminated by the Company or the Bank without Cause (as defined in Mr. Jones’ employment agreement), by Mr. Jones with Good Reason (as defined in Mr. Jones’ employment agreement) or upon the Term Expiration (as defined in Mr. Jones’ employment agreement), (i) his base salary through the date of termination, (ii) an amount equal to two times the base salary to be paid to Mr. Jones for the second 12 month period of the term of his employment agreement (which base salary amount is $498,000), payable in equal monthly installments over 24 months, (iii) an amount equal to two times his three-year average annual cash incentive payments, payable in equal monthly installments over 24 months, and (iv) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date;
• If Mr. Jones’ employment is terminated due to death or Disability (as defined in Mr. Jones’ employment agreement), (i) his base salary through the end of the next pay period following the date of termination, and (ii) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date; and
• Upon a Change In Control (as defined in the Amended and Restated 2017 Plan), all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the date of such Change In Control.
Unless earlier terminated pursuant to the terms of his employment agreement, the term of Mr. Jones’ employment agreement will end on October 15, 2021, subject to automatic annual renewals for additional one-year terms unless either party gives written notice of its election to terminate the agreement at least 150 days prior to the end of any such term.
Christopher J. Black Employment Agreement
Pursuant to the terms of Mr. Black’s employment agreement, Mr. Black is entitled to, among other things:
• An annual base salary of not less than $362,870, subject to annual review for increase (but not decrease);
• Be eligible to receive (but not entitled to) discretionary cash bonuses or other incentive compensation, including equity compensation;
• Participate in the Company’s equity compensation plans and any employee benefit plans available to similarly situated employees;
• If Mr. Black’s employment is terminated by the Company or the Bank without Cause (as defined in Mr. Black’s employment agreement) or by Mr. Black with Good Reason (as defined in Mr. Black’s employment agreement), (i) his base salary through the date of termination, (ii) an amount equal to two times his then-current base salary, payable in equal monthly installments over 24 months, (iii) an amount equal to two times his three-year average annual cash incentive payments, payable in equal monthly installments over 24 months, and (iv) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date;
• If Mr. Black’s employment is terminated due to death or Disability (as defined in Mr. Black’s employment agreement), (i) his base salary through the end of the next pay period following the date of termination, and (ii) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date; and
• Upon a Change In Control (as defined in the Amended and Restated 2017 Plan), all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the date of such Change In Control.
Unless earlier terminated pursuant to the terms of his employment agreement, the term of Mr. Black’s employment agreement will end on August 28, 2022, subject to automatic annual renewals for additional one-year terms unless either party gives written notice of its election to terminate the agreement at least 150 days prior to the end of any such term.
David J. McDaniel, IV Employment Agreement
Pursuant to the terms of Mr. McDaniel’s employment agreement, Mr. McDaniel is entitled to, among other things:
• An annual base salary of not less than $360,133, subject to annual review for increase (but not decrease);
• Be eligible to receive (but not entitled to) discretionary cash bonuses or other incentive compensation, including equity compensation;
• Participate in the Company’s equity compensation plans and any employee benefit plans available to similarly situated employees;
• If Mr. McDaniel’s employment is terminated by the Bank without Cause (as defined in Mr. McDaniel’s employment agreement) or by Mr. McDaniel with Good Reason (as defined in Mr. McDaniel’s employment agreement), (i) his base salary through the date of termination, (ii) an amount equal to two times his then-current base salary, payable in equal monthly installments over 24 months, (iii) an amount equal to two times his three-year average annual cash incentive payments, payable in equal monthly installments over 24 months, and (iv) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date;
• If Mr. McDaniel’s employment is terminated due to death or Disability (as defined in Mr. McDaniel’s employment agreement), (i) his base salary through the end of the next pay period following the date of termination, and (ii) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date; and
• Upon a Change In Control (as defined in the Amended and Restated 2017 Plan), all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the date of such Change In Control.
Unless earlier terminated pursuant to the terms of his employment agreement, the term of Mr. McDaniel’s employment agreement will end on August 28, 2022, subject to automatic annual renewals for additional one-year terms unless either party gives written notice of its election to terminate the agreement at least 150 days prior to the end of any such term.
Lee M. Moss Employment Agreement
Pursuant to the terms of Mr. Moss’s employment agreement, Mr. Moss is entitled to, among other things:
• An annual base salary of not less than $329,040, subject to annual review for increase (but not decrease);
• If Mr. Moss’s employment is terminated by the Bank without Cause (as defined in Mr. Moss’s employment agreement) or by Mr. Moss with Good Reason (as defined in Mr. Moss’s employment agreement), (i) his base salary through the date of termination, (ii) an amount equal to two times his then-current base salary, payable in equal monthly installments over 24 months, (iii) an amount equal to two times his three-year average annual cash incentive payments, payable in equal monthly installments over 24 months, and (iv) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date;
• If Mr. Moss’s employment is terminated due to death or Disability (as defined in Mr. Moss’s employment agreement), (i) his base salary through the end of the next pay period following the date of termination, and (ii) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date; and
Unless earlier terminated pursuant to the terms of his employment agreement, the term of Mr. Moss’s employment agreement will end on August 28, 2022, subject to automatic annual renewals for additional one-year terms unless either party gives written notice of its election to terminate the agreement at least 150 days prior to the end of any such term.
Eddie A. Maynard, Jr. Employment Agreement
Pursuant to the terms of Mr. Maynard’s employment agreement, Mr. Maynard is entitled to, among other things:
• An annual base salary of not less than $315,370, subject to annual review for increase (but not decrease);
• If Mr. Maynard’s employment is terminated by the Bank without Cause (as defined in Mr. Maynard’s employment agreement) or by Mr. Maynard with Good Reason (as defined in Mr. Maynard’s employment agreement), (i) his base salary through the date of termination, (ii) an amount equal to two times his then-current base salary, payable in equal monthly installments over 24 months, (iii) an amount equal to two times his three-year average annual cash incentive payments, payable in equal monthly installments over 24 months, and (iv) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date;
• If Mr. Maynard’s employment is terminated due to death or Disability (as defined in Mr. Maynard’s employment agreement), (i) his base salary through the end of the next pay period following the date of termination, and (ii) all outstanding, unearned and unvested equity awards will automatically become earned or vest in full on the termination date; and
Unless earlier terminated pursuant to the terms of his employment agreement, the term of Mr. Maynard’s employment agreement will end on August 28, 2022, subject to automatic annual renewals for additional one-year terms unless either party gives written notice of its election to terminate the agreement at least 150 days prior to the end of any such term.
Executive Transition Agreement with Richard E. Herrington
On March 8, 2019, Richard E. Herrington entered into an Executive Transition Agreement with FFN and the Bank, pursuant to which Mr. Herrington retired from his position as an executive officer of the company and a member of the board of directors, in each case effective as of March 8, 2019. Mr. Herrington also agreed to remain an employee of the company through September 8, 2019 to provide services to the company on a transitional basis. The Executive Transition Agreement provides that Mr. Herrington was entitled to receive, in exchange for his release of all potential claims against the Company, a payment of the gross amount of $1,322,018.00. Mr. Herrington also received a payment of $661,009.00 pursuant to the terms of his Confidentiality, Non-Competition, and Non-Solicitation Agreement dated as of January 29, 2014, and, pursuant to the terms of his employment agreement with the Bank dated as of January 29, 2014, all of his outstanding, unvested equity awards became fully-vested on September 8, 2019.
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning total compensation for our Named Executive Officers for 2019, 2018 and 2017 (as applicable). For additional information on the compensation summarized below and other benefits, please refer to “Compensation Discussion and Analysis” above.
|Name and Principal Position||Year||Salary ($)||Bonus ($)|
|All Other Compensation ($)||Total|
|Former Chief Executive Officer||2018||$587,001||$25,482||$59,837||$244,080||$94,373||$1,010,773|
|J. Myers Jones, III||2019||$453,000||$39,656||$146,150||$0||$28,746||(3)||$667,552|
|Chief Executive Officer||2018||$278,280||$16,241||$38,090||$119,435||$32,258||$484,304|
|Christopher J. Black||2019||$362,870||$34,943||$287,538||$0||$15,006||(4)||$700,357|
|Chief Financial Officer||2018||$300,000||$43,617||$167,800||$0||$667||$512,084|
|Kevin A. Herrington||2019||$304,125||$12,011||$36,872||$105,277||$968,147||(5)||$1,426,432|
|Former Chief Operating Officer of the Bank||2018||$276,334||$12,011||$37,299||$115,047||$40,795||$481,486|
|David J. McDaniel||2019||$360,133||$35,466||$193,585||$0||$35,692||(6)||$624,876|
|Chief Lending Officer and Williamson County President||2018||$327,607||$21,509||$41,912||$140,576||$34,940||$566,544|
|Lee M. Moss||2019||$329,040||$26,143||$122,544||$0||$33,396||(7)||$511,123|
|Eddie A. Maynard, Jr.||2019||$315,370||$29,701||$132,410||$0||$28,535||(8)||$506,016|
|Chief Credit Officer||2018||$254,563||$23,367||$22,175||$95,634||$26,752||$422,491|
(1) The amounts in the Stock Awards and Option Awards columns represent grant date fair values computed in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Stock Compensation (FASB ASC Topic 718). The assumptions used in determining the values of option awards are provided in Note 15 to FFN’s Consolidated Financial Statements included in FFN’s Annual Report on Form 10-K for the year ended December 31, 2019.
(2) For 2019, includes: a company car allowance of $7,400; country club membership dues of $10,255; 401(k) company matching contributions of $12,695; life insurance and disability premiums of $1,460; director fees of $5,583; health insurance premiums of $9,344 and severance payments of $1,983,027.
(3) For 2019, includes: a company car allowance of $2,975; 401(k) company matching contributions of $12,813; life insurance and disability premiums of $1,913; split dollar insurance of $1,712; and health insurance premiums of $9,333.
(4) For 2019, includes: a company car allowance of $3,225; 401(k) company matching contributions of $9,809; and life insurance and disability premiums of $1,972.
(5) For 2019, includes: a company car allowance of $5,800; 401(k) company matching contributions of $8,740; life insurance and disability premiums of $1,449; health insurance premiums of $13,010; country club dues of $854; split dollar insurance premiums of $155; and severance payments totaling $938,139.
(6) For 2019, includes: a company car allowance of $3,675; 401(k) company matching contributions of $11,200; country club dues of $1,027; split dollar premiums of $437; life insurance and disability premiums of $2,000; and health insurance premiums of $17,353.
(7) For 2019, includes: a company car allowance of $3,600; 401(k) company matching contributions of $10,789; life insurance and disability premiums of $1,865; health insurance premiums of $10,383; split dollar premiums of $731; and country club dues of $6,028.
(8) For 2019, includes: a company car allowance of $1,650; 401(k) company matching contributions of $11,200; life insurance and disability premiums of $1,990; split dollar premiums of $94; and health insurance premiums of $13,601.
GRANTS OF PLAN-BASED AWARDS
The table below summarizes all grants of plan-based awards during the year ended December 31, 2019 to our Named Executive Officers.
|Estimated Future Payouts Under Non-Equity Incentive Plan Awards Target|
|All Other Option Awards; Number of Securities Underlying Options|
|Exercise or Base Price of Option or Awards|
|Grant Date Fair Value ($)|
|Richard E. Herrington||04/15/19||$0||2,124||—||$27.89||$59,238|
|J. Myers Jones, III||08/28/19||$0||5,244||—||$27.87||$146,150|
|Christopher J. Black||08/28/19||$0||6,012||—||$27.87||$167,554|
|Kevin A. Herrington||04/15/19||$0||1,323||—||$27.87||$36,872|
|David J. McDaniel||08/28/19||$0||6,946||—||$27.87||$193,585|
|Lee M. Moss||08/28/19||$0||4,397||—||$27.87||$122,544|
|Eddie A. Maynard, Jr.||08/28/19||$0||4,751||—||$27.87||$132,410|
Outstanding Equity Awards at Fiscal Year End
The table below summarizes all outstanding equity awards at December 31, 2019 for our Named Executive Officers.
|Richard E. Herrington||4,627||—||$10.00||07/22/20||—||—||—||—|
|J. Myers, Jones, III||8,735||—||$10.50||06/02/21||7,207||$247,416||—||—|
|Christopher J. Black||—||—||$0.00||—||13,470||$462,425||—||—|
|Kevin A. Herrington||—||—||$0.00||—||—||—||—||—|
|David A. McDaniel||6,328||—||$12.00||06/01/22||8,998||$308,901||—||—|