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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________
FORM 10-Q
________________________________________________________
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-36895
________________________________________________________
FRANKLIN FINANCIAL NETWORK, INC.
(Exact name of registrant as specified in its charter)
________________________________________________________
Tennessee 20-8839445
(State or other jurisdiction of
incorporation or organization) 		(I.R.S. Employer
Identification No.)
722 Columbia Avenue, Franklin, Tennessee 37064
(Address of principal executive offices) (Zip Code)

615-236-2265
(Registrant’s telephone number, including area code)

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 FSB New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer
☒
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒
The number of shares outstanding of the registrant’s common stock, no par value per share, as of July 31, 2020, was 14,972,793.


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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements regarding, among other things, our anticipated financial and operating results, the transaction with FB Financial Corporation, and the impact of the COVID-19 pandemic. The Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect our management’s current assumptions, beliefs, and expectations. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “objective,” “may,” “could,” “would,” “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 under the heading “Risk Factors” and elsewhere in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 16, 2020, and in this Form 10-Q. 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 Form 10-Q is filed with the 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 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;
1
•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;
•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 continuation of the disruption to the global and national economy caused by COVID-19, which could affect our capital and liquidity position, impair the ability of borrowers to repay outstanding loans and increase our allowance for loan and lease losses, impair the collateral values, cause an outflow of deposits, result in lost revenue or additional expenses, result in goodwill impairment charges, and increase our cost of capital;
•natural or other disasters, acts of terrorism, widespread protests and civil unrest and pandemics could have an adverse effect on us, including a material disruption of our operations or the ability or willingness of clients to access our products and services;
•widespread system outages, caused by the failure of critical internal systems or critical services provided by third parties, could adversely impact our financial condition and results of operations; and
•depressed market values for our stock and adverse economic conditions sustained over a period of time may require a write down to goodwill.
2

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 our Annual Report on Form 10-K filed March 16, 2020 with the SEC, and our Quarterly Report on Form 10-Q filed with the SEC on May 7, 2020, as well as the section below entitled “Statement Regarding the Impact of the COVID-19 Pandemic” and the section entitled “Risk Factors” in this Form 10-Q. 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.

Statement Regarding the Impact of the COVID-19 Pandemic

The Company prioritizes the health and safety of its employees and customers, and it will continue to do so throughout the duration of the pandemic. At the same time, the Company remains focused on improving shareholder value, managing credit exposure, challenging expenses, enhancing the customer experience and supporting the communities it serves.

Throughout this Form 10-Q, the Company has sought to describe the historical and future impact of the COVID-19 pandemic on the Company's operations, including the discussions of our loan portfolio, allowances for loan and lease losses and credit quality. Although the Company believes that the statements that pertain to future events, results and trends and their impact on the Company's business are reasonable at the present time, those statements are not historical facts and are based upon current assumptions, expectations, estimates and projections, many of which, by their nature, are beyond the Company's control. Accordingly, all discussions regarding future events, results and trends and their impact on the Company's business, even in the near term, are necessarily uncertain given the fluid and evolving nature of the pandemic.

If the health, logistical or economic effects of the pandemic worsen, or if the assumptions, expectations, estimates or projections that underlie the Company's statements regarding future effects or trends prove to be incorrect, then the Company's operations may be materially and adversely impacted in ways that the Company cannot reasonably forecast.

Therefore, when reading this Form 10-Q, undue reliance should not be placed upon any statement pertaining to future events, results and trends and their impact on the Company's business in future periods.
3
PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands, except share and per share data)
June 30,
2020 		December 31,
2019
(Unaudited)
ASSETS
Cash and due from financial institutions $ 236,775    $ 234,991   
Certificates of deposit at other financial institutions 3,506    3,590   
Securities available for sale 503,877    652,132   
Loans held for sale, at fair value 61,142    43,162   
Loans held for investment 2,794,768    2,812,444   
Allowance for loan losses (38,100)   (45,436)  
Net loans 2,756,668    2,767,008   
Restricted equity securities, at cost 24,110    24,802   
Premises and equipment, net 47,305    12,141   
Accrued interest receivable 18,576    12,362   
Bank owned life insurance 57,432    56,726   
Deferred tax asset 10,093    14,229   
Servicing rights, net 4,035    3,246   
Goodwill 18,176    18,176   
Core deposit intangible, net 271    448   
Other assets 33,775    53,149   
Total assets $ 3,775,741    $ 3,896,162   
LIABILITIES AND EQUITY
Deposits
Non-interest bearing $ 483,445    $ 319,373   
Interest bearing 2,659,814    2,888,211   
Total deposits 3,143,259    3,207,584   
Federal Home Loan Bank advances 100,000    155,000   
Subordinated notes, net 58,961    58,872   
Accrued interest payable 2,711    4,201   
Other liabilities 48,747    60,079   
Total liabilities 3,353,678    3,485,736   
Commitments and Contingencies (Note 9)
Equity
Preferred stock, no par value: 1.0 million shares authorized; no shares outstanding at June 30, 2020 and December 31, 2019
—    —   
Common stock, no par value: 30.0 million authorized; 14.9 million issued and outstanding at June 30, 2020 and 14.8 million issued and outstanding December 31, 2019, respectively
279,232    275,412   
Retained earnings 140,339    133,102   
Accumulated other comprehensive income 2,399    1,819   
Total shareholders’ equity 421,970    410,333   
Non-controlling interest in consolidated subsidiary 93    93   
Total equity 422,063    410,426   
Total liabilities and equity $ 3,775,741    $ 3,896,162   
See accompanying notes to consolidated financial statements.
4
FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Three Months Ended
June 30, 		Six Months Ended
June 30,
2020 2019 2020 2019
Interest income and dividends
Loans, including fees
$ 36,623    $ 40,202    $ 73,661    $ 78,540   
Securities:
Taxable
1,700    4,614    4,124    11,008   
Tax-Exempt
1,219    1,410    2,602    2,880   
Dividends on restricted equity securities
220    350    382    684   
Federal funds sold and other
52    877    652    1,864   
Total interest income
39,814    47,453    81,421    94,976   
Interest expense
Deposits
8,929    16,679    21,175    33,669   
Federal funds purchased and repurchase agreements
1    90    15    162   
Federal Home Loan Bank advances and other borrowings
274    2,237    1,075    4,196   
Subordinated notes
1,082    1,082    2,164    2,164   
Total interest expense
10,286    20,088    24,429    40,191   
Net interest income
29,528    27,365    56,992    54,785   
Provision for loan losses
3,195    7,031    16,217    12,086   
Net interest income after provision for loan losses
26,333    20,334    40,775    42,699   
Noninterest income
Service charges on deposit accounts
74    77    166    151   
Other service charges and fees
1,397    903    2,294    1,660   
Mortgage banking revenue
8,688    2,473    11,373    4,145   
Wealth management
702    673    1,516    1,300   
Gain on sale or call of securities 166    367    1,562    517   
Net (loss) gain on sale of loans held for investment (372)   3    (788)   (214)  
Net gain on sale of foreclosed assets
5    3    7    7   
Other
(105)   424    318    844   
Total noninterest income
10,555    4,923    16,448    8,410   
Noninterest expense
Salaries and employee benefits
14,762    11,365    27,342    26,108   
Occupancy and equipment
2,832    3,283    5,918    6,396   
FDIC assessment expense 900    660    1,350    1,650   
Marketing
133    301    378    620   
Professional fees
2,345    1,073    5,413    1,996   
Amortization of core deposit intangible
82    132    177    277   
Other
2,922    2,556    5,819    4,939   
Total noninterest expense
23,976    19,370    46,397    41,986   
Income before income tax expense 12,912    5,887    10,826    9,123   
Income tax expense 2,730    706    1,792    1,040   
Net income 10,182    5,181    9,034    8,083   
Earnings attributable to noncontrolling interest
(8)   (8)   (8)   (8)  
Net income available to common shareholders $ 10,174    $ 5,173    $ 9,026    $ 8,075   
Earnings per share:
Basic
$ 0.68    $ 0.35    $ 0.61    $ 0.55   
Diluted
0.66    0.34    0.59    0.54   

See accompanying notes to consolidated financial statements.

5
FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Three Months Ended
June 30, 2020 		Six Months Ended
June 30,
2020 2019 2020 2019
Net income $ 10,182    $ 5,181    $ 9,034    $ 8,083   
Other comprehensive income, net of tax:
Unrealized gains/losses on securities:
Unrealized holding gains arising during the period 2,704    7,116    4,443    19,109   
Reclassification adjustment for gains on sales, calls, and prepayments of securities included in net income (166)   (367)   (1,562)   (517)  
Tax effect (634)   (1,760)   (714)   (4,849)  
Net unrealized gains on securities 1,904    4,989    2,167    13,743   
Unrealized gain/loss on cash flow hedge:
Unrealized holding gain (losses) arising during the period 192    (1,667)   (2,149)   (1,667)  
Tax effect (50)   436    562    436   
Net unrealized gains (losses) on cash flow hedge 142    (1,231)   (1,587)   (1,231)  
Total other comprehensive income 2,046    3,758    580    12,512   
Comprehensive income $ 12,228    $ 8,939    $ 9,614    $ 20,595   

See accompanying notes to consolidated financial statements.

6
FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Three Months Ended June 30, 2020 and June 30, 2019
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Shareholders’ Equity
Preferred Stock
Common Stock
Retained Earnings
Accumulated
Other
Comprehensive Income (Loss)
Noncontrolling Interest
Total Equity
Shares
Amount
Balance at April 1, 2019 $ —    14,574,339    $ 266,758    $ 123,250    $ (6,587)   $ 93    $ 383,514   
Exercise of common stock options, includes net settlement of shares
—    74,116    753    —    —    —    753   
Stock based compensation expense, net of restricted share forfeitures
—    —    1,513    —    —    —    1,513   
Issuance of restricted stock awards, net of forfeitures
—    (988)   —    —    —    —    —   
Purchase of treasury stock —    (19,180)   (519)   —    —    —    (519)  
Cash Dividends - common stock ($0.04 per share)
—    —    —    (583)   —    —    (583)  
Noncontrolling interest distributions —    —    —    (8)   —    —    (8)  
Net income —    —    —    5,181    —    —    5,181   
Other comprehensive income —    —    —    —    3,758    —    3,758   
Balance at June 30, 2019 $ —    14,628,287    $ 268,505    $ 127,840    $ (2,829)   $ 93    $ 393,609   
Balance at April 1, 2020 $ —    14,859,704    $ 277,341    $ 131,061    $ 353    $ 93    $ 408,848   
Exercise of common stock options, includes net settlement of shares
—    39,073    449    —    —    —    449   
Stock based compensation expense, net of restricted share forfeitures
—    —    1,442    —    —    —    1,442   
Issuance of restricted stock awards, net of forfeitures, and vesting of restricted stock units
—    38,999    —    —    —    —    —   
Cash dividends - common stock ($0.06 per share)
—    —    —    (896)   —    —    (896)  
Noncontrolling interest distributions —    —    —    (8)   —    —    (8)  
Net income —    —    —    10,182    —    —    10,182   
Other comprehensive income —    —    —    —    2,046    —    2,046   
Balance at June 30, 2020 $ —    14,937,776    $ 279,232    $ 140,339    $ 2,399    $ 93    $ 422,063   

See accompanying notes to consolidated financial statements.

7

FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Six Months Ended June 30, 2020 and June 30, 2019
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Shareholders’ Equity
Preferred Stock
Common Stock
Retained Earnings
Accumulated
Other
Comprehensive Income (Loss)
Noncontrolling Interest
Total Equity
Shares
Amount
Balance at January 1, 2019 $ —    14,538,085    $ 264,905    $ 123,176    $ (15,341)   $ 93    $ 372,833   
Cumulative-effect of accounting change —    —    —    (2,244)   —    —    (2,244)  
Balance at January 1, 2019 adjusted $ —    14,538,085    $ 264,905    $ 120,932    $ (15,341)   $ 93    $ 370,589   
Exercise of common stock options, includes net settlement of shares —    109,162    1,277    —    —    —    1,277   
Stock based compensation expense, net of restricted share forfeitures —    —    2,842    —    —    —    2,842   
Issuance of restricted stock awards, net of forfeitures —    220    —    —    —    —    —   
Purchase of treasury stock —    (19,180)   (519)   —    —    —    (519)  
Cash Dividends - common stock ($0.08 per share)
—    —    —    (1,167)   —    —    (1,167)  
Noncontrolling interest distributions —    —    —    (8)   —    —    (8)  
Net income —    —    —    8,083    —    —    8,083   
Other comprehensive income —    —    —    —    12,512    —    12,512   
Balance at June 30, 2019 $ —    14,628,287    $ 268,505    $ 127,840    $ (2,829)   $ 93    $ 393,609   
Balance at January 1, 2020 $ —    14,821,594    $ 275,412    $ 133,102    $ 1,819    $ 93    $ 410,426   
Exercise of common stock options, includes net settlement of shares —    76,489    866    —    —    —    866   
Stock based compensation expense, net of restricted share forfeitures —    —    2,954    —    —    —    2,954   
Issuance of restricted stock awards, net of forfeitures, and vesting of restricted stock units —    39,693    —    —    —    —    —   
Cash dividends - common stock ($0.12 per share)
—    —    —    (1,789)   —    —    (1,789)  
Noncontrolling interest distributions —    —    —    (8)   —    —    (8)  
Net income —    —    —    9,034    —    —    9,034   
Other comprehensive income —    —    —    —    580    —    580   
Balance at June 30, 2020 $ —    14,937,776    $ 279,232    $ 140,339    $ 2,399    $ 93    $ 422,063   

See accompanying notes to consolidated financial statements.

8
FRANKLIN FINANCIAL NETWORK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
Six Months Ended June 30,
2020 2019
Cash flows from operating activities
Net income $ 9,034    $ 8,083   
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization on premises and equipment 1,200    850   
Accretion of purchase accounting adjustments (169)   (346)  
Net amortization of securities 2,675    3,078   
Amortization of loan servicing right asset 1,013    487   
Amortization of core deposit intangible 177    277   
Amortization of debt issuance costs 89    89   
Provision for loan losses 16,217    12,086   
Impairment charges on loan servicing right asset 316    —   
Deferred income tax expense (benefit) 3,984    (2,121)  
Excess tax benefit related to stock compensation (3)   (205)  
Origination of loans held for sale (380,107)   (208,009)  
Proceeds from sale of loans held for sale 371,034    197,230   
Net gain on sale of loans held for sale (11,025)   (5,594)  
Loss on sale of loans held for investment 788    227   
Gain on sale of available for sale securities (1,562)   (517)  
Income from bank owned life insurance (705)   (750)  
Stock-based compensation 2,954    2,842   
Deferred gain on sale of loans (8)   (7)  
Deferred gain on sale of foreclosed assets (7)   (7)  
Net change in:
Accrued interest receivable and other assets (7,370)   4,478   
Accrued interest payable and other liabilities (3,539)   6,875   
Net cash from operating activities $ 4,986    $ 19,046   
Cash flows from investing activities
Securities available for sale :
Sales and calls 119,888    347,037   
Purchases (369)   (94,860)  
Maturities and prepayments 39,619    82,556   
Securities held to maturity :
Purchases —    (3,284)  
Maturities, prepayments and calls —    5,261   
Net change in loans (144,828)   (241,477)  
Proceeds from sale of loans held for investment 138,332    18,468   
Purchase of restricted equity securities (83)   (3,011)  
Proceeds from sale of restricted equity securities 775    —   
Purchases of premises and equipment, net (36,364)   (1,427)  
Decrease (increase) in certificates of deposits at other financial institutions 84    (246)  
Net cash from investing activities $ 117,054    $ 109,017   
Cash flows from financing activities
Decrease in deposits (64,325)   (285,162)  
Proceeds from Federal Home Loan Bank advances 145,000    340,000   
Repayment of Federal Home Loan Bank advances (200,000)   (312,000)  
Proceeds from exercise of common stock options 866    1,277   
Purchase of treasury stock —    (494)  
Dividends paid on common stock (1,789)   (1,167)  
Noncontrolling interest distributions (8)   (8)  
Net cash from financing activities $ (120,256)   $ (257,554)  

9
Net change in cash and cash equivalents 1,784    (129,491)  
Cash and cash equivalents at beginning of period 234,991    280,212   
Cash and cash equivalents at end of period $ 236,775    $ 150,721   
Supplemental information:
Interest paid $ 25,920    $ 40,579   
Income taxes paid $ 48    $ 6,043   
Non-cash supplemental information:
Establishment and extinguishment of lease liability and right-of use asset $ (21,522)   $ 43,723   
Transfers from securities held to maturity to securities available for sale $ —    $ 1,206   

See accompanying notes to consolidated financial statements.

10
FRANKLIN FINANCIAL NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except share and per share data)
(Unaudited)

NOTE 1—BASIS OF PRESENTATION

These consolidated financial statements include the accounts of Franklin Financial Network, Inc. (“FFN”), and its wholly-owned subsidiaries, Franklin Synergy Bank (“Franklin Synergy” or the “Bank”) and Franklin Synergy Risk Management, Inc. (collectively, the “Company”). Franklin Synergy Investments of Tennessee, Inc., Franklin Synergy Investments of Nevada, Inc., and Franklin Synergy Preferred Capital, Inc. are direct or indirect subsidiaries of the Bank and are included in these consolidated financial statements. Significant intercompany transactions and accounts are eliminated in consolidation.

The Company provides financial services through its offices in Franklin, Brentwood, Spring Hill, Murfreesboro, Nashville, Nolensville, and Smyrna, Tennessee, as well as through its loan and deposit production location in Mt. Juliet, 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 lines 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.

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with United States Generally Accepted Accounting Principles (“GAAP”) for interim financial information and in accordance with guidance provided by the SEC. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

In the opinion of management, the accompanying unaudited consolidated financial statements reflect all normal and recurring adjustments considered necessary for a fair presentation. Transactions between the subsidiaries have been eliminated. These consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, and our Quarterly Report on Form 10-Q filed with the SEC on May 7, 2020. Operating results for the three and six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. On January 21, 2020, the Company announced a strategic merger with FB Financial Corporation that is expected to close in the third quarter of 2020, with an anticipated closing date of August 15, 2020.

Risks and Uncertainties

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. During the first quarter of 2020, the World Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The pandemic has caused significant disruptions in the U.S. economy, has disrupted banking and other financial activity in the areas in which the Company operates. The pandemic and its adverse consequences continued throughout the second quarter of 2020, and will likely present significant economic risks for at least the next several quarters. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company.

The United States Congress, the President of the United States, and the Federal Reserve have taken several actions designed to cushion the economic fallout from the COVID-19 pandemic. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law on March 27, 2020 as a $2.2 trillion legislative relief package. The goal of the CARES Act is to limit the impact of a potentially severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and medical providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts, together with other proposed and/or pending legislature and regulatory actions, are expected to have a material impact on the Company’s operations.
11

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. It is not possible at this time to know the full extent that the impact of COVID-19, and resulting measures to curtail its spread, could have on the Company’s operations, but such impacts could be material and adverse.

Financial position and results of operations

The Company’s fee income could be reduced due to the impacts of COVID-19. In keeping with guidance from regulators, the Company continues to work with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact is likely to impact its fee income in future periods.

The Company’s interest income could be reduced due to the impacts of COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. During the second quarter of 2020, the Company sold approximately $76.6 million of SBA PPP loans originated to a third party at a minimal discount. While interest and fees for any remaining SBA PPP loans will still accrue to income through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued may need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.

In an agreement with a third party provider, the Company sold substantially all of its Paycheck Protection Program ("PPP") loan portfolio that were originated and funded during the first and second quarter of 2020. This transaction allowed the Company to immediately recognize the origination fees paid by the Small Business Administration (“SBA”) during the second quarter of 2020. The Company no longer retains the servicing or other risks associated with the administration of the transferred loan portfolio.

Lending operations and accommodations to borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company continues to execute a payment deferral program for its eligible clients that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment, with the typical deferral period of 90 days. The majority of the Company’s first round of 90-day loan payment deferrals began to mature toward the end of the second quarter of 2020 and during the first part of the third quarter of 2020. The Company is working with its customers during this timeframe to determine if a second 90-day loan payment deferral is necessary. During the period ended June 30, 2020, interagency guidance and the CARES Act rules provided clarity to accounting for modifications whereby under certain circumstances, such modifications would not be considered troubled debt restructurings ("TDRs").

As of July 31, 2020, we have approximately 305 loans with a balance of approximately $478,000 that have returned to regular payment status, and we have approximately 101 loans with a balance of approximately $253,000 that remain on temporary payment deferral program.

Credit

Pertaining to the Company’s June 30, 2020 financial condition and results of operations, COVID-19 had an impact on the Company’s allowance for loan and lease losses (“ALLL”) and the resulting provision for loan losses were impacted by changes in economic conditions. Should economic conditions worsen, we could experience further increases in our ALLL and record additional provision expense. The execution of the payment deferral program discussed above improved our ratio of past due loans to total loans. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

12
Goodwill

COVID-19 could cause a further and sustained decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform an additional goodwill impairment test and could result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.

Reclassifications

Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or equity.

Recently Adopted and Effective Accounting Pronouncements
In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation and instead treats goodwill impairment as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance remains largely unchanged. ASU 2017-04 became effective for us on January 1, 2020, and it did not have a material impact on the Company’s consolidated financial statements. The Company's policy is to test goodwill for impairment annually on December 31 or on an interim basis if an event triggering impairment may have occurred. During the period ended June 30, 2020, the economic turmoil and market volatility resulting from the COVID-19 crisis resulted in a decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis. Under the new simplified guidance, the Company determined that none of its goodwill was impaired as of June 30, 2020. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.
In August 2018, the FASB issued ASU No. 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 became effective for us on January 1, 2020, and only revises disclosure requirements. It did not have a material impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 became effective for the Company on January 1, 2020, and it did not have a significant impact on the Company's consolidated financial statements.

Status of New Accounting Standard for Accounting for Allowance for Credit Losses

On January 1, 2020, ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, became effective for the Company which replaces the existing incurred loss impairment methodology ("ILM") for loans that are collectively evaluated for impairment with a methodology that reflects management’s best estimate of lifetime expected credit losses and requires consideration of reasonable and supportable economic forecasts to develop a lifetime credit loss estimate. Topic 326 requires additional qualitative and quantitative disclosure to allow users to better understand the credit risk within the portfolio and the methodologies for determining the allowance for credit losses ("ACL"). The Cumulative Expected Credit Loss ("CECL") standard also simplifies the accounting model for purchased credit impaired loans. Additionally, Topic 326 requires expected credit losses on available-for-sale ("AFS") debt securities be recorded as an ACL. For certain types of debt securities, such as U.S. Treasuries and other securities with government guarantees, entities may utilize an assumption of zero credit losses.

13
In accordance with Section 4014 of the CARES Act, the Company deferred implementation of CECL and thus elected to continue to utilize the ILM to calculate loan loss reserves in the first and second quarters 2020.

The temporary deferral of CECL will remain effective until the earlier of the termination of the national emergency declaration concerning the COVID-19 pandemic or December 31, 2020, with an effective retrospective implementation date of January 1, 2020. There is increased uncertainty on the local, regional, and national economy as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level. The Company has taken actions to mitigate the impact or potential prospective credit losses including permitting short-term payment deferrals to current customers. These conditions significantly impact management’s determination of a reasonable and supportable forecast, an essential requirement in the calculation of expected credit losses under CECL methodology. The Company believes that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses. Management will continue to measure and monitor the estimated impacts of CECL adoption through continued parallel testing of model simulations based on our portfolio composition and current expectations of future economic conditions.

The Company’s CECL implementation efforts will remain in process in order to adequately comply with the provisions of CECL once the deferral period ceases. Management will continue to measure and monitor the estimated impacts of CECL adoption through continued parallel testing of model simulations based on our portfolio composition and current expectations of future economic conditions.

NOTE 2—SECURITIES

The following table summarizes the amortized cost and fair value of the securities available-for-sale portfolio at June 30, 2020 and December 31, 2019 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income.
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
June 30, 2020
Mortgage-backed securities: residential $ 250,810    $ 6,828    $ (1)   $ 257,637   
Mortgage-backed securities: commercial 15,217    454    (79)   15,592   
Corporate notes 2,500    92    —    2,592   
State and political subdivisions 228,567    5,698    (6,209)   228,056   
Total $ 497,094    $ 13,072    $ (6,289)   $ 503,877   

Amortized
Cost 		Gross
Unrealized
Gains 		Gross
Unrealized
Losses 		Fair
Value
December 31, 2019
Mortgage-backed securities: residential $ 374,923    $ 1,876    $ (856)   $ 375,943   
Mortgage-backed securities: commercial 17,858    56    (134)   17,780   
Corporate notes 32,825    539    (3)   33,361   
State and political subdivisions 222,624    2,566    (142)   225,048   
Total $ 648,230    $ 5,037    $ (1,135)   $ 652,132   
There were no securities held-to-maturity at June 30, 2020 or December 31, 2019.
The proceeds from sales, calls, and prepayments of available for sale securities and the associated gains and losses were as follows:
Three Months Ended
June 30, 		Six Months Ended
June 30,
2020 2019 2020 2019
Proceeds $ 17,462    $ 87,424    $ 119,888    $ 347,037   
Gross gains 253    367    1,677    2,168   
Gross losses (87)   —    (115)   (1,651)  
14
The amortized cost and fair value of the investment securities portfolio are shown by contractual maturity. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
June 30, 2020
Amortized
Cost
Fair
Value
Available-for-sale
Over one year through five years $ 1,606    $ 1,634   
Over five years through ten years 5,461    5,437   
Over ten years 224,000    223,577   
Mortgage-backed securities: residential 250,810    257,637   
Mortgage-backed securities: commercial 15,217    15,592   
Total $ 497,094    $ 503,877   
Securities pledged at June 30, 2020, and December 31, 2019 had a carrying amount of $283,970 and $294,585, respectively, that were pledged to secure public deposits.
At June 30, 2020 and December 31, 2019, there were no holdings of securities of any one issuer, other than the U.S. government-sponsored entities and agencies, in an amount greater than 10% of shareholders’ equity.
The following table summarizes the securities with unrealized and unrecognized losses at June 30, 2020 and December 31, 2019, aggregated by major security type and length of time in a continuous unrealized loss position:

Less Than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
June 30, 2020
Available-for-sale
Mortgage-backed securities: residential $ —    $ —    $ 102    $ (1)   $ 102    $ (1)  
Mortgage-backed securities: commercial —    —    3,109    (79)   3,109    (79)  
State and political subdivisions 116,336    (6,209)   —    —    116,336    (6,209)  
Total available-for-sale $ 116,336    $ (6,209)   $ 3,211    $ (80)   $ 119,547    $ (6,289)  

Less Than 12 Months
12 Months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
December 31, 2019
Available-for-sale
Mortgage-backed securities: residential $ 49,390    $ (172)   $ 91,644    $ (684)   $ 141,034    $ (856)  
Asset-backed securities 4,436    (29)   7,286    (105)   11,722    (134)  
Corporate notes 997    (3)   —    —    997    (3)  
State and political subdivisions 29,843    (142)   —    —    29,843    (142)  
Total available-for-sale $ 84,666    $ (346)   $ 98,930    $ (789)   $ 183,596    $ (1,135)  

Unrealized losses on debt securities have not been recognized into income because the issuers’ bonds are of high credit quality. As of June 30, 2020, management does not intend to sell and it is more likely than not that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The fair value is expected to recover as the bonds approach maturity.

15
NOTE 3—LOANS

Loans at June 30, 2020 and December 31, 2019 were as follows:

June 30,
2020 		December 31,
2019
Loans
Construction and land development $ 645,281    $ 591,541   
Commercial real estate:
Nonfarm, nonresidential 969,870    944,021   
Other 47,559    49,891   
Residential real estate:
Closed-end 1-4 family 424,786    455,920   
Other 186,746    187,681   
Commercial and industrial 520,413    582,641   
Consumer and other 3,570    4,769   
Loans before net deferred loan fees 2,798,225    2,816,464   
Deferred loan fees, net (3,457)   (4,020)  
Total loans 2,794,768    2,812,444   
Allowance for loan losses (38,100)   (45,436)  
Total loans, net of allowance for loan losses $ 2,756,668    $ 2,767,008   
The following table presents the activity in the allowance for loan losses by portfolio segment for the three-month periods ended June 30, 2020 and 2019:

Construction
and Land
Development 		Commercial
Real
Estate 		Residential
Real
Estate 		Commercial
and
Industrial 		Consumer
and
Other 		Total
Three Months Ended June 30, 2020
Allowance for loan losses:
Beginning balance $ 6,417    $ 9,018    $ 4,767    $ 18,146    $ 55    $ 38,403   
Provision for loan losses 102    540    (288)   2,032    809    3,195   
Loans charged-off —    —    —    (5,163)   (3)   (5,166)  
Recoveries —    —    —    1,662    6    1,668   
Total ending allowance balance $ 6,519    $ 9,558    $ 4,479    $ 16,677    $ 867    $ 38,100   
Three Months Ended June 30, 2019
Allowance for loan losses:
Beginning balance $ 4,742    $ 7,027    $ 4,810    $ 11,229    $ 49    $ 27,857   
Provision for loan losses 42    614    18    6,382    (25)   7,031   
Loans charged-off —    —    —    (7,563)   (29)   (7,592)  
Recoveries —    —    16    70    61    147   
Total ending allowance balance $ 4,784    $ 7,641    $ 4,844    $ 10,118    $ 56    $ 27,443   

The following table presents the activity in the allowance for loan losses by portfolio segment for the six-month periods ended June 30, 2020 and 2019:
16
Construction
and Land
Development 		Commercial
Real
Estate 		Residential
Real
Estate 		Commercial
and
Industrial 		Consumer
and
Other 		Total
Six Months Ended June 30, 2020
Allowance for loan losses:
Beginning balance $ 4,847    $ 8,113    $ 4,462    $ 27,957    $ 57    $ 45,436   
Provision for loan losses 1,672    1,445    24    12,254    822    16,217   
Loans charged-off —    —    (8)   (25,664)   (24)   (25,696)  
Recoveries —    —    1    2,130    12    2,143   
Total ending allowance balance $ 6,519    $ 9,558    $ 4,479    $ 16,677    $ 867    $ 38,100   
Six Months Ended June 30, 2019
Allowance for loan losses:
Beginning balance $ 4,743    $ 6,725    $ 4,743    $ 7,166    $ 74    $ 23,451   
Provision for loan losses 41    916    101    11,012    16    12,086   
Loans charged-off —    —    (15)   (8,131)   (99)   (8,245)  
Recoveries —    —    15    71    65    151   
Total ending allowance balance $ 4,784    $ 7,641    $ 4,844    $ 10,118    $ 56    $ 27,443   

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2020 and December 31, 2019. For purposes of this disclosure, recorded investment in loans excludes accrued interest receivable and net deferred loan fees due to immateriality.

17
Construction
and Land
Development 		Commercial
Real
Estate 		Residential
Real
Estate 		Commercial
and
Industrial 		Consumer
and
Other 		Total
June 30, 2020
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment $ —    $ —    $ —    $ 1,528    $ —    $ 1,528   
Collectively evaluated for impairment 6,519    9,558    4,479    15,149    867    36,572   
Total ending allowance balance $ 6,519    $ 9,558    $ 4,479    $ 16,677    $ 867    $ 38,100   
Loans:
Individually evaluated for impairment $ 335    $ 4,305    $ 4,413    $ 18,016    $ —    $ 27,069   
Collectively evaluated for impairment 644,946    1,013,124    607,119    502,397    3,570    2,771,156   
Total ending loans balance $ 645,281    $ 1,017,429    $ 611,532    $ 520,413    $ 3,570    $ 2,798,225   
December 31, 2019
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment $ —    $ —    $ 17    $ 20,754    $ —    $ 20,771   
Collectively evaluated for impairment 4,847    8,113    4,445    7,203    57    24,665   
Total ending allowance balance $ 4,847    $ 8,113    $ 4,462    $ 27,957    $ 57    $ 45,436   
Loans:
Individually evaluated for impairment $ 30    $ —    $ 2,477    $ 24,528    $ —    $ 27,035   
Collectively evaluated for impairment 591,511    993,912    641,124    558,113    4,769    2,789,429   
Total ending loans balance $ 591,541    $ 993,912    $ 643,601    $ 582,641    $ 4,769    $ 2,816,464   

Loans collectively evaluated for impairment reported at June 30, 2020 include certain acquired loans. At June 30, 2020, these non-purchased credit impaired (PCI) loans had a carrying value of $47,053, comprised of contractually unpaid principal totaling $47,707 and discounts totaling $654. Management evaluated these loans for credit deterioration since acquisition and determined that an allowance for loan losses of $71 was necessary at June 30, 2020.
18
The following table presents information related to impaired loans by class of loans as of June 30, 2020 and December 31, 2019:
Unpaid
Principal
Balance 		Recorded
Investment 		Allowance for
Loan Losses
Allocated
June 30, 2020
With no allowance recorded:
Construction and land development $ 335    $ 335    $ —   
Commercial real estate:
Nonfarm, nonresidential 4,305    4,305    —   
Residential real estate:
Closed-end 1-4 family 1,875    1,868    —   
Other 2,545    2,545    —   
Commercial and industrial 15,472    15,472    —   
Subtotal 24,532    24,525    —   
With an allowance recorded:
Commercial and industrial 7,697    2,544    1,528   
Subtotal 7,697    2,544    1,528   
Total $ 32,229    $ 27,069    $ 1,528   
December 31, 2019
With no allowance recorded:
Construction and land development $ 30    $ 30    $ —   
Residential real estate:
Closed-end 1-4 family 319    311    —   
Other 1,523    1,523    —   
Commercial and industrial 11    11    —   
Subtotal 1,883    1,875    —   
With an allowance recorded:
Residential real estate:
Closed-end 1-4 family 643    643    17   
Commercial and industrial 24,517    24,517    20,754   
Subtotal 25,160    25,160    20,771   
Total $ 27,043    $ 27,035    $ 20,771   
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The following table presents the average recorded investment of impaired loans by class of loans for the three and six months ended June 30, 2020 and 2019:
Three Months Ended
June 30, 		Six Months Ended
June 30,
Average Recorded Investment 2020 2019 2020 2019
With no allowance recorded:
Construction and land development $ 224    $ —    $ 117    $ 384   
Commercial real estate:
Nonfarm, nonresidential 4,736    —    4,660    25   
Residential real estate:
Closed-end 1-4 family 1,947    681    1,603    744   
Other 2,252    1,086    2,546    1,174   
Commercial and industrial 16,563    2,638    17,863    1,319   
Subtotal 25,722    4,405    26,789    3,646   
With an allowance recorded:
Construction and land development —    —    —    91   
Commercial real estate:
Nonfarm, nonresidential —    —    78    —   
Residential real estate:
Closed-end 1-4 family 214    —    213    —   
Commercial and industrial 3,649    4,404    7,232    3,787   
Subtotal 3,863    4,404    7,523    3,878   
Total average recorded investment $ 29,585    $ 8,809    $ 34,312    $ 7,524   
The impact on net interest income for these loans was not material to the Company’s results of operations for the three and six months ended June 30, 2020 and 2019.
The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still on accrual by class of loans as of June 30, 2020 and December 31, 2019:
Nonaccrual Loans Past Due
Over 90 Days And
Still Accruing Interest
June 30, 2020
Commercial real estate:
Nonfarm, nonresidential $ 5,760    $ —   
Residential real estate:
Closed-end 1-4 family 1,868    —   
Other 1,612    —   
Commercial and industrial 15,193    —   
Total $ 24,433    $ —   
December 31, 2019
Construction and land development $ 30    $ —   
Residential real estate:
Closed-end 1-4 family 954    —   
Other 1,523    —   
Commercial and industrial 24,528    654   
Total $ 27,035    $ 654   

20
Nonaccrual loans and any loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
The following table presents the aging of the recorded investment in past due loans as of June 30, 2020 and December 31, 2019 by class of loans:
30-59
Days
Past Due 		60-89
Days
Past Due 		Greater
Than 89
Days
Past Due 		Total
Past Due 		Loans
Not
Past Due 		Total
June 30, 2020
Construction and land development $ —    $ 1,174    $ —    $ 1,174    $ 644,107    $ 645,281   
Commercial real estate:
Nonfarm, nonresidential 2,981    —    3,460    6,441    963,429    969,870   
Other —    —    —    —    47,559    47,559   
Residential real estate:
Closed-end 1-4 family —    1,930    —    1,930    422,856    424,786   
Other 194    421    749    1,364    185,382    186,746   
Commercial and industrial 393    —    2,916    3,309    517,104    520,413   
Consumer and other —    —    —    —    3,570    3,570   
$ 3,568    $ 3,525    $ 7,125    $ 14,218    $ 2,784,007    $ 2,798,225   
December 31, 2019
Construction and land development
$ 508    $ —    $ 30    $ 538    $ 591,003    $ 591,541   
Commercial real estate:
Nonfarm, nonresidential 3,981    —    —    3,981    940,040    944,021   
Other —    —    —    —    49,891    49,891   
Residential real estate:
Closed-end 1-4 family 2,688    224    8    2,920    453,000    455,920   
Other 85    961    555    1,601    186,080    187,681   
Commercial and industrial 663    7,156    735    8,554    574,087    582,641   
Consumer and other —    —    —    —    4,769    4,769   
$ 7,925    $ 8,341    $ 1,328    $ 17,594    $ 2,798,870    $ 2,816,464   

Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans as well as non-homogeneous residential real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

COVID-19 Supplemental information. The loan modifications and payment deferrals established in accordance with the CARES Act and interagency guidance disclosed in Note 1 did not result in immediate credit risk modifications. The impacted credits will continue to be monitored and assessed as the sustained impact of COVID-19 becomes better understood.
21
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. The following table excludes deferred loan fees and includes PCI loans, which are included in the “Substandard” column. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of June 30, 2020 and December 31, 2019:
Pass Special
Mention 		Substandard Total
June 30, 2020
Construction and land development $ 644,946    $ —    $ 335    $ 645,281   
Commercial real estate:
Nonfarm, nonresidential 958,145    6,974    4,751    969,870   
Other 47,559    —    —    47,559   
Residential real estate:
Closed-end 1-4 family 422,128    765    1,893    424,786   
Other 182,979    —    3,767    186,746   
Commercial and industrial 488,215    597    31,601    520,413   
Consumer and other 3,570    — — 3,570   
$ 2,747,542    $ 8,336    $ 42,347    $ 2,798,225   

Pass Special
Mention 		Substandard Total
December 31, 2019
Construction and land development $ 591,293    $ 248    $ —    $ 591,541   
Commercial real estate:
Nonfarm, nonresidential 941,260    997    1,764    944,021   
Other 49,891    —    —    49,891   
Residential real estate:
Closed-end 1-4 family 452,363    825    2,732    455,920   
Other 185,170    —    2,511    187,681   
Commercial and industrial 539,442    943    42,256    582,641   
Consumer and other 4,769    —    — 4,769   
$ 2,764,188    $ 3,013    $ 49,263    $ 2,816,464   

Troubled Debt Restructurings (TDRs)
As of June 30, 2020, the Company’s loan portfolio contains four loans that have been modified as TDRs with a balance of $4,303. Three loans with a balance of $3,992 were added as TDRs during the second quarter of 2020. As of December 31, 2019, the Company’s loan portfolio contained one loan that had been modified in a troubled debt restructuring with a balance of $311.
As of June 30, 2020, the Company had 437 loans with outstanding loan balances of $730,696 that were on temporary loan payment deferral, in accordance with the COVID-19 relief provided by the CARES Act.

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The following table presents the loan deferral balances as of June 30, 2020:
June 30, 2020 Deferred Loan Total % of loans HFI
Loans
Construction and land development $ 75,801    2.7  %
Commercial real estate:
Nonfarm, nonresidential 471,210    16.9  %
Other 23,806    0.9  %
Residential real estate:
Closed-end 1-4 family 37,917    1.4  %
Other 7,348    0.3  %
Commercial and industrial 114,595    4.1  %
Consumer and other 19    —  %
Total $ 730,696    26.2  %

As of July 31, 2020, we had approximately 305 loans with a balance of approximately $478,000 that had returned to regular payment status, and we had approximately 101 loans with a balance of approximately $253,000 that remained on a temporary payment deferral program. In accordance with the interagency guidance issued during the period ended June 30, 2020, these short-term deferrals are not considered TDRs..

NOTE 4—LOAN SERVICING
Loans serviced for others are not reported as assets. The principal balances of these loans at June 30, 2020 and December 31, 2019 are as follows:
June 30,
2020 		December 31,
2019
Loan portfolios serviced for:
Federal Home Loan Mortgage Corporation $ 591,181    $ 488,790   
Federal National Mortgage Association 58,292    10,221   
Other 3,403    3,504   
The related loan servicing rights activity for the three and six months ended June 30, 2020 and 2019 were as follows:
Three Months Ended
June 30, 		Six Months Ended
June 30,
2020 2019 2020 2019
Servicing rights:
Beginning of period $ 3,057    $ 3,366    $ 3,246    $ 3,403   
Additions 1,724    196    2,118    383   
Amortized to expense (655)   (263)   (1,013)   (487)  
Change in impairment (91)   —    (316)   —   
End of period $ 4,035    $ 3,299    $ 4,035    $ 3,299   
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The components of net loan servicing fees for the three and six months ended June 30, 2020 and 2019 were as follows:
Three Months Ended
June 30, 		Six Months Ended
June 30,
2020 2019 2020 2019
Loan servicing fees, net:
Loan servicing fees $ 332    $ 312    $ 654    $ 618   
Amortization of loan servicing fees (655)   (263)   (1,013)   (487)  
Change in impairment (91)   —    (316)   —   
Total $ (414)   $ 49    $ (675)   $ 131   
The fair value of servicing rights was estimated by management to be approximately $4,035 at June 30, 2020. Fair value for June 30, 2020 was determined using a weighted average discount rate of 9.5% and a weighted average prepayment speed of 21.4%. At December 31, 2019, the fair value of servicing rights was estimated by management to be approximately $3,922. Fair value for December 31, 2019 was determined using a weighted average discount rate of 9.5% and a weighted average prepayment speed of 16.8%.

NOTE 5—LEASES
Lessee Accounting
The majority of leases in which the Company is the lessee are comprised of real estate property for branches and office space and are recorded as operating leases with terms extending through 2034. The Company has one finance lease with a lease term through 2035.
In February 2020, the Company purchased the properties at Columbia Avenue and 120 9th Avenue in Franklin, Tennessee, therefore ending these lease agreements that represented approximately $19,000 and $20,000 in right-of-use assets and lease liabilities, respectively. In May 2020, the Company added one finance lease for a branch in Williamson County, Tennessee that relocated that added $1,627 in right-of-use assets and $1,618 in lease liabilities. In May 2020, a finance lease for an office space located in Williamson County, Tennessee was terminated and therefore decreased right-of-use assets and lease liabilities by $2,751 and $2,903, respectively.
The following table represents lease assets and lease liabilities as of June 30, 2020, and December 31, 2019.
Lease right-of-use assets Classification June 30, 2020 December 31, 2019
Operating lease right-of-use assets Other Assets $ 19,175    $ 39,594   
Finance lease right-of-use assets Other Assets 1,611    2,819   
Total lease right-of-use assets $ 20,786    $ 42,413   
Lease liabilities Classification June 30, 2020 December 31, 2019
Operating lease liabilities Other Liabilities $ 20,130    $ 41,308   
Finance lease liabilities Other Liabilities 1,615    2,942   
Total lease liabilities $ 21,745    $ 44,250   

NOTE 6—SHARE-BASED PAYMENTS
The Company has two share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $1,442 and $2,954 for the three and six months ended June 30, 2020 and $1,513 and $2,842 for the three and six months ended June 30, 2019. The total income tax benefit and expense, which is shown on the Consolidated Statements of Income was an increase of income tax expense of $210 and benefit of $3 for the three and six months ended June 30, 2020, respectively, and was a benefit of $92 and $205 for the three and six months ended June 30, 2019, respectively.
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Stock Options: The Company’s 2007 Omnibus Equity Incentive Plan (the “2007 Plan”), as amended and shareholder-approved, provided for authorized shares up to 4,000,000. The 2007 Plan provided that no options intended to be ISOs may be granted after April 9, 2017. As a result, the Company’s board of directors approved, and recommended to its shareholders for approval, an equity incentive plan, the 2017 Omnibus Equity Incentive Plan which the Company’s shareholders approved at the 2017 annual meeting of shareholders. On April 12, 2018, the Company’s Board of Directors approved the Amended and Restated 2017 Omnibus Equity Incentive Plan (the “Amended and Restated 2017 Plan”) to make certain changes in response to feedback received from the Company's shareholders. The terms of the Amended and Restated 2017 Plan are substantially similar to the terms of the 2007 Plan it was intended to replace. The Amended and Restated 2017 Plan provides for authorized shares up to 3,500,000. At June 30, 2020, there were 2,410,666 authorized shares available for issuance under the Amended and Restated 2017 Plan.
Employee, organizer and director stock option 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 10 year contractual term with varying vesting requirements. 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.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected stock price volatility is based on historical volatilities of the Company. The Company uses historical data to estimate option exercise and post-vesting termination behavior.
The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.
There were no options granted during the six months ended June 30, 2020. The fair value of options granted during the six months ended June 30, 2019, was determined using the following weighted-average assumptions as of grant date.

June 30, 2019
Risk-free interest rate 2.47  %
Expected term 7 years
Expected stock price volatility 30.64  %
Dividend yield 0.57  %
The weighted average fair value of options granted for the six months ended June 30, 2020 and 2019 were $0.00 and $9.78, respectively.
A summary of the activity in the plans for the six months ended June 30, 2020 follows:  
Shares
Weighted
Average
Exercise
Price
Weighted
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
Outstanding at January 1, 2020 1,502,070    $ 22.39   
Granted —    —   
Exercised (76,489)   11.33   
Forfeited, expired, or cancelled (19,252)   21.26   
Outstanding at period end 1,406,329    $ 17.54    6.10 $ 4,993   
Vested or expected to vest 1,336,013    $ 26.54    5.76 $ 4,743   
Exercisable at period end 601,711    $ 17.49    5.76 $ 4,972   

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For the Six Months Ended
June 30,
2020 2019
Stock options exercised:
Intrinsic value of options exercised $ 1,399    $ 1,869   
Cash received from options exercised 866    1,277   
Tax benefit realized from option exercises 212    205   
As of June 30, 2020, there was $2,271 of total unrecognized compensation cost related to non-vested stock options granted under the plans. The cost is expected to be recognized over a weighted-average period of 1.17 years.
Restricted Stock and Restricted Stock Units: Additionally, the 2007 Plan and the Amended and Restated 2017 Plan each provides for the granting of restricted share awards and other performance related incentives. When the restricted shares are awarded, a participant receives voting and dividend rights with respect to the shares, but is not able to transfer the shares until the restrictions have lapsed. In April 2019, the Company began awarding restricted stock units, which do not have voting rights or dividend rights until the restrictions have lapsed. These awards typically have a vesting period of three to five years and vest in equal annual installments on the anniversary date of the grant.
A summary of activity for non-vested restricted share awards for the six months ended June 30, 2020 is as follows:
Non-vested Shares Shares Weighted-
Average
Grant-
Date
Fair Value
Non-vested at January 1, 2020 90,992    $ 32.54   
Granted —    —   
Vested (48,599)   32.10   
Forfeited (180)   31.75   
Non-vested at June 30, 2020 42,213   
Compensation expense associated with the restricted share awards is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of June 30, 2020, there was $387 of total unrecognized compensation cost related to non-vested shares granted under the 2007 Plan and Amended and Restated 2017 Plan. The cost is expected to be recognized over a weighted-average period of 1 year.
The Company began granting restricted stock units in 2019. The restricted stock units vest annually into common stock outstanding on the date of grant during the service period. The following table outlines restricted stock units that were outstanding, grouped by similar vesting criteria, as of June 30, 2020:
Grant year Units Awarded Service period in years
2019 2,870    5.0
2019 109,373    3.0
2020 118,725    3.0
Stock compensation expense related with the restricted stock units for the three and six months ended June 30, 2020 was $717 and $1,399, respectively. Stock compensation expense related with the restricted stock units for the three and six months ended June 30, 2019 was $483 and $579, respectively. This stock compensation is recognized on a straight-line basis over the time period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. As of June 30, 2020 and 2019, there were $7,222 and $3,814 of total unrecognized compensation cost related to non-vested restricted stock units granted under the Amended and Restated 2017 Plan. The cost is expected to be recognized over a weighted-average period of 1.99 years.

NOTE 7—REGULATORY CAPITAL MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of
26
assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) provide for counter cyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness. Under the Basel III rules, banks must maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital equal to 2.5% of risk-weighted assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying certain discretionary bonuses. This capital conservation buffer became fully effective for the Company as of January 1, 2019.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At June 30, 2020, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Management believes that, as of June 30, 2020, the Company and Bank met all capital adequacy requirements to which they are subject. There are no conditions or events since that notification that management believes have changed the institution’s category.
In October 2019, the federal bank regulatory agencies, or the Agencies, issued a final rule, the Community Bank Leverage Ratio Framework, the “Framework,” to simplify capital calculations for community banks. The Framework provides for a simple measure of capital adequacy for certain community banking organizations and is consistent with Section 201 of the Economic Growth, Regulatory Relief and Consumer Protection Act. The Framework is optional and is designed to reduce burden by removing requirements for calculating and reporting risk-based capital ratios. Depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, are considered qualifying community banking organizations and are eligible to opt into the Framework. The final rule became effective January 1, 2020, and organizations that opt into the Framework and meet the criteria established by the rule can use the Framework for regulatory reports for the quarter ended March 31, 2020. In April 2020, the Agencies announced two interim final rules to provide relief associated with Section 4012 of the CARES Act. For institutions that elect the Framework, the interim rules temporarily lower the leverage ratio requirement to 8% for the second quarter of 2020 through the end of calendar year 2020 and to 8.5% for the 2021 calendar year. An institution will have until January 1, 2022 before the 9% leverage ratio requirement is re-established. The Company and the Bank have elected to opt into the Framework and will file their regulatory capital reports in accordance with the Framework’s guidance.
For comparative purposes, the Company has included in the table below estimated regulatory capital ratios for the Company and for the Bank as of June 30, 2020, and December 31, 2019, based on the Basel III Capital Rules discussed above.
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Actual Required
For Capital
Adequacy Purposes 		To Be Well
Capitalized Under
Prompt Corrective
Action Regulations
Amount Ratio Amount Ratio Amount Ratio
June 30, 2020
Company-Level
Company common equity Tier 1 capital to RWA $ 399,384    12.5  % $ 143,700    4.5  % N/A N/A
Company Total Capital to RWA $ 496,529    15.5  % $ 255,466    8.0  % N/A N/A
Company Tier 1 (Core) Capital to RWA $ 399,384    12.5  % $ 191,599    6.0  % N/A N/A
Company Tier 1 Leverage Ratio $ 399,384    10.4  % $ 153,401    4.0  % N/A N/A
Bank-Level
Bank common equity Tier 1 capital to RWA $ 453,654    14.2  % $ 143,586    4.5  % $ 207,403    6.5  %
Bank Total Capital to RWA $ 491,846    15.4  % $ 255,265    8.0  % $ 319,081    10.0  %
Bank Tier 1 (Core) Capital to RWA $ 453,654    14.2  % $ 191,449    6.0  % $ 255,265    8.0  %
Bank Tier 1 Leverage Ratio $ 453,654    11.8  % $ 153,114    4.0  % $ 191,392    5.0  %
December 31, 2019
Company-Level
Company common equity Tier 1 capital to RWA $ 388,199    11.9  % $ 146,711    4.5  % N/A N/A
Company Total Capital to RWA $ 487,966    15.0  % $ 260,819    8.0  % N/A N/A
Company Tier 1 (Core) Capital to RWA $ 388,199    11.9  % $ 195,614    6.0  % N/A N/A
Company Tier 1 Leverage Ratio $ 388,199    10.3  % $ 151,456    4.0  % N/A N/A
Bank-Level
Bank common equity Tier 1 capital to RWA $ 441,348    13.6  % $ 146,491    4.5  % $ 211,599    6.5  %
Bank Total Capital to RWA $ 482,183    14.8  % $ 260,429    8.0  % $ 325,536    10.0  %
Bank Tier 1 (Core) Capital to RWA $ 441,348    13.6  % $ 195,322    6.0  % $ 260,429    8.0  %
Bank Tier 1 Leverage Ratio $ 441,348    11.7  % $ 151,255    4.0  % $ 189,069    5.0  %
Note: Minimum ratios presented exclude the capital conservation buffer
Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above.

NOTE 8—DERIVATIVE INSTRUMENTS
Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings.
Derivatives designated as fair value hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The gain or loss on the derivative instrument is presented on the same income statement line item as the earnings effect of the hedged item. The Company utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable securities available-for-sale. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities.
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During 2019, the Company entered into 16 swap transactions with a notional amount of $101,205 designated as fair value hedges. These derivatives are intended to protect against the effects of changing interest rates on the fair values of fixed rate securities. As of June 30, 2020, there were no additional swap transactions during 2020.
A summary of the Company's fair value hedge relationships as of June 30, 2020 and December 31, 2019 are as follows (in thousands):
June 30, 2020 December 31, 2019
Balance Sheet Location Weighted Average Remaining Maturity (In Years) Weighted Average Pay Rate Receive Rate Notional Amount Estimated Fair Value Notional Amount Estimated Fair Value
Liability derivative
Interest rate swap agreements - securities Other liabilities 6.55 2.527% 3 month LIBOR $ 101,205    $ 14,068    $ 101,205    $ 4,954   
The effects of fair value hedge relationships reported in interest income on securities on the consolidated statements of income for the three months ended June 30, 2020 and 2019 were as follows (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
Gain (loss) on fair value hedging relationship 2020 2019 2020 2019
Interest rate swap agreements - securities:
Hedged items $ 706    $ 3,615    $ 9,114    $ 4,733   
Derivative designated as hedging instruments (706)   (3,615)   (9,114)   (4,733)  
The following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges at June 30, 2020:
Carrying Amount of the Hedged Assets (in thousands) Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets
Line item on the balance sheet June 30, 2020 December 31, 2019 June 30, 2020 December 31, 2019
Securities available-for-sale $ 101,205    $ 101,205    $ 9,114    $ 4,954   
Derivatives designated as cash flow hedges
For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. The Company uses cash flow hedge relationships in an effort to manage future interest rate exposure. The hedging strategy converts the LIBOR-based variable interest rate on forecasted borrowings to a fixed interest rate and is used in an effort to protect the Company from floating interest rate variability. A summary of the Company's cash flow hedge relationships as of June 30, 2020 and December 31, 2019 are as follows (in thousands):

June 30, 2020 December 31, 2019
Balance Sheet Location Weighted Average Remaining Maturity (In Years) Weighted Average Pay Rate Receive Rate Notional Amount Estimated Fair Value Notional Amount Estimated Fair Value
Liability derivatives
Interest rate swap agreements Other liabilities 2.1 2.232% 1 month LIBOR $ 100,000    $ 3,741    $ 100,000    $ 1,592   

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The effects of the Company's cash flow hedge relationships on the statement of comprehensive income (loss) during the three months ended June 30, 2020 and 2019 were as follows:
Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss) Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss)
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Liability derivatives
Interest rate swap agreements $ 142    $ (1,231)   $ (1,587)   $ (1,231)  
The cash flow hedges were determined to be highly effective during the periods presented and as a result qualify for hedge accounting treatment. The Company expects the hedges to continue to be highly effective and qualify for hedge accounting during the remaining terms of the swaps.

NOTE 9—COMMITMENTS AND CONTINGENCIES
We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. Those agreements involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. These off-balance sheet arrangements include commitments to make loans, credit lines and standby letters of credit which would impact our liquidity and capital resources to the extent customers accept or use these commitments. A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our customers under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Actual borrowing needs of our customers may exceed our expected funding requirements, especially during a challenging economic environment when our client companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from other sources. Any failure to meet our unfunded credit commitments in accordance with the actual borrowing needs of our customers may have a material adverse effect on our business, financial condition, results of operations or reputation.
Commitments to make loans, credit lines and standby letters of credit involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet financial instruments.
The contractual amounts of financial instruments with off-balance sheet risk were as follows:

June 30, 2020 December 31, 2019
Fixed
Rate 		Variable
Rate 		Total Fixed
Rate 		Variable
Rate 		Total
Unused lines of credit $ 89,642    $ 637,394    $ 727,036    $ 89,040    $ 701,326    $ 790,366   
Standby letters of credit 6,865    44,326    51,191    7,119    48,750    55,869   
Mortgage loan commitments 136,235    —    136,235    48,999    —    48,999   

Commitments to make loans are generally made for periods of over 365 days. At June 30, 2020, our loan commitments have interest rates ranging from 0.00% to 12.00% and maturity terms ranging from less than 1 year to 25 years.

Of the $727,036 of unused lines of credit at June 30, 2020, the Company estimates approximately $294,290, or approximately 40.5%, are available to be drawn by customers without further approval by the Bank.

NOTE 10—FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
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Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:
Fair Value Measurements at June 30,
2020 Using:
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1) 		Significant
Other
Observable
Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
Financial Assets
Securities available-for-sale
Mortgage-backed securities-residential $ —    $ 257,637    $ —   
Mortgage-backed securities-commercial —    15,592    —   
Corporate notes —    2,592    —   
State and political subdivisions —    228,056    —   
Total securities available-for-sale $ —    $ 503,877    $ —   
Loans held for sale $ —    $ 61,142    $ —   
Derivative assets $ —    $ 2,269    $ —   
Financial Liabilities
Derivative liabilities $ —    $ 18,269    $ —   

Fair Value Measurements at December 31,
2019 Using:
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1) 		Significant
Other
Observable
Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
Financial Assets
Securities available-for-sale
Mortgage-backed securities-residential $ —    $ 375,943    $ —   
Asset-backed securities —    17,780    —   
Corporate notes —    33,361    —   
State and political subdivisions —    225,048    —   
Total securities available for sale $ —    $ 652,132    $ —   
Loans held-for-sale $ —    $ 43,162    $ —   
Derivative assets $ —    $ 225    $ —   
Financial Liabilities
Derivative liabilities $ —    $ 6,619    $ —   

The Company used the following methods and significant assumptions to estimate the fair value of financial instruments that are measured at fair value on a recurring basis:
Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
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Derivative assets: Included in other assets are certain assets carried at fair value and interest rate locks associated with the mortgage loan pipeline. The fair value of the mortgage loan pipeline rate locks is based upon the projected sales price of the underlying loans, taking into account market interest rates and other market factors at the measurement date, net of the projected fallout rate. These assets are valued using similar observable data that occurs in the market (Level 2).
Loans Held For Sale: These loans are typically sold to an investor following loan origination and the fair value of such accounts are readily available based on direct quotes from investors or similar transactions experienced in the secondary loan market. Fair value adjustments, as well as realized gains and losses are recorded in current earnings. Fair value is determined by market prices or similar transactions adjusted for specific attributes of that loan (Level 2).
Derivative liabilities: The Company has certain liabilities carried at fair value including certain interest rate swap agreements to facilitate customer transactions, and the cash flow hedge and interest rate locks associated with the funding for its mortgage loan originations. The fair value of these liabilities is based on pricing models that utilize observable market inputs (Level 2).
There were no transfers between levels at June 30, 2020, and December 31, 2019 that had required write-downs to fair value.
The following table presents assets measured at fair value on a non-recurring basis. There were no liabilities measured at fair value on a non-recurring basis as of June 30, 2020, and December 31, 2019.


Total carrying value in the
consolidated balance sheet 		Quoted market prices in
an active market
(Level 1) 		Models with significant
observable market parameters
(Level 2) 		Models with significant
unobservable market parameters
(Level 3) 		Total losses for the period ended
June 30, 2020
Impaired loans, net: (1)
Commercial and industrial $ 1,016    $ —    $ —    $ 1,016    $ 5,153   
Servicing rights, net 4,035    —    —    4,035    316   
Total $ 5,051    $ —    $ —    $ 5,051    $ 5,469   
December 31, 2019
Impaired loans, net: (1)
Residential real estate:
Closed-end 1-4 family $ 626    $ —    $ —    $ 626    $ —   
Commercial and industrial 3,763    —    3,650    113    —   
Total $ 4,389    $ —    $ 3,650    $ 739    $ —   
(1) Amount is net of a valuation allowance of $6,760 and $20,771 at June 30, 2020 and December 31, 2019, respectively, as required by ASC 310-10, "Receivables."
As of June 30, 2020 and December 31, 2019, the only Level 3 assets with material unobservable inputs are associated with impaired loans and servicing rights. The table above includes those loans and servicing rights that are impaired and have a carrying balance as of June 30, 2020 and December 31, 2019.
Impaired Loans: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due pursuant to the contractual terms of the loan. Impairment is measured by estimating the fair value of the loan based on the present value of expected cash flows, the market price of the loan, or the underlying fair value of the loan's collateral. For real estate loans, fair value of the impaired loan's collateral is determined by third party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. The unobservable inputs may vary depending on the individual assets with no one of the three methods being the predominant approach. The Company reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically is 10% of the appraised value. For non-real estate collateral loans, the unobservable inputs will vary depending on the credit. The fair value of the impaired loan's collateral may be determined using a third party
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appraisal, transactional values, discounted cash flows ("DCF"), sales comparisons, asset value, or aging reports, adjusted or discounted. As of June 30, 2020, the fair value of the non-real estate collateral loans was determined primarily based on the DCF method, resulting in a Level 3 fair value classification.
Mortgage Servicing Rights: Fair value of mortgage servicing rights is based on valuation models that calculate the present value of estimated net cash flows based on industry market data. The valuation model incorporates assumptions that market participants would use in estimating future net cash flows resulting in a Level 3 classification.
Financial Instruments Recorded Using Fair Value Option
As of June 30, 2020, the unpaid principal balance of loans held for sale was $58,674 resulting in an unrealized gain of $2,468 included in gains on sale of loans. As of December 31, 2019, the unpaid principal balance of loans held for sale was $42,152, resulting in an unrealized gain of $1,010 included in gains on sale of loans. None of the loans as of June 30, 2020, or December 31, 2019 are 90 days or more past due or on nonaccrual.
The following tables present the carrying amounts, estimated fair value and placement in the fair value hierarchy at June 30, 2020 and December 31, 2019.

Fair Value Measurements at June 30,
2020 Using:
Carrying
Amount 		Level 1 Level 2 Level 3 Total
Financial assets
Cash and cash equivalents $ 236,775    $ 236,775    $ —    $ —    $ 236,775   
Certificates of deposit held at other financial institutions
3,506    —    3,506    —    3,506   
Securities available for sale 503,877    —    503,877    —    503,877   
Loans held for sale 61,142    —    61,142    —    61,142   
Net loans 2,756,668    —    —    2,713,013    2,713,013   
Other assets 2,269    —    2,269    —    2,269   
Accrued interest receivable 18,576    15    3,208    15,353    18,576   
Financial liabilities
Deposits $ 3,143,259    $ 2,646,541    $ 502,722    $ —    $ 3,149,263   
Federal Home Loan Bank advances 100,000    —    99,971    —    99,971   
Subordinated notes, net 58,961    —    —    60,461    60,461   
Other liabilities 18,269    —    18,269    —    18,269   
Accrued interest payable 2,711    71    1,953    687    2,711   

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Fair Value Measurements at December 31,
2019 Using:
Carrying
Amount 		Level 1 Level 2 Level 3 Total
Financial assets
Cash and cash equivalents $ 234,991    $ 234,991    $ —    $ —    $ 234,991   
Certificates of deposit held at other financial institutions
3,590    —    3,590    —    3,590   
Securities available-for-sale 652,132    —    652,132    —    652,132   
Loans held for sale 43,162    —    43,162    —    43,162   
Net loans 2,767,008    —    —    2,753,761    2,753,761   
Other assets 225    —    225    —    225   
Accrued interest receivable 12,362    96    3,775    8,491    12,362   
Financial liabilities
Deposits $ 3,207,584    $ 2,458,555    $ 749,656    $ —    $ 3,208,211   
Federal Home Loan Bank advances 155,000    —    155,090    —    155,090   
Subordinated notes, net 58,872    —    —    60,922    60,922   
Other liabilities 6,619    —    6,619    —    6,619   
Accrued interest payable 4,201    154    687    3,360    4,201   

There were no foreclosed assets as of June 30, 2020, or December 31, 2019, and accordingly, there were no properties at June 30, 2020 or December 31, 2019 that required write-downs to fair value.
The methods and assumptions not previously described used to estimate fair values are described as follows:
(a) Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
(b) Loans: Fair values of loans, excluding loans held for sale, are estimated as follows: In accordance with ASU 2016-01, the fair value of loans held for investment, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using a cash flow projection methodology that relies on three primary assumptions: (1) the expected prepayment rate of loans; (2) the magnitude of future net losses based on expected default rate and severity of loss; and (3) the discount rate applicable to the expected cash flows of the loan portfolio. Loans are considered a Level 3 classification.
(c) Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of fixed-term money market accounts approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
(d) Federal Funds Purchased and Repurchase Agreements: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within 90 days, approximate their fair values resulting in a Level 2 classification.
(e) Federal Home Loan Bank Advances: The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
(f) Subordinated Notes: The fair values of the Company’s subordinated notes are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.
(g) Accrued Interest Receivable/Payable: The carrying amounts of accrued interest approximate fair value resulting in a Level 1, Level 2 or Level 3 classification based on the asset/liability with which they are associated.
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(h) Off-balance Sheet Instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

NOTE 11—EARNINGS PER SHARE
The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. The factors used in the earnings per share computation follow:
Three months ended June 30, Six months ended June 30,
2020 2019 2020 2019
Basic
Net income available to common shareholders $ 10,174    $ 5,173    $ 9,026    $ 8,075   
Less: earnings allocated to participating securities (34)   (41)   (43)   (79)  
Net income allocated to common shareholders $ 10,140    $ 5,132    $ 8,983    $ 7,996   
Weighted average common shares outstanding including participating securities
14,915,317    14,599,407    14,882,426    14,580,370   
Less: Participating securities (50,523)   (117,063)   (70,549)   (143,043)  
Average shares 14,864,794    14,482,344    14,811,877    14,437,327   
Basic earnings per common share $ 0.68    $ 0.35    $ 0.61    $ 0.55   

Three months ended June 30, Six months ended June 30,
2020 2019 2020 2019
Diluted
Net income allocated to common shareholders $ 10,140    $ 5,132    $ 8,983    $ 7,996   
Weighted average common shares outstanding for basic earnings per common share
14,864,794    14,482,344    14,811,877    14,437,327   
Add: Dilutive effects of assumed exercises of stock options
175,652    341,777    241,835    376,762   
Add: Dilutive effects of assumed restricted stock units
230,968    70,019    220,530    35,203   
Average shares and dilutive potential common shares 15,271,414    14,894,140    15,274,242    14,849,292   
Dilutive earnings per common share $ 0.66    $ 0.34    $ 0.59    $ 0.54   
For the three months ended June 30, 2020 and 2019, stock options for 966,571 and 980,099 shares of common stock, respectively, were not considered in computing diluted earnings per common share because they were antidilutive. For the six months ended June 30, 2020 and 2019, stock options for 823,528 and 874,279 shares of common stock, respectively, were not considered in computing diluted earnings per common share because they were antidilutive.

NOTE 12—SUBORDINATED DEBT ISSUANCE
The Company’s subordinated notes, net of issuance costs, totaled $58,961 and $58,872 at June 30, 2020 and at December 31, 2019, respectively. For regulatory capital purposes, the subordinated notes are treated as Tier 2 capital, subject to certain limitations, and are included in total regulatory capital when calculating the Company’s total capital to risk weighted assets ratio as indicated in Note 7 of these consolidated financial statements.
During 2016, the Company completed the issuance of $60,000 in principal amount of subordinated notes in two separate offerings. In March 2016, $40,000 of 6.875% fixed-to-floating rate subordinated notes (the “March 2016 Subordinated Notes”) were issued in a public offering to accredited institutional investors, and in June 2016, $20,000 of 7% fixed-to-floating rate subordinated notes (the “June 2016 Subordinated Notes”) were issued to certain accredited institutional investors in a private offering. The subordinated notes are unsecured and will rank at least equally with all of the Company’s other unsecured subordinated indebtedness and will be effectively subordinated to all of our secured debt to the extent of the value of the collateral securing such debt. The subordinated notes will be subordinated in right of payment to all of our existing and future senior indebtedness, and will rank structurally junior to all existing and future liabilities of our subsidiaries including, in the
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case of the Company’s bank subsidiary, its depositors, and any preferred equity holders of our subsidiaries. The holders of the subordinated notes may be fully subordinated to interests held by the U.S. government in the event that we enter into a receivership, insolvency, liquidation, or similar proceeding.
The issuance costs related to the March 2016 Subordinated Notes amounted to $1,382 and are being amortized as interest expense over the ten-year term of the March 2016 Subordinated Notes. The issuance costs related to the June 2016 Subordinated Notes were $404 and are being amortized as interest expense over the ten-year term of the June 2016 Subordinated Notes. For the six months ended June 30, 2020 and 2019, amortization of issuance costs remained constant at $89.
The following table summarizes the terms of each subordinated note offering:
March 2016
Subordinated
Notes 		June 2016
Subordinated
Notes
Principal amount issued $40,000 $20,000
Maturity date March 30, 2026 July 1, 2026
Initial fixed interest rate 6.875% 7.00%
Initial interest rate period 5 years 5 years
First interest rate change date March 30, 2021 July 1, 2021
Interest payment frequency through year five Semiannually Semiannually
Interest payment frequency after five years Quarterly Quarterly
Interest repricing index and margin
3-month LIBOR plus 5.636%
3-month LIBOR plus 6.04%
Repricing frequency after five years Quarterly Quarterly

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (All dollar values in this section are in thousands.)

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. This discussion and analysis should be read in conjunction with the accompanying unaudited financial statements, the audited financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2020, which includes additional information about critical accounting policies and practices and risk factors. Historical results and trends that might appear in the consolidated financial statements should not be interpreted as being indicative of future operations.
Company Overview

We are a financial holding company headquartered in Franklin, Tennessee. Through our wholly-owned bank subsidiary, Franklin Synergy Bank, a Tennessee-chartered commercial bank and a member of the Federal Reserve System, we provide a full range of banking and related financial services with a focus on service to small businesses, corporate entities, local governments and individuals. We operate through 15 branches in the growing Williamson, Rutherford and Davidson Counties and one loan production and deposit production office in Wilson County, all within the Nashville MSA. 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 June 30, 2020, we had consolidated total assets of $3,775,741, total loans, including loans held for sale, of $2,855,910, total deposits of $3,143,259 and total equity of $422,063.
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.

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Recent Developments:
Merger with FB Financial Corporation
On January 21, 2020, the Company announced a strategic merger with FB Financial Corporation that is expected to close in the third quarter of 2020, with an anticipated closing date of August 15, 2020.
COVID-19 and the CARES Act
The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the temporary, and in some cases permanent, shutting of businesses across the country, significant job loss, and aggressive measures by the government at the federal, state and local levels. The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. During the first quarter of 2020, the World Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the pandemic has caused significant disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. The pandemic and its adverse consequences continued throughout the second quarter of 2020 and will likely present significant economic risks for at least the next several quarters. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company.

The United States Congress, the President of the United States, and the Federal Reserve have taken a multitude of actions designed to cushion the economic fallout from the COVID-19 pandemic. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law on March 27, 2020 as a $2.2 trillion legislative relief package. The goal of the CARES Act is to limit the impact of a potentially severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and medical providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts, together with the proposed and/or pending legislature and regulatory actions, are expected to have a material impact on our operations. It is not possible to know at this time the full universe or extent of these impacts as of the date this filing, but such impacts could be material and adverse.

Financial position and results of operations

Pertaining to our June 30, 2020 financial condition and results of operations, COVID-19 had an impact on our allowance for loan and lease losses (“ALLL”), and the resulting provision for loan losses was impacted by changes in economic conditions. Should economic conditions worsen, we could experience further increases in our ALLL and record additional provision expense. The execution of the payment deferral program discussed below assisted our ratio of past due loans to total loans. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we continue to work with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.

Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued may need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

In an agreement with a third party provider, we sold substantially all of our SBA PPP loan portfolio that were originated and funded during the first and second quarter of 2020. This transaction allowed us to immediately recognize the origination fees paid by the SBA during the second quarter of 2020. We no longer retain the servicing or other risks associated with the administration of this transferred loan portfolio.

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Capital and liquidity

As of June 30, 2020, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses. We rely on cash on hand as well as dividends from our subsidiary bank to service our debt. If our capital deteriorates such that our subsidiary bank is unable to pay dividends to us for an extended period of time, we may not be able to service our debt.

We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.

Asset valuation

As of June 30, 2020, following a thorough analysis and testing for goodwill impairment, management has determined that our goodwill was not impaired. It is possible that subsequent impacts of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform a subsequent goodwill impairment test and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. At June 30, 2020 we had goodwill of $18,176, representing approximately 4.3% of equity.

Our processes, controls and business continuity plan

We implemented our business continuity plans in the aftermath of the early March 2020 tornadoes that severely impacted communities across Middle Tennessee and as COVID-19 was declared a global pandemic. Shortly after invoking those plans, we deployed a successful remote working strategy, provided timely communication to employees and customers, implemented protocols for employee safety, and initiated strategies for monitoring and responding to local COVID-19 impacts – including customer relief efforts. Our preparedness efforts, coupled with quick and decisive plan implementation, resulted in minimal impacts to operations as a result of COVID-19. Prior technology planning resulted in the successful deployment of the majority of our operational teams to a remote environment. These strategies and plans have continued through the second quarter and into the third quarter 2020. Due to the nature of their functions, a portion of our employees continue to operate from physical Company locations, while effectively employing social distancing standards. As of June 30, 2020, more than 50% of the Company’s 309 employees continued to work remotely. As our local communities begin to gradually lift workplace and social distancing restrictions, the Company plans to slowly bring employees back to their physical workplaces, in a conservative and methodical phased approach.

To achieve implementation of the remote working strategy, throughout the duration of the COVID-19 pandemic thus far, we did not incur significant costs to effectively provide for proper equipment to team members who were required to work remotely. We do not anticipate incurring material costs related to our continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date as a result of the pandemic. To prepare for potential staffing shortages resulting from an anticipated peak in COVID-19 cases, we have assessed critical team members and determined that appropriate contingency and succession plans are in place to ensure continued operations. Our COVID-19 Response Team continues to meet regularly to anticipate and respond to any future COVID-19 interruptions or developments. We do not anticipate significant challenges to our ability to maintain our systems and controls in light of the measures we have taken to prevent the spread of COVID-19. We do not currently face any material resource constraint through the implementation of our business continuity plans.

Lending operations and accommodations to borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation, we are executing a payment deferral program for our commercial lending clients that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment for typically 90 days.

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As of June 30, 2020, the Company had 437 loans with outstanding loan balances of $730,696 that were on temporary loan payment deferral, in accordance with the COVID-19 relief provided by the CARES Act. As of July 31, 2020, we had approximately 305 loans with a balance of approximately $478,000 that had returned to regular payment status, and we had approximately 101 loans with a balance of approximately $253,000 that remained on a temporary payment deferral program. In accordance with the interagency guidance issued during the period ended June 30, 2020, these short-term deferrals are not considered TDRs.

Credit

The Company could experience further increases in its required allowance for loan and lease losses and record additional loan loss provision expense should economic conditions worsen. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

While all industries have and will continue to experience adverse impacts as a result of the COVID-19 pandemic, we had exposures (loans held for investment and commitments to lend) in the following loan categories considered to be “at-risk” of significant impact as of June 30, 2020. Our exposure to the retail industry at June 30, 2020 equated to approximately $253,151, or 9.1% of total loans HFI. Our exposure to the health care industry at June 30, 2020 equated to $345,376, or 12.4% of total loans HFI. We have approximately 8.2% of the loans in the health care industry segment risk rated as substandard or worse. Our exposure to hotels at June 30, 2020 equated to approximately $143,879, or 5.1% of total loans HFI. Our exposure to restaurants at June 30, 2020 equated to approximately $77,636, or 2.8% of total loans HFI. At June 30, 2020, our exposure to the transportation and warehousing industry was $27,236, or 1.0% of total loans HFI. These "at-risk" loan categories as of June 30, 2020 totaled $847,278, or 30.3% of total loans HFI.


Industries Commercial and industrial Commercial real estate owner occupied Commercial real estate non-owner occupied real estate Total % of Total Loans HFI
Retail $ 5,390    $ 39,342    $ 208,419    $ 253,151    9.1  %
Healthcare - Institutional 262,417    —    —    262,417    9.4  %
Healthcare - non-Institutional 21,354    10,900    50,705    82,959    3.0  %
Total healthcare 283,771    10,900    50,705    345,376    12.4  %
Hotels 371    4,293    139,215    143,879    5.1  %
Restaurants 5,023    44,153    28,460    77,636    2.8  %
Transportation and warehousing 19,558    1,087    6,591    27,236    1.0  %
Total $ 314,113    $ 99,775    $ 433,390    $ 847,278    30.3  %

Risk Rating Retail Healthcare - Institutional Healthcare - Non-Institutional Total Healthcare Hotels Restaurants Transportation and Warehousing
Pass 95.2  % 87.0  % 97.9  % 89.6  % 90.1  % 92.0  % 93.5  %
Management Attention / Watch(1)
1.8  % 2.3  % 2.1  % 2.2  % 9.9  % 7.0  % 6.3  %
Special mention 1.6  % —  % —  % —  % —  % 0.8  % 0.2  %
Substandard or worse 1.4  % 10.7  % —  % 8.2  % —  % 0.2  % —  %
Total 100.0  % 100.0  % 100.0  % 100.0  % 100.0  % 100.0  % 100.0  %
(1) Assets included in this category are currently protected but potentially weak and require close management attention.

As a part of our continued strategic reduction in non-core assets, we reduced our Institutional loan portfolio from $429,543 at December 31, 2019 to $357,567 at June 30, 2020. Subsequent to June 30, 2020, we sold an additional $10,100 of loans from the Institutional portfolio, with an immaterial sales discount.

Retail operations

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We are committed to assisting our customers and communities in this time of need. As of August 3, 2020, the Bank was utilizing all of its fifteen branches per normal operating procedures, except that nine of its fifteen branches were available to customers on a drive-thru basis or by appointment only. Further, we also continue to temporarily reduce, suspend, or eliminate certain fees for customers eligible for relief under regulatory guidance who have been adversely affected, and we have temporarily suspended adverse credit bureau reporting for customers eligible for such relief under applicable regulatory guidelines.

We continue to serve our customers through our branch and drive-thru operations, as well as through the use of our mobile banking operations, all of which are supported by our Customer Call Center, which has operated under extended hours during the pandemic. We have been able to conduct the vast majority of customer business with minimal disruption to date, and our bankers and entire customer service team are proactively and successfully managing the volume of customer requests and issues.

The Company continues to monitor the safety of our employees, customers and communities. At this time, our staffing is adequate to address the requests for time off by any of our employees who are impacted by health or child care issues.

Critical Accounting Policies
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.
Our accounting policies are integral to understanding the results reported. Accounting policies are described in Note 1 of the notes to the consolidated financial statements (unaudited) which begins on page 11. 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 (ALLL)
The ALLL is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes a loan balance has become uncollectible. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.
Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. 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” or “TDRs”) and classified as impaired.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
All loans classified by management as substandard or worse are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
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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, we determine the amount of reserve in accordance with the accounting policy for the ALLL.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank’s loss history and loss history from the Bank’s peer group over the past three years. This actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.
Goodwill
Due to the estimation process and the potential materiality of the amounts involved, the Company has also identified the accounting for goodwill as an accounting policy critical to our consolidated financial statements. Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill acquired in a business combination has an indefinite useful life and is not systematically amortized. On at least an annual basis, with the annual evaluation occurring on December 31 of each year, goodwill is evaluated for impairment. The Company has only one reporting unit with $18,176 in goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, the Company would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess, not to exceed the carrying value of goodwill. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions. In our 2019 goodwill impairment evaluation, we concluded that the goodwill was not impaired. Additionally, during the period ended June 30, 2020, the economic turmoil and market volatility resulting from the COVID-19 crisis resulted in a decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis. In this analysis, the Company determined that none of its goodwill was impaired as of June 30, 2020. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes. Goodwill is the only intangible asset with an indefinite life on the balance sheet.

Status of New Accounting Standard for Allowance for Credit Losses
On January 1, 2020, ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, became effective for the Company which replaces the existing incurred loss impairment methodology for loans that are collectively evaluated for impairment with a methodology that reflects management’s best estimate of lifetime expected credit losses and requires consideration of reasonable and supportable economic forecasts to develop a lifetime credit loss estimate. Topic 326 requires additional qualitative and quantitative disclosure to allow users to better understand the credit risk within the portfolio and the methodologies for determining the ACL. The CECL standard also simplifies the accounting model for purchased credit impaired loans. Additionally, Topic 326 requires expected credit losses on AFS debt securities be recorded as an ACL. For certain types of debt securities, such as U.S. Treasuries and other securities with government guarantees, entities may expect zero credit losses.

In accordance with Section 4014 of the CARES Act that was signed into law on March 27, 2020, we deferred implementation of CECL and thus elected to continue to utilize the ILM to calculate loan loss reserves as of June 30, 2020.

The temporary deferral of CECL will remain effective until the earlier of the termination of the national emergency declaration concerning the COVID-19 pandemic or December 31, 2020, with an effective retrospective implementation date of January 1, 2020. There is increased uncertainty on the local, regional, and national economy as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level. We have taken actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as actively participating in the SBA’s PPP. These conditions significantly impact management’s determination of a reasonable and supportable forecast, an essential requirement in the calculation of expected credit losses under CECL methodology. We believe that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses, and as such, our allowance for loan losses and provision should not be compared to those under a different accounting method (e.g., CECL).
41

Our CECL implementation efforts will remain in process in order to adequately comply with the provisions of CECL once the deferral period ceases. Management will continue to measure and monitor the estimated impacts of CECL adoption through continued parallel testing of model simulations based on our portfolio composition and current expectations of future economic conditions.

Prior to the CARES Act being signed and our decision to delay the implementation of CECL, we were completing our CECL implementation plan, under the direction of our Chief Financial Officer, Chief Credit Officer, Chief Operating Officer, and Controller. The working group also included individuals from various functional areas including credit, risk management, accounting and information technology, among others. Our implementation plan included assessment and documentation of processes, internal controls and data sources; model development, documentation and validation; Board approval of a CECL Policy; and system configuration, among other things. Additionally, a third-party vendor remains under contract to assist us in the implementation of CECL.

We are unable as of the date of this report to provide an estimate of our allowance for loan losses under the CECL model as of June 30, 2020 and the provision for loan losses for the six months then ended.

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COMPARISON OF RESULTS OF OPERATIONS FOR
THE THREE MONTHS ENDED JUNE 30, 2020 and 2019
(Dollar Amounts in Thousands)
Overview
The Company's net income was $10,182 and $9,034 for the three and six months ended June 30, 2020 compared to net income of $5,181 and $8,083 for the three and six months ended June 30, 2019, an increase of $5,001 quarter-over-quarter and an increase of $951 year-over-year. After earnings attributable to noncontrolling interest, the Company’s net earnings available to common shareholders for the three and six months ended June 30, 2020 was $10,174 and $9,026, respectively, compared to $5,173 and $8,075 for the three and six months ended June 30, 2019, respectively. Net income available to common shareholders increased by $5,001 and $951 for the three and six months ended June 30, 2020, respectively, compared to the three and six months ended June 30, 2019. The increase in net income was primarily related to a decrease of $15,762 and $9,802 in interest expense paid when comparing the same three and six month periods.
Net Interest Income Margin (NIM)
Net interest income consists of interest income generated by earning-assets less interest expense paid on interest-bearing liabilities and is the most significant component of our revenues. Net interest income for the three and six months ended June 30, 2020 totaled $29,528 and $56,992, respectively, compared to $27,365 and $54,785 for the same periods in 2019, an increase of $2,163 and $2,207, between the respective periods.
The net interest margin was 3.26% for the three months ended June 30, 2020, a 42 basis point increase quarter-over-quarter, and a 32 basis point increase year-over-year. The current increase was primarily driven by the accelerated loan fees due to the third party PPP loan sale, which contributed 13 basis points to the NIM. Excluding the recognition of $1,491 of PPP loan fees, NIM would have been 3.13%.
Tax-equivalent interest income was $40,314 and $82,458 for the three and six months ended June 30, 2020, when compared to $48,009 and $96,067 for the same periods last year, a decrease of 16.0% and 14.2%. The yield on average interest earning assets, adjusted for tax equivalent yield, decreased 51 and 39 basis points to 4.38% and 4.46% when comparing the three and six months ended June 30, 2020 to the same periods during 2019. For the three and six months ended June 30, 2020, the tax equivalent yield on loans held for investment was 5.10% and 5.15%, compared to 5.61% and 5.61% during the same periods in 2019. The primary driver for the decrease in yields on loans was the decrease in market interest rates when compared to the same periods in the previous year.
Interest-earning assets averaged $3,701,515 and $3,940,266 during the three months ended June 30, 2020 and 2019, respectively, a decrease of $238,751, or 6.1%. Interest-earning assets averaged $3,714,179 and $3,991,961 during the six months ended June 30, 2020 and 2019, respectively, a decrease of $277,782, or 7.0%. These decreases were due to the strategically planned asset rotation and decrease in the total investment securities during 2019 and 2020. Average investment securities decreased $355,218 and $417,465, or decreased 40.3% and 42.1%, and average loans held for investment increased $11,512 and $40,242 or 0.4% and 1.4% when comparing the three and six months ended June 30, 2020 with the same periods in 2019.
Interest-bearing liabilities averaged $2,950,106 and $3,340,033 during the three months ended June 30, 2020 and 2019, respectively, a decrease of $389,927, or 11.7%. Interest-bearing liabilities averaged $3,013,187 and $3,416,223 during the six months ended June 30, 2020 and 2019, respectively, a decrease of $403,036, or 11.8%. Total average money market deposits increased $302,348 and $275,204, respectively, or 29.5% and 27.3%, respectively for the three and six months ended June 30, 2020, as compared to the same periods during 2019.
Average FHLB advances decreased $208,282 and $219,305, or decreases of 59.6% and 61.2%, respectively when comparing the three and six months ended June 30, 2020 with the same periods in 2019 as a result of the organic growth in the loan portfolio. For the three and six months ended June 30, 2020 and 2019, the cost of average interest-bearing liabilities decreased 101 and 74 basis points, respectively to 1.40% from 2.41% comparing three month periods and to 1.63% from 2.37% comparing six month periods.
Total non-interest deposits averaged $455,540, an increase of $142,436, or 45.5%, during the three months ended June 30, 2020, compared to the same period during 2019. Total non-interest deposits averaged $394,712, an increase of $92,512, or 30.6%, during the six months ended June 30, 2020, compared to the same period during 2019.
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The tables below summarize average balances, annualized yields and rates, cost of funds, and the analysis of changes in interest income and interest expense for the three and six months ended June 30, 2020 and 2019:
Average Balances—Yields & Rates (7)
(Dollars are in thousands)
Three Months Ended June 30,
2020 2019
Average
Balance 		Interest
Inc / Exp 		Average
Yield /
Rate 		Average
Balance 		Interest
Inc / Exp 		Average
Yield /
Rate
ASSETS:
Loans(1)(6)
$ 2,870,460    $ 36,401    5.10  % $ 2,858,948    $ 40,003    5.61  %
Loans held for sale 48,899    290    2.39    23,883    256    4.30   
Securities:
Taxable 299,546    1,700    2.28    673,386    4,614    2.75   
Tax-exempt(6)
227,039    1,651    2.92    208,417    1,909    3.67   
Restricted equity securities 24,675    220    3.59    24,331    350    5.77   
Certificates of deposit at other financial institutions 3,445    20    2.33    3,759    22    2.35   
Federal funds sold and other(2)
227,451    32    0.06    147,542    855    2.32   
TOTAL INTEREST EARNING ASSETS $ 3,701,515    $ 40,314    4.38  % $ 3,940,266    $ 48,009    4.89  %
Allowance for loan and lease losses (38,211)   (28,007)  
All other assets 205,647    192,843   
TOTAL ASSETS $ 3,868,951    $ 4,105,102   
LIABILITIES & EQUITY
Deposits:
Interest checking $ 800,030    $ 1,913    0.96  % $ 816,429    $ 4,357    2.14  %
Money market 1,328,548    3,758    1.14    1,026,200    6,103    2.39   
Savings 42,662    29    0.27    38,882    27    0.28   
Time deposits 567,477    3,229    2.29    1,036,904    6,192    2.40   
Federal Home Loan Bank advances and other (8)
141,333    265    0.75    349,615    2,237    2.57   
Federal funds purchased and other(3)
11,124    10    0.36    13,249    90    2.72   
Subordinated notes 58,932    1,082    7.38    58,754    1,082    7.39   
TOTAL INTEREST BEARING LIABILITIES $ 2,950,106    $ 10,286    1.40  % $ 3,340,033    $ 20,088    2.41  %
Demand deposits 455,540    313,104   
Other liabilities 51,943    63,505   
Total equity 411,362    388,460   
TOTAL LIABILITIES AND EQUITY $ 3,868,951    $ 4,105,102   
NET INTEREST SPREAD(4)
2.98  % 2.48  %
NET INTEREST INCOME $ 30,028    $ 27,921   
NET INTEREST MARGIN(5)
3.26  % 2.84  %
(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.


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Average Balances—Yields & Rates (7)
(Dollars are in thousands)
Six Months Ended June 30,
2020 2019
Average
Balance 		Interest
Inc / Exp 		Average
Yield /
Rate 		Average
Balance 		Interest
Inc / Exp 		Average
Yield /
Rate
ASSETS:
Loans(1)(6)
$ 2,852,449    $ 73,108    5.15  % $ 2,812,207    $ 78,241    5.61  %
Loans held for sale 42,783    669    3.14  % 16,565    371    4.52  %
Securities:
Taxable 349,340    4,124    2.37  % 795,788    11,008    2.79  %
Tax-exempt(6)
224,115    3,523    3.16  % 195,132    3,899    4.03  %
Restricted equity securities 24,750    382    3.10  % 23,213    679    5.90  %
Certificates of deposit at other financial institutions 3,435    40    2.34  % 3,676    42    2.30  %
Federal funds sold and other(2)
217,307    612    0.57  % 145,380    1,827    2.53  %
TOTAL INTEREST EARNING ASSETS $ 3,714,179    $ 82,458    4.46  % $ 3,991,961    $ 96,067    4.85  %
Allowance for loan and lease losses (41,656)   (26,041)  
All other assets 201,941    196,446   
TOTAL ASSETS $ 3,874,464    $ 4,162,366   
LIABILITIES & EQUITY
Deposits:
Interest checking $ 838,891    $ 5,313    1.27  % $ 836,650    $ 8,777    2.12  %
Money market 1,284,817    8,688    1.36  % 1,009,613    12,082    2.41  %
Savings 41,359    56    0.27  % 39,741    55    0.28  %
Time deposits 642,885    7,118    2.23  % 1,100,929    12,755    2.34  %
Federal Home Loan Bank advances and other (8)
139,325    1,066    1.54  % 358,630    4,196    2.36  %
Federal funds purchased and other(3)
7,000    24    0.69  % 11,929    162    2.74  %
Subordinated notes 58,910    2,164    7.39  % 58,731    2,164    7.43  %
TOTAL INTEREST BEARING LIABILITIES $ 3,013,187    $ 24,429    1.63  % $ 3,416,223    $ 40,191    2.37  %
Demand deposits 394,712    302,200   
Other liabilities 52,625    61,133   
Total equity 413,940    382,811   
TOTAL LIABILITIES AND EQUITY $ 3,874,464    $ 4,162,367   
NET INTEREST SPREAD(4)
2.83  % 2.48  %
NET INTEREST INCOME $ 58,029    $ 55,876   
NET INTEREST MARGIN(5)
3.14  % 2.82  %
(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.
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Analysis of Changes in Interest Income and Expenses
Net change three months ended
June 30, 2020 versus June 30, 2019
  Volume Rate Net Change
INTEREST INCOME
Loans $ 166    $ (3,768)   $ (3,602)  
Loans held for sale 267    (233)   34   
Securities
Taxable (2,566)   (348)   (2,914)  
Tax-exempt 173    (431)   (258)  
Restricted equity securities 5    (136)   (131)  
Certificates of deposit at other financial institutions (2)   —    (2)  
Federal funds sold and other 464    (1,286)   (822)  
TOTAL INTEREST INCOME $ (1,493)   $ (6,202)   $ (7,695)  
INTEREST EXPENSE
Deposits
Interest checking $ (87)   $ (2,357)   $ (2,444)  
Money market accounts 1,805    (4,150)   (2,345)  
Savings 3    (1)   2   
Time deposits (2,812)   (151)   (2,963)  
Federal Home Loan Bank advances and other(1)
(1,333)   (639)   (1,972)  
Federal funds purchased and other(2)
(14)   (66)   (80)  
Subordinated notes 3    (3)   —   
TOTAL INTEREST EXPENSE $ (2,435)   $ (7,367)   $ (9,802)  
NET INTEREST INCOME $ 942    $ 1,165    $ 2,107   
(1) Includes finance lease.
(2) Includes repurchase agreements.


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Net change six months ended
June 30, 2020 versus June 30, 2019
Volume Rate Net Change
INTEREST INCOME
Loans $ 1,120    $ (6,253)   $ (5,133)  
Loans held for sale 587    (289)   298   
Securities
Taxable (6,176)   (708)   (6,884)  
Tax-exempt 579    (955)   (376)  
Restricted equity securities 45    (342)   (297)  
Certificates of deposit at other financial institutions (3)   1    (2)  
Federal funds sold and other 904    (2,119)   (1,215)  
TOTAL INTEREST INCOME $ (2,944)   $ (10,665)   $ (13,609)  
INTEREST EXPENSE
Deposits
Interest checking $ 24    $ (3,488)   $ (3,464)  
Money market accounts 3,293    (6,687)   (3,394)  
Savings 2    (1)   1   
Time deposits (5,307)   (330)   (5,637)  
Federal Home Loan Bank advances and other(1)
(2,566)   (564)   (3,130)  
Fed funds purchased and other(2)
(67)   (71)   (138)  
Subordinated Notes 7    (7)   —   
TOTAL INTEREST EXPENSE $ (4,614)   $ (11,148)   $ (15,762)  
NET INTEREST INCOME $ 1,670    $ 483    $ 2,153   
(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 ALLL that, in management’s evaluation, should be adequate to provide coverage for the 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 $3,195 and $7,031 for the three months ended June 30, 2020 and 2019, respectively, and $16,217 and $12,086 for the six months ended June 30, 2020, and 2019. The loan loss provision of $3,195 recorded for the three months ended June 30, 2020 was mostly due to increased quantitative loss factors, as well as an increase in qualitative risk factors due to COVID-19. When combined with the cumulative $32,000 in loan loss provisions recorded in the fourth quarter of 2019 and the first quarter of 2020, and netted against the cumulative $23,600 in net charge-offs recorded in the fourth quarter of 2019 through the second quarter of 2020, the $3,195 loan loss provision recorded for the second quarter of 2020 resulted in a net ALLL build of approximately $11,600, or an increase of approximately 43.9% since the third quarter of 2019.
Non-Interest Income
Non-interest income for the three and six months ended June 30, 2020 was $10,555 and $16,448 compared to $4,923 and $8,410 for the same periods in 2019, respectively. The $5,632 quarter-over-quarter increase during the second quarter of 2020 and the $8,038 increase during the six months ended June 30, 2020, was primarily the result of strong mortgage banking revenue, driven by a combination of historically low interest rates, strong origination pipelines and team, as well as favorable secondary market execution and pricing during the quarter.

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The following is a summary of the components of non-interest income (in thousands):
  Three Months Ended
June 30, 		$
Increase
(Decrease) 		%
Increase
(Decrease)
2020 2019
Service charges on deposit accounts $ 74    $ 77    $ (3)   (3.9) %
Other service charges and fees 1,397    903    494    54.7   
Mortgage banking revenue 8,688    2,473    6,215    251.3  %
Wealth management 702    673    29    4.3  %
Gain on sale or call of securities 166    367    (201)   (54.8)  
Net loss on sale of loans (372)   3    (375)   NM
Net gain on sale of foreclosed assets 5    3    2    66.7   
Other (105)   424    (529)   (124.8)  
Total non-interest income $ 10,555    $ 4,923    $ 5,632    114.4  %

Six Months Ended
June 30, 		$
Increase
(Decrease) 		%
Increase
(Decrease)
2020 2019
Service charges on deposit accounts $ 166    $ 151    $ 15    9.9  %
Other service charges and fees 2,294    1,660    634    38.2   
Mortgage banking revenue 11,373    4,145    7,228    174.4   
Wealth management 1,516    1,300    216    16.6   
Gain on sale or call of securities 1,562    517    1,045    202.1   
Net loss on sale of loans (788)   (214)   (574)   268.2   
Net gain on sale of foreclosed assets 7    7    —    —  %
Other 318    844    (526)   (62.3)  
Total non-interest income $ 16,448    $ 8,410    $ 8,038    95.6  %
Mortgage banking revenue increased $6,215 and $7,228, or 251.3% and 174.4% for the three and six months ended June 30, 2020, compared to the same periods in 2019. The increase was due to the volume of mortgage loans originated, the sales related to those loans and more favorable market rates in 2020, which resulted in favorable fair value adjustments on mortgage derivatives. The Federal Reserve increased rates 100 basis points in 2018 but then decreased rates 75 basis points during the third and fourth quarters of 2019 and then decreased rates by an additional 150 basis points in the first quarter of 2020, resulting in a current target rate range of zero to 25 basis points at the end of June 30, 2020.
Gain (loss) on sale or call of securities decreased $201 for the three months ended June 30, 2020 and increased $1,045 for the six months ended June 30, 2020, when compared with the same periods in 2019. The decrease and increase was due to the Company’s election to sell certain securities to take advantage of the market conditions that existed during that period, at which time, management elected to sell certain of its securities as part of its balance sheet management initiatives.
Net loss on sale of loans was $375 and $574 for the three and six months ended June 30, 2020 compared to the same periods in 2019. The loss for the three and six months ended June 30, 2020 was attributed to sales of the PPP loans to a third party during the second quarter of 2020 and sales of SNC loans during the first quarter of 2020.
Non-Interest Expense
Non-interest expense increased for the three and six months ended June 30, 2020 to $23,976 and $46,397 from $19,370 and $41,986 for the same periods in 2019. The increases were the result of the following components listed in the table below (in thousands):
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Three Months Ended
June 30, 		$
Increase
(Decrease) 		%
Increase
(Decrease)
2020 2019
Salaries and employee benefits $ 14,762    $ 11,365    $ 3,397    29.9  %
Occupancy and equipment 2,832    3,283    (451)   (13.7) %
FDIC assessment expense 900    660    240    36.4  %
Marketing 133    301    (168)   (55.8) %
Professional fees 2,345    1,073    1,272    118.5  %
Amortization of core deposit intangible 82    132    (50)   (37.9) %
Other 2,922    2,556    366    14.3  %
Total non-interest expense $ 23,976    $ 19,370    $ 4,606    23.8  %

Six Months Ended
June 30, 		$
Increase
(Decrease) 		%
Increase
(Decrease)
2020 2019
Salaries and employee benefits $ 27,342    $ 26,108    $ 1,234    4.7  %
Occupancy and equipment 5,918    6,396    (478)   (7.5)  
FDIC assessment expense 1,350    1,650    (300)   (18.2)  
Marketing 378    620    (242)   (39.0)  
Professional fees 5,413    1,996    3,417    171.2   
Amortization of core deposit intangible 177    277    (100)   (36.1)  
Other 5,819    4,939    880    17.8   
Total non-interest expense $ 46,397    $ 41,986    $ 4,411    10.5  %

Salaries and employee benefits increased $3,397, or 29.9%, while professional fees increased $1,272, or 118.5% when comparing the three months ended June 30, 2020 with the same period in 2019. Salaries and employee benefits increased $1,234, or 4.7%, respectively, while professional fees increased $3,417, or 171.2% when comparing the six months ended June 30, 2020 with the same period in 2019. These variations are attributable to employee-related adjustments and professional fees occurring due to our upcoming strategic merger with FB Financial Corporation expected to close in third quarter 2020, with an anticipated closing date of August 15, 2020.
Income Tax Expense
We recognized income tax expense for the three and six months ended June 30, 2020 of $2,730 and $1,792 compared to an income tax expense of $706 and $1,040 for the three and six months ended June 30, 2019. Our quarter-to-date income tax expense for the period ended June 30, 2020 reflects an effective income tax rate of 21.1% which is an increase compared to 12.0% for the same period in 2019. Our year-to-date income tax expense for the period ended June 30, 2020 reflects an effective income tax rate of 16.6% which is an increase compared to 11.4% for the same period in 2019. The primary drivers are from pre-tax income increasing 7,025 and $1,703 compared to the same periods in 2019 as a result of recognizing a decrease in provision for loan losses of 3,836 for the three months ended June 30, 2020 when compared to the same periods in 2019, and recognizing an increase in provision for loan losses of $4,131 for the six months ended June 30, 2020 when compared to the same periods in 2019.

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COMPARISON OF BALANCE SHEETS AT JUNE 30, 2020 and DECEMBER 31, 2019
(Dollar Amounts in Thousands)
Overview
Our total assets decreased by $120,421, or a 12.4% annualized rate, from December 31, 2019 to June 30, 2020. The decrease in total assets has primarily been the result of the continued balance sheet rotation and optimization strategies and the planned sales of investment securities during the twelve months between June 30, 2020 and June 30, 2019, and a planned offset by organic growth in the loan portfolio.
Loans
Lending-related income is the most important component of our net interest income and is a major contributor to profitability. The loan portfolio is the largest component of earning assets, and therefore generates the largest portion of revenues. For purposes of the discussion in this section, the term “loans” refers to loans, excluding loans held for sale, unless otherwise noted.
The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, at June 30, 2020 and December 31, 2019 were $2,794,768 and $2,812,444, respectively, a decrease of $17,676 or a decrease of 2.5% annualized. As a percentage of total assets, total loans, net of deferred fees, at June 30, 2020 and December 31, 2019 were 74.0% and 72.2%, respectively. The decrease in the loans HFI is primarily due to the continued reduction in the Institutional loan portfolio that occurred during the second quarter of 2020.
The table below provides a summary of the loan portfolio composition for the periods noted.
  June 30, 2020 December 31, 2019
Types of Loans Amount % of Total
Loans 		Amount % of Total
Loans
Total loans
Real estate:
Construction and land development $ 645,281    23.1  % $ 591,541    21.0  %
Commercial 1,017,429    36.3  % 993,912    35.2  %
Residential 611,532    21.9  % 643,601    22.9  %
Commercial and industrial 520,413    18.6  % 582,641    20.7  %
Consumer and other 3,570    0.1  % 4,769    0.2  %
Total gross loans $ 2,798,225    100.0  % $ 2,816,464    100.0  %
Less: deferred loan fees, net (3,457)   (4,020)  
Total loans, net of deferred loan fees $ 2,794,768    $ 2,812,444   
Less: allowance for loan losses (38,100)   (45,436)  
Total loans, net allowance for loan losses $ 2,756,668    $ 2,767,008   
Real estate loans comprised 81.3% of the loan portfolio at June 30, 2020. The largest portion of the real estate segments as of June 30, 2020, was commercial real estate loans, which totaled 44.7% of real estate loans. Commercial real estate loans totaled $1,017,429 at June 30, 2020, and comprised 36.3% of the total loan portfolio. The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm, nonresidential real estate properties and other properties.
Construction and land development loans totaled $645,281 at June 30, 2020, and comprised 28.4% of total real estate loans and 23.1% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development. This portfolio has remained steady in absolute dollar terms since 2017, representing a lower corresponding portion of the loan portfolio.
The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit
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and other junior lien mortgage loans. Residential real estate loans totaled $611,532 and comprised 26.9% of real estate loans and 21.9% of total loans at June 30, 2020.
Commercial and industrial loans totaled $520,413 at June 30, 2020. Loans in this classification comprised 18.6% of total loans at June 30, 2020. The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and commercial healthcare loans.
This net loan decline for the second quarter of 2020 was driven partly by the $5,924 linked-quarter reduction in the SNC portfolio to a balance of $99,602, representing a 56.9% year-over-year and 22.6% annualized linked-quarter decrease. This is the lowest SNC balance held by the Company during the last six quarters, representing 3.6% of loans HFI, which is almost half of the Company’s concentration of 9.3% of loans HFI at the peak of the SNC portfolio at December 31, 2018. Non-SNC loan decline in the second quarter was $11,752, representing an annualized decline of 1.7% from the first quarter of 2020 and is primarily due to the second quarter continued Institutional loan portfolio reduction. At June 30, 2020, the Company estimates approximately $294,290, or approximately 41%, of the $727,036 unused lines of credit are available to be drawn by customers without further approval by the Bank.
The tables below provide a summary of the Institutional loan portfolio for the periods noted:

Corporate and Healthcare portfolios(1)
June 30,
2020 		March 31,
2020 		December 31,
2019 		September 30,
2019 		June 30,
2019 		QoQ
Change* 		YoY
Change
Corporate $ 95,150    $ 102,370    $ 139,840    $ 133,386    $ 170,125    (28.4  %) (44.1  %)
Portion SNC 34,912    36,011    59,339    58,544    112,756    (12.3  %) (69.0  %)
Portion not SNC 60,238    66,359    80,501    74,842    57,369    (37.1  %) 5.0  %
Healthcare 262,417    306,343    289,703    273,106    329,818    (57.7  %) (20.4  %)
SNC 64,690    69,515    77,319    85,932    118,460    (27.9  %) (45.4  %)
Non-SNC 197,727    236,828    212,384    187,174    211,358    (66.4  %) (6.4  %)
Total Institutional $ 357,567    $ 408,713    $ 429,543    $ 406,492    $ 499,943    (50.3  %) (28.5  %)
Commercial and industrial(1)
519,040    579,751    580,696    576,018    666,025    (42.1  %) (22.1  %)
Percent of Institutional within
commercial and industrial 		69  % 70  % 74  % 71  % 75  %
Total SNC $ 99,602    $ 105,526    $ 136,658    $ 144,476    $ 231,216    (22.6  %) (56.9  %)
Percent of total loans HFI 3.6  % 3.7  % 4.9  % 5.2  % 8.0  %
*Annualized
(1) Loan balances are net of deferred loan fees and costs.

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Institutional loans asset quality June 30,
2020 		March 31,
2020 		December 31,
2019 		September 30,
2019 		June 30,
2019
Corporate loans $ 95,150    $ 102,370    $ 139,840    $ 133,386    $ 170,125   
Loans classified as criticized or worse —    17,608    17,598    —   
Loans criticized or worse as % of corporate loans —  % —  % 12.6  % 13.2  % —  %
Loans requiring specific reserve $ —    $ —    $ 17,608    $ —    $ —   
Specific reserve —    —    13,894    —    —   
Specific reserve as % impaired corporate loans —  % —  % 78.9  % —  % —  %
Net (charge-offs) recoveries $ 1,586    $ (20,428)   $ —    $ —    $ —   
Healthcare loans $ 262,417    $ 306,343    $ 289,703    $ 273,106    $ 329,818   
Loans classified as criticized or worse 28,209    33,735    21,517    21,554    20,699   
Loans criticized or worse as a % of healthcare loans 10.7  % 11.0  % 7.4  % 7.9  % 6.3  %
Loans requiring specific reserve $ 1,339    $ 6,592    $ 6,667    $ —    $ 2,193   
Specific reserve 1,339    6,544    6,667    —    2,193   
Specific reserve as % of impaired healthcare loans 100.0  % 99.3  % —  % —  % 100.0  %
Net (charge-offs) recoveries $ (3,566)   $ —    $ —    $ (1,691)   $ (7,563)  
Total Institutional $ 357,567    $ 408,713    $ 429,543    $ 406,492    $ 499,943   

The repayment of loans is a source of additional liquidity for the Company. The following table sets forth the loans maturing within specific intervals at June 30, 2020, excluding net unearned fees and costs.
Loan Maturity Schedule
June 30, 2020
One year
or less 		Over one
year to five
years 		Over five
years 		Total
Real estate:
Construction and land development $ 276,339    $ 199,263    $ 169,679    $ 645,281   
Commercial 46,066    303,813    667,550    1,017,429   
Residential 30,604    158,439    422,489    611,532   
Commercial and industrial 103,934    337,695    78,784    520,413   
Consumer and other 1,772    1,576    222    3,570   
Total $ 458,715    $ 1,000,786    $ 1,338,724    $ 2,798,225   
Fixed interest rate $ 140,884    $ 442,891    $ 451,154    $ 1,034,929   
Variable interest rate 317,831    557,895    887,570    1,763,296   
Total $ 458,715    $ 1,000,786    $ 1,338,724    $ 2,798,225   
The information presented in the above table is based upon the contractual maturities of the individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity structure of the loan portfolio.
Allowance for Loan Losses (ALLL)
The Company maintains an ALLL that management believes is adequate to absorb the probable incurred losses inherent in the Company’s loan portfolio. The allowance is increased by provisions for loan losses charged to earnings and is decreased by loan charge-offs net of recoveries of prior period loan charge-offs. The level of the allowance is determined on a quarterly
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basis, although management is engaged in monitoring the adequacy of the allowance on a more frequent basis. In estimating the allowance balance, the following factors are considered:
•past loan experience;
•the nature and volume of the portfolio;
•risks known about specific borrowers;
•underlying estimated values of collateral securing loans;
•current and anticipated economic conditions; and
•other factors which may affect the allowance for probable incurred losses.
The ALLL consists of two primary components: (1) a specific component which relates to loans that are individually classified as impaired; and (2) a general component which covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Company’s loss history and loss history from peer group data over the past three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.
The following loan portfolio segments have been identified: (1) Construction and land development loans; (2) Commercial real estate loans; (3) Residential real estate loans; (4) Commercial and industrial loans; and (5) Consumer and other loans. Management evaluates the risks associated with these segments based upon specific characteristics associated with the loan segments. These risk characteristics include, but are not limited to, the value of the underlying collateral, adverse economic conditions and the borrower’s cash flow. While the total allowance consists of a specific portion and a general portion, both portions of the allowance are available to provide for probable incurred loan losses in the entire portfolio.
In the table below, the components, as discussed above, of the ALLL are shown at June 30, 2020 and December 31, 2019.
June 30, 2020 December 31, 2019 Increase (Decrease)
HFI Loan
Balance(1)
ALLL
Balance 		ALLL to % Total Loans HFI
HFI Loan
Balance(1)
ALLL
Balance 		ALLL to % Total Loans HFI Loan
Balance 		ALLL
Balance
Non impaired loans $ 2,724,103    $ 36,501    1.34  % $ 2,730,684    $ 24,588    0.90  % $ (6,581)   $ 11,913    44 bps
Acquired loans (2)
47,053    71    0.15  % 58,745    77    0.13  % (11,692)   (6)   2 bps
Impaired loans 27,069    1,528    5.64  % 27,035    20,771    76.83  % 34    (19,243)   (7,119) bps
Total loans $ 2,798,225    $ 38,100    1.36  % $ 2,816,464    $ 45,436    1.61  % $ (18,239)   $ (7,336)   (25) bps
(1) HFI loan balance is before net deferred loan fees and costs.
(2) Acquired loans are performing loans recorded at estimated fair value at the acquisition date. Based on the analysis performed by management as of June 30, 2020, $71 in ALLL was recorded at June 30, 2020 related to the loans acquired.

At June 30, 2020, the ALLL was $38,100, compared to $45,436 at December 31, 2019. The ALLL as a percentage of total loans HFI was 1.36% at June 30, 2020 and 1.61% at December 31, 2019. As of June 30, 2020, the Company’s total non-performing assets ("NPAs") were 0.65% of assets, or $24,433, a decrease of approximately $3,256 from December 31, 2019. The NPA/ALLL coverage ratio was 1.56 at June 30, 2020, a decrease of 8 basis points from the 1.64 coverage present at December 31, 2019. Criticized and Classified Assets were $50,683 at June 30, 2020, representing 1.81% of loans HFI, consistent with 1.86% of loans HFI at December 31, 2019.

Potential problem loans, which are not included in nonperforming assets, amounted to $17,914, or 0.64% of total loans held for investment at June 30, 2020, compared to $22,228, or 0.79% of total loans held for investment at December 31, 2019. Potential problem loans represent those loans where information about possible credit problems of borrowers has caused management to have doubts about the borrower’s ability to comply with present repayment terms. This definition is for substandard loans, which are still accruing interest and excluding the impact of substandard nonaccrual loans. The Company also monitors the aging of loans less than 90 days past due and the loans that have been deferred under the Company's COVID-19 related payment deferral program as reported in Notes 1 and 3 in the Condensed Notes to Interim Consolidated Financial Statements.

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The table below sets forth the activity in the ALLL for the periods presented.
Six Months Ended
June 30, 2020 		Six Months Ended
June 30, 2019
Beginning balance $ 45,436    $ 23,451   
Loans charged-off:
Residential real estate 8    15   
Commercial & industrial 25,664    8,131   
Consumer & other 24    99   
Total loans charged-off 25,696    8,245   
Recoveries on loans previously charged-off:
Residential real estate 1    15   
Commercial & industrial 2,130    71   
Consumer & other 12    65   
Total loan recoveries 2,143    151   
Net charge-offs (23,553)   (8,094)  
Provision for loan losses charged to expense 16,217    12,086   
Total allowance at end of period $ 38,100    $ 27,443   
Total loans, gross, at end of period(1)
$ 2,798,225    $ 2,884,510   
Average gross loans(1)
$ 2,856,722    $ 2,811,954   
Allowance to total loans 1.36  % 0.95  %
Net charge-offs (recoveries) to average loans, annualized 1.66  % 0.58  %
(1)Loan balances exclude loans held for sale

While no portion of the allowance is in any way restricted to any individual loan or group of loans, and the entire allowance is available to absorb losses from any and all loans, the following table summarizes the allocation of ALLL by loan category and loans in each category as a percentage of total loans, for the periods presented.
June 30, 2020 December 31, 2019
Amount % of
Loan Segment to Total Loans 		Amount % of
Loan Segment to Total Loans
Real estate loans:
Construction and land development $ 6,519    23.1  % $ 4,847    21.0  %
Commercial 9,558    36.3    8,113    35.3   
Residential 4,479    22.0    4,462    22.8   
Total real estate $ 20,556    81.3    $ 17,422    79.1   
Commercial and industrial 16,677    18.6    27,957    20.7   
Consumer and other 867    0.1    57    0.2   
$ 38,100    100.0  % $ 45,436    100.0  %
Nonperforming Assets
Non-performing loans consist of non-accrual loans and loans that are past due 90 days or more and still accruing interest. Non-performing assets consist of non-performing loans plus foreclosed real estate. Loans are placed on non-accrual status when they are past due 90 days and/or management believes the borrower’s financial condition, after giving consideration to economic conditions and collection efforts, is such that collection of interest is doubtful. When a loan is placed on non-accrual status, interest accruals cease, and uncollected interest is reversed and charged against current income. The interest on these loans is accounted for on the cash-basis, or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The primary component of non-performing loans is non-accrual loans, which as of June 30, 2020 totaled $24,433. At June 30, 2020, there were no loans past due greater than 90 days and still accruing interest which is the other component of non-
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performing loans. Loans past due greater than 90 days are placed on non-accrual status, unless they are both well-secured and in the process of collection.
The table below summarizes non-performing loans and assets for the periods presented.
June 30,
2020 		December 31,
2019
Non-accrual loans $ 24,433    $ 27,035   
Past due loans 90 days or more and still accruing interest —    654   
Total non-performing loans $ 24,433    $ 27,689   
Foreclosed real estate and repossessed assets —    —   
Total non-performing assets $ 24,433    $ 27,689   
Total non-performing loans as a percentage of total loans 0.87  % 0.98  %
Total non-performing assets as a percentage of total assets 0.65  % 0.71  %
Allowance for loan losses as a percentage of non-performing loans 156  % 164  %

As of June 30, 2020, there were 29 loans on non-accrual status. The amount and number are further delineated by loan segment and number of loans in the table below.
Total Amount Percentage of Total Non-Accrual
Loans 		Number of
Non-Accrual
Loans
Commercial real estate $ 5,760    23.6  % 2   
Residential real estate 3,480    14.2    9   
Commercial & industrial 15,193    62.2    18   
Total non-accrual loans $ 24,433    100.0  % 29   
Investment Securities and Other Earning Assets
The investment securities portfolio is intended to provide the Company with adequate liquidity and a source of stable income. The portfolio is structured with minimal credit exposure to the Company and consists of securities classified as AFS. All AFS securities are carried at fair value and may be used for liquidity purposes should management deem it to be in the Company’s best interest. Securities AFS, consisting primarily of mortgage-backed securities, totaled $503,877 at June 30, 2020, compared to $652,132 at December 31, 2019, a decrease of $148,255, or 22.7%. The decrease in AFS securities was primarily attributed to security sales during the six months ended June 30, 2020.
There were no HTM securities at June 30, 2020, or December 31, 2019.
The Company also had other investments of $24,110 and $24,802 at June 30, 2020 and December 31, 2019, respectively, primarily consisting of capital stock in the Federal Reserve and the Federal Home Loan Bank required as members of the Federal Reserve Bank System (“FRB”) and the Federal Home Loan Bank System (“FHLB”). The FHLB and FRB 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 $47,305 at June 30, 2020 compared to $12,141 at December 31, 2019, an increase of $35,164, due to the purchase of the properties at Columbia Avenue and 120 9th Avenue locations in Franklin, Tennessee, therefore ending the lease agreements by the Company on February 5, 2020. In May 2020, the Company was notified that the landlord of an office space located in Williamson County had sold the property, therefore, terminating the lease. One branch in Williamson County, Tennessee plans to relocate to another leased facility within the same general area.
Deposits
At June 30, 2020, total deposits were $3,143,259, a decrease of $64,325, or 8.1% annualized, compared to $3,207,584 at December 31, 2019. Included in the Company’s funding strategy are brokered deposits, public funds deposits and reciprocal deposits. Total brokered deposits decreased $225,782, or 143.6% annualized, to $406,459 at June 30, 2020, when compared with $632,241 at December 31, 2019, which reflects the Company’s strategy to reduce its dependence on non-core funding. Public funds deposits decreased $157,218, or 163.4% annualized, to $229,685 at June 30, 2020 when compared with $386,903
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at December 31, 2019 due to the Company’s strategy to redirect some of the Company’s local government customers into the reciprocal account relationships, thereby decreasing the Company’s requirements to collateralize those public funds deposits. As a result, reciprocal deposits increased $96,434, or 80.5% annualized, to $578,175 at June 30, 2020, compared to $481,741 at December 31, 2019.
Time deposits, excluding brokered deposits and public funds, as of June 30, 2020, were $379,879, compared to $399,258 as of December 31, 2019, a decrease of $19,379, or 19.5% annualized.
The following table shows time deposits in denominations of $100 or more based on time remaining until maturity:
June 30,
2020
Three months or less $ 729   
Three through six months 31,525   
Six through twelve months 57,874   
Over twelve months 179,150   
Total $ 269,278   

Federal Funds Purchased and Repurchase Agreements
The Company had no federal funds purchased from correspondent banks or repurchase agreements as of June 30, 2020, and December 31, 2019.
Federal Home Loan Bank Advances
The Company has established a line of credit with the FHLB of Cincinnati which is secured by a blanket pledge of 1-4 family residential mortgages and home equity lines of credit. At June 30, 2020 and at December 31, 2019 advances totaled $100,000 and $155,000, respectively, and the scheduled maturities and interest rates of these advances were as follows:
Scheduled Maturities
Amount
Weighted
Average Rates
2020 $ 100,000    0.30  %
Subordinated Notes
At June 30, 2020, the Company’s subordinated notes, net of issuance costs, totaled $58,961 compared with $58,872 at December 31, 2019. For more information related to the subordinated notes and the related issuance costs, please see Note 12 of the consolidated financial statements.
Liquidity
Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis.
Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, management focuses on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet the Company’s needs. Our source of funds to pay interest on our March 2016 Subordinated Notes and June 2016 Subordinated Notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. 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 AFS, and sales of brokered deposits. As of June 30, 2020, $503,877 of the investment securities portfolio was classified as AFS and is reported at fair value on the consolidated balance sheet. Approximately $283,970 of the total $503,877 investment securities portfolio on hand at June 30, 2020 was pledged to secure public deposits and repurchase agreements. Other funding sources available include
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repurchase agreements, federal funds purchased, and borrowings from the Federal Home Loan Bank and the Federal Reserve Bank.
Equity
As of June 30, 2020, the Company’s equity was $422,063, as compared with $410,426 as of December 31, 2019. The $11,637 increase in equity was mainly driven by the Company's net income of $10,174 in the three months ended June 30, 2020.
On January 23, 2019, our board of directors announced they had authorized a share repurchase program for up to $30,000 of our outstanding common stock. The repurchase program expired on January 23, 2020, and no additional shares were purchased after December 31, 2019.
Effects on 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 unused lines of credit, outstanding standby letters of credit, and outstanding mortgage loan commitments to customers in the ordinary course of business. At June 30, 2020, the Company had unused lines of credit of $727,036, outstanding standby letters of credit of $95,517, and outstanding mortgage loan commitments of $136,235.
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;
•“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; and
•“Return on Average Tangible Common Equity” is defined as net income available to common shareholders divided by average tangible common shareholders’ equity.
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.

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

As of or for the Three Months Ended
(Amounts in thousands, except share/per share data and percentages)
June 30,
2020 		March 31, 2020 December 31, 2019 September 30,
2019 		June 30,
2019
Total shareholders’ equity $ 421,970    $ 408,755    $ 410,333    $ 408,168    $ 393,516   
Less: Preferred stock —    —    —    —    —   
Total common equity $ 421,970    $ 408,755    $ 410,333    $ 408,168    $ 393,516   
Common shares outstanding 14,937,776    14,859,704    14,821,594    14,636,484    14,628,287   
Book value per share $ 28.25    $ 27.51    $ 27.68    $ 27.89    $ 26.90   
Total common equity $ 421,970    $ 408,755    $ 410,333    $ 408,168    $ 393,516   
Less: Goodwill and other intangible assets 18,469    18,555    18,652    18,763    18,885   
Tangible common equity $ 403,501    $ 390,200    $ 391,681    $ 389,405    $ 374,631   
Common shares outstanding 14,937,776    14,859,704    14,821,591    14,636,484    14,628,287   
Tangible book value per share $ 27.01    $ 26.26    $ 26.43    $ 26.61    $ 25.61   
Average total common equity $ 411,362    $ 416,518    $ 414,251    $ 399,096    $ 388,460   
Less: Average Preferred stock —    —    —    —    —   
Less: Average Goodwill and other intangible assets 18,576    18,615    18,809    18,763    18,971   
Average tangible common shareholders’ equity $ 392,786    $ 397,903    $ 395,442    $ 380,333    $ 369,489   
Net income available to common shareholders 9,026    (1,148)   (4,592)   11,324    5,173   
Average tangible common equity 392,786    397,903    395,442    380,333    369,489   
Return on average tangible common equity(1)
9.2  % (1.2) % (4.6) % 11.8  % 5.6  %
Efficiency Ratio:
Net interest income $ 29,528    $ 27,464    $ 28,113    $ 28,262    $ 27,365   
Noninterest income 10,555    5,893    4,573    4,793    4,923   
Operating revenue $ 40,083    $ 33,357    $ 32,686    $ 33,055    $ 32,288   
Expense
Total noninterest expense $ 23,976    $ 22,421    $ 21,279    $ 18,614    $ 19,370   
Efficiency ratio(2)
59.8  % 67.2  % 65.1  % 56.3  % 60.0  %
(1)Annualized
(2)Efficiency ratio (GAAP) is calculated by dividing reported noninterest expense by reported total revenue
58
FRANKLIN FINANCIAL NETWORK, INC.
SUMMARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
(Amounts in thousands, except per share data and percentages)
As of and for the three months ended
June 30,
2020 		March 31,
2020 		December 31,
2019 		September 30,
2019 		June 30,
2019
Income Statement Data:
Interest income $ 39,814    $ 41,607    $ 43,185    $ 46,531    $ 47,453   
Interest expense 10,286    14,143    15,072    18,269    20,088   
Net interest income 29,528    27,464    28,113    28,262    27,365   
Provision for loan losses 3,195    13,022    18,961    1,000    7,031   
Noninterest income 10,555    5,893    4,573    4,793    4,923   
Noninterest expense 23,976    22,421    21,279    18,614    19,370   
Net income (loss) before taxes 12,912    (2,086)   (7,554)   13,441    5,887   
Income tax (benefit) expense 2,730    (938)   (2,970)   2,117    706   
Net income (loss) 10,182    (1,148)   (4,584)   11,324    5,181   
Pre-tax pre-provision profit 16,107    10,936    11,407    14,441    12,918   
Earnings before interest and taxes 23,198    12,057    7,518    31,710    25,975   
Net income (loss) available to common shareholders 10,182    (1,148)   (4,592)   11,324    5,173   
Weighted average diluted common shares 15,271,414    14,758,960    14,633,399    14,991,363    14,894,140   
Earnings per share, basic 0.68    (0.08)   (0.31)   0.77    0.35   
Earnings per share, diluted 0.66    (0.08)   (0.31)   0.75    0.34   
Dividend per share 0.06    0.06    0.06    0.04    0.04   
Profitability (%)
Return on average assets 1.06  % (0.12) % (0.48) % 1.12  % 0.51  %
Return on average equity 9.9  % (1.1) % (4.4) % 11.3  % 5.3  %
Return on average tangible common equity(3)
9.2  % (1.2) % (4.6) % 11.8  % 5.6  %
Efficiency ratio 59.8  % 67.2  % 65.1  % 56.3  % 60.0  %
Net interest margin(1)
3.3  % 3.0  % 2.8  % 3.0  % 2.8  %
Balance Sheet Data ($):
Loans (including HFS) $ 2,855,910    $ 2,898,450    $ 2,855,606    $ 2,852,803    $ 2,907,526   
Loan loss reserve 38,100    38,403    45,436    26,474    27,443   
Cash 236,775    173,482    234,991    178,747    150,721   
Securities 503,877    543,225    652,132    612,371    834,095   
Goodwill 18,176    18,176    18,176    18,176    18,176   
Intangible assets (Sum of core deposit intangible and SBA servicing rights)
293    379    476    587    709   
Assets 3,775,741    3,791,601    3,896,162    3,818,324    4,071,971   
Deposits 3,143,259    3,137,471    3,207,584    3,061,950    3,146,645   
Liabilities 3,353,678    3,382,753    3,485,736    3,410,063    3,678,362   
Total shareholders' equity 421,970    408,755    410,333    408,168    393,516   
Total equity 422,063    408,848    410,426    408,261    393,609   
Tangible common equity(3)
403,501    390,200    391,681    374,631    374,631   
Asset Quality (%)
Nonperforming loans/ total loans(2)
0.87  % 0.96  % 0.98  % 0.11  % 0.16  %
Nonperforming assets / (total loans(2)
     and foreclosed assets)
0.87  % 0.96  % 0.98  % 0.11  % 0.16  %
Loan loss reserve / total loans(2)
1.36  % 1.34  % 1.61  % 0.95  % 0.95  %
Net charge-offs (recoveries) / average loans HFI(4)
1.66  % 2.84  % 0.00  % 0.27  % 1.04  %
Capital (%)
Tangible common equity to tangible assets(3)
10.7  % 10.3  % 10.1  % 10.2  % 9.2  %
Leverage ratio 10.4  % 10.3  % 10.3  % 9.8  % 9.2  %
59
Common Equity Tier 1 ratio 12.5  % 11.9  % 11.9  % 12.0  % 11.2  %
Tier 1 risk-based capital ratio 12.5  % 11.9  % 11.9  % 12.0  % 11.2  %
Total risk-based capital ratio 15.5  % 15.0  % 15.0  % 14.7  % 13.7  %
(1)Net interest margins shown in the table above include tax-equivalent adjustments to adjust interest income on tax-exempt loans and tax-exempt investment securities to a fully taxable basis.
(2)Total loans in this ratio exclude loans held for sale.
(3)See Non-GAAP table in the preceding pages.
(4)Annualized.


Termination of Emerging Growth Company Status
Effective as of December 31, 2019, the Company ceased to be an emerging growth company.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Based upon the nature of the Company’s operations, the Company is not subject to foreign currency exchange or commodity price risk.
Management seeks to maintain profitability in both immediate and long-term earnings through funds management/interest rate risk management. Interest rate risk (sensitivity) management deals with the potential impact on earnings associated with changing interest rates using various rate change (shock) scenarios. The Company’s rate sensitivity position has an important impact on earnings. Senior management monitors the Company’s rate sensitivity position throughout each month, and the Asset Liability Committee (“ALCO”) of the Bank meets on a quarterly basis to analyze the rate sensitivity position and other aspects of asset/liability management. These meetings cover the spread between the cost of funds (primarily time deposits) and interest yields generated primarily through loans and investments, rate shock analyses, liquidity and dependency positions, and other areas necessary for proper balance sheet management.
Management believes interest rate risk is best measured by earnings simulation modeling. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, 300 and 400 basis points or decreasing 100 and 200 basis points. All rates are increased or decreased parallel to the change in prime rate. As a result of the simulation, over a 12-month time period ended June 30, 2020, net interest income was estimated to decrease 1.73% and 1.82% if rates were to increase 100 basis points and 200 basis points, respectively, and was estimated to increase 1.93% and decrease 4.10% in a 100 basis points and 200 basis points declining rate assumption, respectively. These results are in line with the Company’s guidelines for rate sensitivity.
The following chart reflects the Company’s sensitivity to changes in interest rates as indicated as of June 30, 2020.
Projected Interest Rate Change
Net Interest
Income $
Net Interest Income $ Change from Base
% Change
from Base
-200 122,643    (5,243)   (4.10) %
-100 130,359    2,473    1.93  %
Base 127,886    —    —  %
+100 125,670    (2,216)   (1.73) %
+200 125,553    (2,333)   (1.82) %
+300 126,314    (1,572)   (1.23) %
+400 127,233    (653)   (0.51) %
The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, changes in the shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of pay downs and maturities of loans, investments and deposits, changes in spreads between key market rates, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences
60
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. Accordingly, the modeling analysis may not be an accurate indicator of how our net interest income will be affected by changes in interest rates as the inputs utilized by management may be inaccurate. 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. The model is a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results.

ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of June 30, 2020, the end of the fiscal quarter covered by this Quarterly Report on Form 10-Q. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that, due to the ongoing efforts to remediate the material weakness in its internal control over financial reporting identified in its Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as described in more detail below, the Company's disclosure controls and procedures were not effective as of the end of the period covered by this report in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management, including its chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
(b) Changes in Internal Controls. Other than as described below in regards to our ongoing efforts to fully remediate the material weakness identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, no change in our internal control over financial reporting occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Previously Identified Material Weakness
Based on the assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2019, as described in our Annual Report on Form 10-K, 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. As stated in the 2019 Annual Report on Form 10-K, management concluded that the existence of this material weakness did not result in a 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.
Remediation of Material Weakness

The Company has made progress toward remediation of the underlying causes of the above-described material weakness in 2019. However, the identified material weakness in internal control over financial reporting will not be considered fully addressed until the internal controls over this area have been in operation for a sufficient period of time for the Company’s management to conclude that the material weakness has been fully remediated. The Company will continue to evaluate these internal controls throughout 2020 to ensure the remediation efforts are working as designed. As a result, the Company may alter its control structure to enhance these and other related controls in this area, but the Company’s evaluation as to full remediation will primarily involve an ongoing review of its current control structure to make sure the controls in this area are being performed as designed by the individuals responsible for performance of these controls. Once this evaluation is complete, the Company will make its final determination as to full remediation.
61
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, the Company believes would have a material adverse impact on the Company’s financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS.
There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K filed with the SEC on March 16, 2020, with the exception of:

The ongoing COVID-19 pandemic and measures intended to prevent its spread could have a material adverse effect on our business, results of operations and financial condition, and such effects will depend on future developments, which are highly uncertain and are difficult to predict.

Global health concerns relating to the COVID-19 pandemic and related government actions taken to reduce the spread of the virus have been weighing on the macroeconomic environment, and the pandemic has significantly increased economic uncertainty and reduced economic activity. The pandemic has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act, but there can be no assurance that such steps will be effective or achieve their desired results in a timely fashion.

The pandemic has adversely impacted and is likely to further adversely impact our workforce and operations and the operations of our borrowers, customers and business partners. In particular, we may experience financial losses due to a number of operational factors impacting us or our borrowers, customers or business partners, including but not limited to:

•credit losses resulting from financial stress being experienced by our borrowers as a result of the pandemic and related governmental actions, particularly in the hospitality, energy, retail and restaurant industries, but across other industries as well;
•declines in collateral values;
•decreased demand for our products and services;
•third party disruptions, including outages at network providers and other suppliers;
•increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity; and
•operational failures due to changes in our normal business practices necessitated by the pandemic and related governmental actions.

These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the COVID-19 pandemic has subsided.

The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, and developing work from home and social distancing plans for our employees), and we may take further actions as may be required by government authorities or as we determine are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or will otherwise be satisfactory to government authorities.

The extent to which the coronavirus pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.

62
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the pandemic is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.

As a participating lender in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), the Company and the Bank are subject to additional risks regarding the Bank’s processing of loans for the PPP.

On March 27, 2020, President Trump signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes us to potential risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Subsequent legislation was enacted to authorize an additional $310 billion in PPP loans.

In the first and second quarters of 2020, the Company originated and funded PPP loans. In an agreement with a third party provider, the Company sold substantially all of its PPP loan portfolio.

Since the initiation of the PPP, several larger banks have been subject to litigation regarding the protocols and procedures that they used in processing applications for the PPP. We may be exposed to the risk of similar litigation, from both customers and non-customers that approached us regarding PPP loans, regarding our policies and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to us, it could result in financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have an adverse impact on our business, financial condition and results of operations.

We may experience increases to, and volatility in, the balance of the allowance for credit losses and related provision expense due to the adoption of the current expected credit losses (“CECL”) methodology.

As permitted by the CARES Act, we have delayed adoption until the earlier of the termination date of the national emergency declared by President Trump under the National Emergencies Act on March 31, 2020, related to the outbreak of COVID-19, and December 31, 2020. Relative to the incurred loss methodology that we currently use, the CECL methodology requires increased use of judgments and dependence on forward-looking information and forecasts, any of which may prove to be incorrect. For this reason, and due to the effects of the COVID-19 pandemic and the uncertain duration of the permitted delay referred to above, we are not able to estimate the amount of increase in our allowance for credit losses upon our compliance with this standard.

The CECL methodology differs substantially from the incurred loss methodology currently used in that it is forward looking, requiring measurement to occur when a financial asset is first added to the balance sheet and periodically thereafter. The measurements will require increased use of management judgments as well as forward-looking information and forecasts. Although every effort is made to ensure that the judgements are correct and the forecasts accurate, the future is uncertain, and there can be no guarantee that the judgments and forecasts will prove to be correct.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
(a)Unregistered Sales of Equity Securities. None.
(b)Use of Proceeds. Not applicable.
(c)Repurchase of Equity Securities. None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.

63
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.

ITEM 5. OTHER INFORMATION.
None

ITEM 6. EXHIBITS
Exhibit No. Description
10.1†
10.2
10.3
31.1*
31.2*
32**
101.INS* XBRL Instance Document.-the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH* XBRL Taxonomy Extension Schema Document.
101.CAL* XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF* XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB* XBRL Taxonomy Extension Label Linkbase Document.
101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document.

* Filed herewith
** Furnished herewith
† Indicates a management contract or compensatory plan or arrangement


64
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FRANKLIN FINANCIAL NETWORK, INC.
August 7, 2020 By: /s/ Christopher J. Black
Christopher J. Black
Executive Vice President and Chief Financial Officer
On behalf of the registrant and as Chief Financial Officer
(Principal Financial Officer)

65
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