UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_________________________________________________

FORM 10-Q

_________________________________________________

(Mark One)

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

For the quarterly period ended September 30, 2014

OR

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

For the transition period from              to             .

COMMISSION FILE NO. 000-49747

_________________________________________________

FIRST SECURITY GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

_________________________________________________

Tennessee	58-2461486
(State of Incorporation)	(I.R.S. Employer Identification No.)
531 Broad Street, Chattanooga, TN	37402
(Address of principal executive offices)	(Zip Code)

(423) 266-2000

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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  ý    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	ý
Non-accelerated filer	¨	Smaller reporting company	¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $0.01 par value: 66,826,254 shares outstanding and issued as of November 5, 2014

First Security Group, Inc. and Subsidiary

Form 10-Q

INDEX

		Page No.
PART I.	FINANCIAL INFORMATION	1
Item 1.	Financial Statements (Unaudited)	1
	Consolidated Balance Sheets - September 30, 2014, December 31, 2013 and September 30, 2013	1
	Consolidated Statements of Operations - Three and Nine Months ended September 30, 2014 and 2013	3
	Consolidated Statements of Comprehensive Income (Loss) - Three and Nine Months ended September 30, 2014 and 2013	4
	Consolidated Statement of Shareholders’ Equity - Nine Months ended September 30, 2014	5
	Consolidated Statements of Cash Flows - Nine Months ended September 30, 2014 and 2013	6
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	84
Item 4.	Controls and Procedures	85
PART II.	OTHER INFORMATION	86
Item 1.	Legal Proceedings	86
Item 1A.	Risk Factors	86
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	86
Item 3.	Defaults Upon Senior Securities	86
Item 4.	Mine Safety Disclosures	86
Item 5.	Other Information	86
Item 6.	Exhibits	87
SIGNATURES		88

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

First Security Group, Inc. and Subsidiary

Consolidated Balance Sheets

	September 30, 2014		December 31, 2013		September 30, 2013
(in thousands)	(unaudited)				(unaudited)
ASSETS
Cash and Due from Banks	$	11,519	$	10,742	$	10,357
Interest Bearing Deposits in Banks	7,344		10,126		59,943
Cash and Cash Equivalents	18,863		20,868		70,300
Securities Available-for-Sale	98,677		172,830		207,009
Securities Held-to-Maturity, at amortized cost (fair value - $131,549 at September 30, 2014, $132,104 at December 31, 2013 and $130,170 at September 30, 2013)	129,313		132,568		129,164
Loans Held-for-Sale	46,904		220		1,661
Loans	666,728		583,097		534,627
Less: Allowance for Loan and Lease Losses	8,600		10,500		10,700
Net Loans	658,128		572,597		523,927
Premises and Equipment, net	27,862		27,888		28,810
Bank Owned Life Insurance	29,020		28,346		28,155
Other Real Estate Owned	5,952		8,201		8,662
Other Assets	13,163		14,056		14,167
TOTAL ASSETS	$	1,027,882	$	977,574	$	1,011,855

(See Accompanying Notes to Consolidated Financial Statements)

1

First Security Group, Inc. and Subsidiary

Consolidated Balance Sheets

	September 30, 2014			December 31, 2013			September 30, 2013
(in thousands, except share and per share data)	(unaudited)						(unaudited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Deposits
Noninterest Bearing Demand	$	155,177		$	144,365		$	147,865
Interest Bearing Demand	104,404			95,559			92,108
Savings and Money Market Accounts	252,218			206,125			215,293
Certificates of Deposit less than $100 thousand	157,629			182,408			195,129
Certificates of Deposit of $100 thousand or more	125,606			153,750			170,466
Brokered Deposits	83,995			75,062			88,987
Total Deposits	879,029			857,269			909,848
Federal Funds Purchased and Securities Sold under Agreements to Repurchase	12,878			12,520			12,657
Other Borrowings	43,485			20,000			—
Other Liabilities	4,527			4,137			5,962
Total Liabilities	939,919			893,926			928,467
SHAREHOLDERS’ EQUITY
Common Stock – $.01 par value – 150,000,000 shares authorized; 66,826,254 shares issued as of September 30, 2014, 66,602,601 issued as of December 31, 2013, and 66,602,601 issued as of September 30, 2013	766			764			764
Paid-In Surplus	197,326			196,536			196,059
Accumulated Deficit	(102,547		)	(104,042		)	(103,395		)
Accumulated Other Comprehensive Loss	(7,582		)	(9,610		)	(10,040		)
Total Shareholders’ Equity	87,963			83,648			83,388
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,027,882		$	977,574		$	1,011,855

(See Accompanying Notes to Consolidated Financial Statements)

2

First Security Group, Inc. and Subsidiary

Consolidated Statements of Operations

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(in thousands, except per share data)	2014		2013			2014			2013
INTEREST INCOME
Loans, including fees	$	8,805	$	6,461		$	23,493		$	19,537
Investment Securities – taxable	887		1,321			2,883			3,143
Investment Securities – non-taxable	86		312			524			749
Other	2		77			52			338
Total Interest Income	9,780		8,171			26,952			23,767
INTEREST EXPENSE
Interest Bearing Demand Deposits	42		62			137			213
Savings Deposits and Money Market Accounts	193		188			467			628
Certificates of Deposit of less than $100 thousand	253		466			824			1,551
Certificates of Deposit of $100 thousand or more	246		475			793			1,558
Brokered Deposits	484		795			1,576			2,873
Other	75		20			198			51
Total Interest Expense	1,293		2,006			3,995			6,874
NET INTEREST INCOME	8,487		6,165			22,957			16,893
Provision (Credit) for Loan and Lease Losses	11		(1,632		)	(1,231		)	(1,780		)
NET INTEREST INCOME AFTER PROVISION (CREDIT) FOR LOAN AND LEASE LOSSES	8,476		7,797			24,188			18,673
NONINTEREST INCOME
Service Charges on Deposit Accounts	778		798			2,288			2,298
Mortgage Banking Income	462		420			921			927
Gain on Sales of Securities Available-for-Sale	10		—			628			154
Gain on Sale of Loans Transferred to Held-for-Sale	254		—			726			—
Other	1,301		1,074			3,907			3,118
Total Noninterest Income	2,805		2,292			8,470			6,497
NONINTEREST EXPENSE
Salaries and Employee Benefits	5,153		5,807			15,652			17,081
Expense on Premises and Fixed Assets, net of rental income	1,379		1,547			4,052			4,301
Other	3,690		3,843			11,064			16,232
Total Noninterest Expense	10,222		11,197			30,768			37,614
INCOME (LOSS) BEFORE INCOME TAX PROVISION	1,059		(1,108		)	1,890			(12,444		)
Income Tax Provision	132		322			395			358
NET INCOME (LOSS)	927		(1,430		)	1,495			(12,802		)
Preferred Stock Dividends	—		—			—			(929		)
Accretion on Preferred Stock Discount	—		—			—			(452		)
Effect of Exchange of Preferred Stock to Common Stock	—		—			—			26,179
NET INCOME AVAILABLE (LOSS ALLOCATED) TO COMMON SHAREHOLDERS	$	927	$	(1,430	)	$	1,495		$	11,996
NET INCOME (LOSS) PER SHARE:
Net Income (Loss) Per Share – Basic	$	0.01	$	(0.02	)	$	0.02		$	0.30
Net Income (Loss) Per Share – Diluted	$	0.01	$	(0.02	)	$	0.02		$	0.30

(See Accompanying Notes to Consolidated Financial Statements)

3

First Security Group, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(in thousands)	2014			2013			2014			2013
Net income (loss)	$	927		$	(1,430	)	$	1,495		$	(12,802	)
Other comprehensive income (loss)
Change in securities available-for-sale:
Unrealized holding gains (losses) for the period	(164		)	(6,300		)	1,221			(13,251		)
Reclassifications for securities transferred to held-to-maturity	—			8,711			—			8,711
Reclassification adjustment for securities (gains) losses realized in income	(10		)	—			(628		)	(154		)
Income tax effect, net of valuation allowance	—			—			—			—
Unrealized gains (losses) on available-for-sale securities	(174		)	2,411			593			(4,694		)
Change in securities held-to-maturity:
Fair value adjustment for securities transferred from available-for-sale	—			(8,711		)	—			(8,711		)
Amortization of fair value for securities held-to-maturity reclassified out of accumulated other comprehensive loss to investment income	497			88			1,432			88
Income tax effect, net of valuation allowance	—			—			—			—
Changes from securities held-for-maturity	497			(8,623		)	1,432			(8,623		)
Cash flow hedges:
Net unrealized derivative (losses) gains on cash flow hedges	16			(95		)	3			(23		)
Income tax effect, net of valuation allowance	—			—			—			—
Changes from cash flow hedges	16			(95		)	3			(23		)
Other comprehensive income (loss), net of tax	339			(6,307		)	2,028			(13,340		)
Comprehensive income (loss)	$	1,266		$	(7,737	)	$	3,523		$	(26,142	)

(See Accompanying Notes to Consolidated Financial Statements)

4

First Security Group, Inc. and Subsidiary

Consolidated Statement of Shareholders’ Equity

(unaudited)

	Common Stock									Accumulated Other Comprehensive Income (Loss)
(in thousands)	Shares	Amount		Paid-In Surplus			Accumulated Deficit						Total
Balance - December 31, 2013	66,603	$	764	$	196,536		$	(104,042	)	$	(9,610	)	$	83,648
Net Income	—	—		—			1,495			—			1,495
Other Comprehensive Income	—	—		—			—			2,028			2,028
Issuance of Restricted Stock, net of forfeitures	223	2		(2		)	—			—			—
Share-Based Compensation, net of forfeitures	—	—		792			—			—			792
Balance - September 30, 2014	66,826	$	766	$	197,326		$	(102,547	)	$	(7,582	)	$	87,963

(See Accompanying Notes to Consolidated Financial Statements)

5

First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(unaudited)
	Nine Months Ended
	September 30,
(in thousands)	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	1,495		$	(12,802	)
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by (Used in) Operating Activities
Credit for Loan and Lease Losses	(1,231		)	(1,780		)
Amortization, net	1,013			2,233
Share-Based Compensation	792			124
Depreciation	1,227			1,315
Gain on Sales of Loans Originated to be Held-For-Sale	(921		)	(927		)
Gain on Sales of Loans	(726		)	—
Gain on Sales of Available-for-Sale Securities	(628		)	(154		)
Gain on Sales of Premises and Equipment, net	—			18
Net (gain) loss on Sales of Other Real Estate Owned and Repossessions, net	(111		)	435
Write-down of Other Real Estate Owned and Repossessions	674			1,997
Accretion of Fair Value Adjustment, net	(658		)	(10		)
Loans Originated to be Held-for-Sale	(16,428		)	(33,801		)
Sale of Loans Originated to be Held-for-Sale	16,549			34,814
Changes in Operating Assets and Liabilities -
Interest Receivable	246			(192		)
Other Assets	(177		)	(1,246		)
Interest Payable	(187		)	(526		)
Other Liabilities	577			(2,254		)
Net Cash Provided by (Used in) Operating Activities	1,506			(12,756		)
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in Securities Available-for-Sale:
Maturities, Prepayments and Calls	11,144			48,476
Sales	66,485			34,181
Purchases	(3,122		)	(179,957		)
Activity in Securities Held-to-Maturity:
Maturities, Prepayments and Calls	4,687			—
Loan Originations and Principal Collections, net	(175,302		)	3,778
Proceeds from Sales of Premises and Equipment	—			403
Proceeds from Sale of Loans	45,920			22,296
Proceeds from Sales of Other Real Estate and Repossessions	3,849			6,372
Additions to Premises and Equipment	(2,702		)	(1,242		)
Capital Improvements to Other Real Estate and Repossessions	(73		)	(820		)
Net Cash Used in Investing Activities	(49,114		)	(66,513		)

(See Accompanying Notes to Consolidated Financial Statements)

6

First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(unaudited)
	Nine Months Ended
	September 30,
(in thousands)	2014			2013
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase (Decrease) in Deposits	21,760			(98,218		)
Net Increase in Federal Funds Purchased and Securities Sold Under Agreements to Repurchase	358			176
Net Increase of Other Borrowings	23,485			—
Net Proceeds from Issuance of Common Stock, net of offering costs	—			75,126
Proceeds from Exercise of Stock Options	—			14
Net Cash Provided by (Used in) Financing Activities	45,603			(22,902		)
NET CHANGE IN CASH AND CASH EQUIVALENTS	(2,005		)	(102,171		)
CASH AND CASH EQUIVALENTS – beginning of period	20,868			172,471
CASH AND CASH EQUIVALENTS – end of period	$	18,863		$	70,300
	Nine Months Ended
	September 30,
	2014			2013
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Loans and leases transferred to OREO and repossessions	$	2,086		$	3,778
Financed sales of OREO and repossessions	$	—		$	509
Accrued and deferred cash dividends on preferred stock	$	—		$	929
Effect of accrued and unpaid dividends on preferred stock redemption	$	—		$	6,085
Securities transferred from available-for-sale to held-to-maturity	$	—		129,164
Transfers of loans to loans held for sale at fair value	$	86,592		$	—
SUPPLEMENTAL SCHEDULE OF CASH FLOWS
Interest paid	$	4,181		$	7,400
Income taxes paid	$	203		$	—

(See Accompanying Notes to Consolidated Financial Statements)

7

FIRST SECURITY GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature. Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net loss or shareholders’ equity.

The consolidated financial statements include the accounts of First Security Group, Inc. ("First Security" or the "Company") and FSGBank, N.A. ("FSGBank" or the "Bank"), its wholly owned subsidiary bank. All significant intercompany balances and transactions have been eliminated.

Operating results for the three and nine months endedSeptember 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 or any other period. These interim financial statements should be read in conjunction with the Company’s latest annual consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

NOTE 2 – REGULATORY MATTERS

FSGBank, N.A.

On March 10, 2014, the Office of the Comptroller of the Currency (the "OCC") lifted the Consent Order (defined below) and issued non-objections to the Bank's required capital and strategic plans. On March 11, 2014, the Company filed a Current Report on Form 8-K that provides additional details relating to the lifting of the Consent Order and the Bank's improved condition. The Order had been in place since April 28, 2010, when, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, FSGBank consented and agreed to the issuance of a Consent Order by the OCC ("Consent Order" or the "Order"). On April 29, 2010, the Company filed a Current Report on Form 8-K describing the Order. A copy of the Order is filed as Exhibit 10.1 to such Form 8-K.

As of September 30, 2014, the Bank is considered well-capitalized for regulatory purposes.

First Security Group, Inc.

On October 2, 2014, the Federal Reserve Bank of Atlanta (the "Federal Reserve"), the Company's primary regulator, terminated the Company's Written Agreement (the "Agreement") that had been in place since September 7, 2010. On October 7, 2014, the Company filed a Current Report on Form 8-K that provides additional details relating to the termination of the Agreement. The Agreement was designed to enhance the Company's ability to act as a source of strength to the Company's wholly owned subsidiary, FSGBank, including, but not limited to, taking steps to ensure that the Bank complied with all material aspects of the Order issued by the OCC. A copy of the Agreement was attached as Exhibit 10.1 to the Current Report on Form 8-K filed by the Company on September 14, 2010.

While the Agreement has been terminated, the Company expects to continue to seek approval from the Federal Reserve prior to paying any dividends on our capital stock or incurring any additional indebtedness.

Regulatory Capital Ratios

Banks and bank holding companies, as regulated institutions, are subject to various regulatory capital requirements administered by the OCC and Federal Reserve, the primary federal regulators for FSGBank and the Company, respectively. The OCC and Federal Reserve have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

8

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of tier 1 capital (as defined) to the average assets (as defined).

Prior to the termination of the Order on March 10, 2014, FSGBank was required to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. The Company made cash contributions into FSGBank of $65.0 million in the second quarter of 2013 and $6.4 million in the third quarter of 2013. Despite meeting the capital thresholds required to be considered "well capitalized" for regulatory purposes, because of the capital requirements of the Order, the Bank was classified as "adequately capitalized." Following the termination of the Order, the Bank is currently considered "well capitalized."

The following table compares the required capital ratios maintained by the Company and FSGBank:

CAPITAL RATIOS

September 30, 2014	FSGBank Consent  Order 1		Minimum Capital Requirements to be "Well Capitalized"			First Security		FSGBank
Tier 1 capital to risk adjusted assets	n/a		6.0	%		12.0	%	11.3	%
Total capital to risk adjusted assets	n/a		10.0	%		13.1	%	12.5	%
Leverage ratio	n/a		5.0	%	2	9.4	%	8.9	%
December 31, 2013
Tier 1 capital to risk adjusted assets	n/a		6.0	%		13.6	%	12.8	%
Total capital to risk adjusted assets	13.0	%	10.0	%		14.9	%	14.1	%
Leverage ratio	9.0	%	5.0	%	2	9.4	%	8.7	%
September 30, 2013
Tier 1 capital to risk adjusted assets	n/a		6.0	%		14.6	%	13.7	%
Total capital to risk adjusted assets	13.0	%	10.0	%		15.8	%	14.9	%
Leverage ratio	9.0	%	5.0	%	2	9.0	%	8.3	%

_____________

¹ The Order was terminated on March 10, 2014 and accordingly, FSGBank is no longer subject to the elevated capital requirements and is considered "well capitalized."

² The Federal Reserve Board definition of well capitalized for bank holding companies does not include a leverage ratio component; accordingly, the leverage ratio requirement for well capitalized status only applies to FSGBank.

9

NOTE 3 –OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) for the Company consists of changes in net unrealized gains and losses on investment securities available-for-sale and derivatives.  The following tables present a summary of the changes in accumulated other comprehensive income balances for the applicable periods.

Changes in Accumulated Other Comprehensive Income (Loss) from June 30, 2014 to September 30, 2014
	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Available-for-Sale Securities			Unrealized Gain (Loss) on Held-to-Maturity Securities			Accumulated Other Comprehensive Income (Loss)
	(in thousands)
Beginning balance, June 30, 2014	$	(50	)	$	(863	)	$	(7,008	)	$	(7,921	)
Other comprehensive loss before reclassifications	16			(164		)	—			(148		)
Amortization of fair value for securities held-to-maturity reclassified out of accumulated other comprehensive loss to investment income	—			—			497			497
Reclassification adjustment for securities gain realized in income	—			(10		)	—			(10		)
Net current period other comprehensive income (loss)	16			(174		)	497			339
Ending balance, September 30, 2014	$	(34	)	$	(1,037	)	$	(6,511	)	$	(7,582	)

Changes in Accumulated Other Comprehensive Income (Loss) from June 30, 2013 to September 30, 2013
	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Available-for-Sale Securities			Unrealized Gain (Loss) on Held-to-Maturity Securities		Accumulated Other Comprehensive Income (Loss)
	(in thousands)
Beginning balance, June 30, 2013	$	18		$	(3,751	)	—		$	(3,733	)
Other comprehensive loss before reclassifications	(95		)	(6,300		)	—		(6,395		)
Amortization of fair value for securities held-to-maturity reclassified out of accumulated other comprehensive loss to investment income	—			—			88		88
Reclassification for securities transferred to held-to-maturity	—			8,711			(8,711	)	—
Net current period other comprehensive income (loss)	(95		)	2,411			(8,623	)	(6,307		)
Ending balance, September 30, 2013	$	(77	)	$	(1,340	)	(8,623	)	$	(10,040	)

10

Changes in Accumulated Other Comprehensive Income (Loss) from December 31, 2013 to September 30, 2014
	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Available-for-Sale Securities			Unrealized Gain (Loss) on Held-to-Maturity Securities			Accumulated Other Comprehensive Income (Loss)
	(in thousands)
Beginning balance, December 31, 2013	$	(37	)	$	(1,630	)	$	(7,943	)	$	(9,610	)
Other comprehensive income before reclassifications	3			1,221			—			1,224
Amortization of fair value for securities held-to-maturity reclassified out of accumulated other comprehensive loss to investment income	—			—			1,432			1,432
Reclassification adjustment for securities gain realized in income	—			(628		)	—			(628		)
Net current period other comprehensive income (loss)	3			593			1,432			2,028
Ending balance, September 30, 2014	$	(34	)	$	(1,037	)	$	(6,511	)	$	(7,582	)

Changes in Accumulated Other Comprehensive Income (Loss) from December 31, 2012 to September 30, 2013
	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Available-for-sale Securities			Unrealized Gain (Loss) on Held-to-Maturity Securities			Accumulated Other Comprehensive Income (Loss)
	(in thousands)
Beginning balance, December 31, 2012	$	(54	)	$	3,354		$	—		$	3,300
Other comprehensive loss before reclassification	(23		)	(13,251		)	—			(13,274		)
Amortization of fair value for securities held-to-maturity reclassified out of accumulated other comprehensive loss to investment income	—			—			88			88
Reclassifications for securities transferred to held-for-sale				8,711			(8,711		)	—
Reclassification adjustment for securities gain realized in income	—			(154		)	—			(154		)
Net current period other comprehensive income (loss)	(23		)	(4,694		)	(8,623		)	(13,340		)
Ending balance, September 30, 2013	$	(77	)	$	(1,340	)	$	(8,623	)	$	(10,040	)

For the three and nine months endedSeptember 30, 2014 and 2013, no amounts were reclassified into interest income due to gains on derivatives. For the three and nine months endedSeptember 30, 2014, there were $10 thousand and $628 thousand, respectively, of gains reclassified from unrealized gains (losses) on available-for-sale securities to earnings as a result of sales during the period. For the three and nine months endedSeptember 30, 2013, there were $154 thousand of gains on available-for-sale securities reclassified to earnings.

During 2013, approximately $143 million of available-for-sale securities were transferred to the held-to-maturity classification. As of the transfer date, the securities held an unrealized loss of approximately $8.9 million. The fair value as of the transfer date became the new amortized cost basis with the unrealized loss, along with any remaining purchase discount or premium, being reclassified out of accumulated other comprehensive loss over the remaining life of the security. For the three and nine months endedSeptember 30, 2014, approximately $497 thousand and $1.4 million, respectively, of the unrealized loss was reclassified out of accumulated other comprehensive loss, compared to $88 thousand for both the three and nine months endedSeptember 30, 2013. As of September 30, 2013, the securities classified as held-to-maturity totaled approximately $129 million.

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NOTE 4 – EARNINGS PER COMMON SHARE

The difference in basic and diluted weighted average shares is due to the assumed conversion of outstanding stock options and restricted stock awards using the treasury stock method. The Company has issued certain restricted stock awards, which are unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents. These restricted shares are considered participating securities. Accordingly, the Company calculated net income available to common shareholders pursuant to the two-class method, whereby net income is allocated between common shareholders and participating securities. In periods of a net loss, no allocation is made to participating securities as they are not contractually required to fund net losses. The computation of basic and diluted earnings per share is as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(in thousands, except per share amounts)
Numerator:
Net income (loss)	$	927		$	(1,430	)	$	1,495		$	(12,802	)
Preferred stock dividends	—			—			—			(929		)
Accretion of preferred stock discount	—			—			—			(452		)
Dividends and undistributed earnings allocated on participating securities	(12		)	—			(27		)	(88		)
Effect of exchange of preferred stock to common stock	—			—			—			26,179
Net income available (loss allocated) to common shareholders	$	915		$	(1,430	)	$	1,468		$	11,908
Denominator:
Weighted average common shares outstanding including participating securities	66,701			63,280			66,644			40,317
Less: Participating securities	832			680			868			297
Weighted average basic common shares outstanding	65,869			62,600			65,776			40,020
Effect of diluted securities:
Equivalent shares issuable upon exercise of stock options, stock warrants and restricted stock awards	5			—			3			—
Weighted average diluted common shares outstanding	65,874			62,600			65,779			40,020
Net earnings per share:
Basic	$	0.01		$	(0.02	)	$	0.02		$	0.30
Diluted	$	0.01		$	(0.02	)	$	0.02		$	0.30

As of September 30, 2014 and September 30, 2013 a total of 3.5 million and 3.2 million stock options and restricted stock grants were considered anti-dilutive, respectively.

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NOTE 5 – SECURITIES

Investment Securities by Type

The following table presents the amortized cost and fair value of securities available-for-sale and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive loss.

Available-for-sale	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(in thousands)
September 30, 2014
Debt securities—
Mortgage-backed—residential	$	82,912	$	740	$	804	$	82,848
Municipals	4,644		95		89		4,650
Other	11,171		24		16		11,179
Total	$	98,727	$	859	$	909	$	98,677
December 31, 2013
Debt securities—
Federal agencies	$	4,078	$	78	$	—	$	4,156
Mortgage-backed—residential	116,314		1,428		1,763		115,979
Municipals	31,748		473		500		31,721
Other	21,350		—		376		20,974
Total	$	173,490	$	1,979	$	2,639	$	172,830
September 30, 2013
Debt securities—
Federal agencies	$	6,177	$	208	$	251	$	6,134
Mortgage-backed—residential	146,521		1,849		1,942		146,428
Municipals	33,336		548		504		33,380
Other	21,343		21		297		21,067
Total	$	207,377	$	2,626	$	2,994	$	207,009

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The following table presents the amortized cost and fair value of securities held-to-maturity and the corresponding amounts of gross unrecognized gains and losses.

Held-to-maturity	Amortized Cost		Gross Unrecognized Gains		Gross Unrecognized Losses		Fair Value
	(in thousands)
September 30, 2014
Debt securities—
Federal agencies	$	63,942	$	802	$	523	$	64,221
Mortgage-backed—residential	38,231		506		138		38,599
Municipals	27,140		1,612		23		28,729
Total	$	129,313	$	2,920	$	684	$	131,549
December 31, 2013
Debt securities—
Federal agencies	$	63,684	$	206	$	791	$	63,099
Mortgage-backed—residential	41,801		60		302		41,559
Municipals	27,083		390		27		27,446
Total	$	132,568	$	656	$	1,120	$	132,104
September 30, 2013
Debt securities—
Federal agencies	$	61,292	$	447	$	214	$	61,525
Mortgage-backed—residential	40,271		377		47		40,601
Municipals	27,601		572		129		28,044
Total	$	129,164	$	1,396	$	390	$	130,170

During 2013, approximately $143 million of available-for-sale securities were transferred to the held-to-maturity portfolio. As of the transfer date, the securities held an unrealized loss of approximately $8.9 million. The fair value as of the transfer date became the new amortized cost basis with the unrealized loss, along with any remaining purchase discount or premium, being reclassified into accumulated other comprehensive income are amortized over the life of the security. No gain or loss was recognized at the time of the transfer. For the three and nine months endedSeptember 30, 2014, approximately $497 thousand and $1.4 million, respectively, of the unrealized loss was recognized in accumulated other comprehensive income.

During the three months endedSeptember 30, 2014, the Company sold one corporate bond resulting in proceeds of approximately $2.0 million and gross gains of $10 thousand. During the nine months endedSeptember 30, 2014, the Company sold fifty-eight tax exempt municipal securities resulting in proceeds of approximately $23.1 million and gross gains of $484 thousand and gross losses of $253 thousand, three federal agency securities resulting in proceeds of approximately $4.0 million and gross gains of $38 thousand and gross losses of $0 thousand, twenty-three mortgage-backed securities resulting in proceeds of $34.4 million and gross gains of $618 thousand and $269 thousand gross losses and one corporate bond resulting in proceeds of $2.0 million and gross gains of $10 thousand.

The Company also sold $2.9 million in certificates of deposit resulting in gross gains of $1 thousand and gross losses of $1 thousand, resulting in no gain or loss for the nine months endedSeptember 30, 2014.

During the three months endedSeptember 30, 2013, the Company had no sales of securities. During the nine months endedSeptember 30, 2013, the Company sold one federal agency security resulting in proceeds of $1.0 million and gross gains of less than $1 thousand and sold 54 mortgage backed securities resulting in proceeds of approximately $33.2 million, gross gains of $344 thousand and gross losses of $190 thousand.

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At September 30, 2014, December 31, 2013 and September 30, 2013, securities with a carrying value of $35.3 million, $34.6 million and $35.1 million, respectively, were pledged to secure public deposits. At September 30, 2014, December 31, 2013 and September 30, 2013, the carrying amount of securities pledged to secure repurchase agreements was $17.2 million, $13.8 million and $19.6 million, respectively. At September 30, 2014, December 31, 2013 and September 30, 2013, securities of $5.0 million, $6.8 million and $6.9 million were pledged to the Federal Reserve Bank of Atlanta to secure the Company’s daytime correspondent transactions. At September 30, 2014, December 31, 2013 and September 30, 2013 the carrying amount of securities pledged to secure lines of credit with the Federal Home Loan Bank (the "FHLB") totaled $100.8 million, $52.4 million and $53.3 million, respectively. At September 30, 2014, pledged and unpledged securities totaled $158.3 million and $69.7 million, respectively.

Maturity of Securities

The following table presents the amortized cost and fair value of debt securities by contractual maturity at September 30, 2014.

	Available-For-Sale				Held-To-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(in thousands)
Within 1 year	$	918	$	921	$	—	$	—
Over 1 year through 5 years	2,975		2,971		13,119		13,344
5 years to 10 years	8,266		8,274		58,542		59,500
Over 10 years	3,656		3,663		19,421		20,106
	15,815		15,829		91,082		92,950
Mortgage-backed residential securities	82,912		82,848		38,231		38,599
Total	$	98,727	$	98,677	$	129,313	$	131,549

Impairment Analysis

The following table shows the gross unrealized losses and fair value of the Company’s available-for-sale investments with unrealized losses and the gross unrecognized losses and fair value of the Company's held-to-maturity investments that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2014, December 31, 2013 and September 30, 2013.

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	Less than 12 months				12 months or greater				Totals
Available-For-Sale	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(in thousands)
September 30, 2014
Mortgage-backed—residential	$	6,780	$	27	$	59,075	$	777	$	65,855	$	804
Municipals	2,255		59		1,192		30		3,447		89
Other	—		—		2,984		16		2,984		16
Totals	$	9,035	$	86	$	63,251	$	823	$	72,286	$	909
December 31, 2013
Mortgage-backed—residential	$	77,451	$	1,763	$	—	$	—	$	77,451	$	1,763
Municipals	11,652		500		—		—		11,652		500
Other	20,918		371		56		5		20,974		376
Totals	$	110,021	$	2,634	$	56	$	5	$	110,077	$	2,639
September 30, 2013
Federal agencies	$	13,043	$	251	$	—	$	—	$	13,043	$	251
Mortgage-backed—residential	82,545		1,942		—		—		82,545		1,942
Municipals	13,377		504		—		—		13,377		504
Other	16,991		291		55		6		17,046		297
Totals	$	125,956	$	2,988	$	55	$	6	$	126,011	$	2,994

	Less than 12 months				12 months or greater				Totals
Held-To-Maturity	Fair Value		Unrecognized Losses		Fair Value		Unrecognized Losses		Fair Value		Unrecognized Losses
	(in thousands)
September 30, 2014
Federal agencies	$	—	$	—	$	22,627	$	531	$	22,627	$	531
Mortgage-backed—residential	—		—		14,346		130		14,346		130
Municipals	559		23		—		—		559		23
Totals	$	559	$	23	$	36,973	$	661	$	37,532	$	684
December 31, 2013
Federal agencies	$	40,149	$	791	$	—	$	—	$	40,149	$	791
Mortgage-backed—residential	30,793		302		—		—		30,793		302
Municipals	1,739		27		—		—		1,739		27
Totals	$	72,681	$	1,120	$	—	$	—	$	72,681	$	1,120
September 30, 2013
Federal agencies	$	13,919	$	214	$	—	$	—	$	13,919	$	214
Mortgage-backed—residential	17,552		47		—		—		17,552		47
Municipals	4,225		129		—		—		4,225		129
Totals	$	35,696	$	390	$	—	$	—	$	35,696	$	390

As of September 30, 2014, the Company performed an impairment assessment of the available-for-sale and held-to-maturity securities in its portfolio that had unrealized losses to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) the Company intends to sell the security, (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized costs basis or (3) the Company does not expect to recover the security’s entire amortized cost basis, even if the Company does not intend to sell. Additionally, accounting guidance requires that for impaired available-for-sale securities that the Company does not intend to sell and/or that it is not more-likely-than-not that the Company will have to sell prior to recovery but for which credit losses exist, the other-

16

than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. Losses related to held-to-maturity securities are not recorded, as these securities are carried at their amortized cost. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual available-for-sale or held-to-maturity security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.

In evaluating the recovery of the entire amortized cost basis, the Company considers factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.

As of September 30, 2014, gross unrealized losses in the Company’s available-for-sale portfolio totaled $909 thousand, compared to $2.6 million as of December 31, 2013 and $3.0 million as of September 30, 2013. As of September 30, 2014, gross unrecognized losses in the Company's held-to-maturity portfolio totaled $684 thousand compared to $1.1 million as of December 31, 2013 and $390 thousand as of September 30, 2013. As of September 30, 2014, the available-for-sale securities unrealized losses in mortgage-backed securities (consisting of twenty-seven securities), municipals (consisting of two securities) and the held-to-maturity unrecognized losses in mortgage-backed securities (consisting of twenty-four securities), municipals (consisting of sixty-six securities) and federal agencies (consisting of twenty-six securities) are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. Between September 30, 2013 and September 30, 2014, the rate on the 10-year U.S. Treasury decreased slightly from approximately 2.64% to 2.52%. As this represented a decrease in interest rates, the market valuation of the Company's securities adjusted accordingly. The unrealized loss in other available-for-sale securities relates to one corporate note. The unrealized loss in the corporate note is primarily due to changes in interest rates subsequent to purchase. The Company does not intend to sell the available-for-sale investments with unrealized losses and it is not more likely than not that the Company will be required to sell the available-for-sale investments before recovery of their amortized cost basis, which may be maturity. Based on results of the Company’s impairment assessment, the unrealized losses related to the available-for-sale securities and the unrecognized losses related to the held-to-maturity securities at September 30, 2014 are considered temporary.

In October 2011, the Federal Reserve and other regulators jointly issued a proposed rule implementing requirements of a new Section 13 to the Bank Holding Company Act, commonly referred to as the “Volcker Rule.” We continue to monitor and review applicable regulatory guidance on the implementation of the Volcker Rule. On April 7, 2014, the Federal Reserve Board announced that it intends to exercise its authority to give banking entities two additional one-year extensions to conform their ownership interests in and sponsorship of certain collateralized loan obligations (“CLOs”) covered by the Volcker Rule.

As of September 30, 2014, the Company has identified approximately $11.2 million of collateralized loan obligations ("CLOs") within its investment security portfolio that may be impacted by the Volcker Rule. If these securities are deemed to be prohibited bank investments, the Company would have to sell the securities prior to the compliance date of July 21, 2017. At this time, the Company continues to evaluate the additional regulatory guidance on the subject as well as the specific terms of the CLOs in the Company's portfolio to determine whether such CLOs will remain permitted investments. The unrealized loss as of September 30, 2014 for the Company's CLOs totaled $93 thousand.

NOTE 6 – LOANS HELD-FOR-SALE

The Company maintains loans held-for-sale in connection with three distinct departments: the mortgage department, the government lending department and the TriNet division. The Company's mortgage department primarily originates long-term loans held-for-sale and uses various correspondent relationships to sell the loans on the secondary market. The mortgage department also originates certain mortgage loans to be retained and classifies as loans held-for-investment. From time to time, certain of these loans may be marketed and sold in order to manage the Company's interest rate risk position and concentration limits. The government lending department originates SBA and USDA government guaranteed loans with the primary purpose of selling the guaranteed portion in the secondary market. The Company's TriNet division originates construction loans for pre-leased "build to suit" projects and provides interim and long-term financing to professional developers and private investors of commercial real estate with or subject to long-term leases to tenants that are investment grade or have investment grade attributes. The Company classifies all TriNet originations as held-for-investment. From time to time, the Company may evaluate a portion of the originated loans to sell in order to manage the Company's overall interest rate risk and asset-liability sensitivity. The Company transfers the loans to held-for-sale once specific loans are identified and the decision to sell the loan has been made. This is generally represented by the Company's execution of a letter of intent.

Residential loans held-for-sale by the Company's mortgage department totaled $1.0 million, $220 thousand and $1.7 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively. During the third quarter of 2014, the Company identified a group of residential 1-4 family loans to be sold to a third party. These loans were transferred from the

17

held-for-investment portfolio to the held-for-sale portfolio at approximately $6.9 million, which was the lower of cost or market value. These loans sold during the during the third quarter of 2014, resulting in a gain of approximately 156 thousand.

The Company's government lending department had loans held-for-sale at September 30, 2014 of approximately $292 thousand. This amount represents the portion of the SBA loan the Company intends to sell to third parties. Sales of SBA loans have generated income of approximately $87 thousand and $206 thousand for the three and nine months endedSeptember 30, 2014.

During the first quarter of 2014, the Company identified a group of commercial real estate loans to be sold to third parties from the TriNet division. This group of loans was initially recorded in the held-for-investment loan portfolio with a balance of $33.7 million. These loans were transferred to loans held-for-sale at the lower of cost or market value at a value of $33.6 million, which is net of an allowance of approximately $100 thousand as of March 31, 2014. The sale of these loans resulted in total gains of approximately $520 thousand. During the third quarter, the Company identified additional TriNet loans to sell. This group of loans was initially recorded in the held-for-investment loan portfolio with a balance of $45.7 million. These loans were transferred to loans held-for-sale at the lower of cost or market value at a value of $45.6 million, which is net of an allowance of approximately $148 thousand. The Company expects to sell these loans during the fourth quarter of 2014 or first quarter of 2015.

Loans held for sale by type are summarized as follows:

	September 30, 2014		December 31, 2013		September 30, 2013
Loans secured by real estate—	(in thousands)
Residential 1-4 family originated to be held-for-sale	$	1,023	$	220	$	1,661
SBA commercial real estate originated to be held-for-sale	191		—		—
SBA commercial and industrial loans originated to be held-for-sale	101		—		—
Commercial loans transferred to held-for-sale	45,589		—		—
Total loans held for sale	$	46,904	$	220	$	1,661

All loans transferred to held-for-sale during 2014 were rated as pass and no loans were past due or classified as non-accrual at the date of transfer. All loans held-for-sale at September 30, 2014, December 31, 2013 and September 30, 2013 were rated as pass and no loans were past due or classified as non-accrual.

NOTE 7 – LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

Loans by type are summarized in the following table.

	September 30, 2014			December 31, 2013			September 30, 2013
Loans secured by real estate—	(in thousands)
Residential 1-4 family	$	183,857		$	181,988		$	173,446
Commercial	315,617			261,935			222,603
Construction	49,542			39,936			42,364
Multi-family and farmland	18,867			17,663			18,844
	567,883			501,522			457,257
Commercial loans	68,001			55,337			50,879
Consumer installment loans	26,382			21,103			21,586
Other	4,462			5,135			4,905
Total loans	666,728			583,097			534,627
Allowance for loan and lease losses	(8,600		)	(10,500		)	(10,700		)
Net loans	$	658,128		$	572,597		$	523,927

The allowance for loan and lease losses is composed of two primary components: (1) specific impairments for substandard/nonaccrual loans and leases and (2) general allocations for classified loan pools, including special mention and substandard/accrual loans, as well as all remaining pools of loans. The Company accumulates pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions. The Company may include an unallocated component to the allowance for inherent risks within the loan portfolio that cannot be quantified through the loss factors or the qualitative factors. The

18

Company determines the allowance on a quarterly basis. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may materially change in the near term. However, the amount of the change that is reasonably possible cannot be estimated.

Included in the Company's loan portfolio are government guaranteed loans the Company purchased totaling $54.2 million, $51.7 million and $50.3 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively. Due to the nature of these loans, there is no specific or general allocation calculated or included in the allowance for loan and lease losses for this group of loans. These loans are reported within the commercial real estate classification.

The following table presents an analysis of the activity in the allowance for loan and lease losses for the three and nine months endedSeptember 30, 2014 and September 30, 2013. The provision for loan and lease losses in the tables below do not include the Company’s provision accrual for unfunded commitments of $6 thousand and $18 thousand for the three and nine months endedSeptember 30, 2014 and September 30, 2013, respectively. The reserve for unfunded commitments is included in other liabilities in the consolidated balance sheets and totaled $300 thousand, $282 thousand and $276 thousand at September 30, 2014, December 31, 2013 and September 30, 2013, respectively.

Allowance for Loan and Lease Losses

For the Three Months EndedSeptember 30, 2014

	Real estate: Residential 1-4 family			Real estate: Commercial			Real estate: Construction			Real estate: Multi-family and farmland		Commercial			Consumer			Other			Unallocated			Total
	(in thousands)
Beginning balance, June 30, 2014	$	3,191		$	2,613		$	902		$	718	$	962		$	584		$	7		$	423		$	9,400
Charge-offs	(149		)	(492		)	(228		)	—		(26		)	(128		)	—			—			(1,023		)
Recoveries	32			18			42			3		178			58			28			—			359
Provision (Credit)	(296		)	107			30			205		(164		)	163			(28		)	(6		)	11
Allowance for loans transfered to held-for-sale	—			(147		)	—			—		—			—			—			—			(147		)
Ending balance, September 30, 2014	$	2,778		$	2,099		$	746		$	926	$	950		$	677		$	7		$	417		$	8,600

Allowance for Loan and Lease Losses

For the Nine Months EndedSeptember 30, 2014

	Real estate: Residential 1-4 family			Real estate: Commercial			Real estate: Construction			Real estate: Multi-family and farmland			Commercial			Consumer			Other			Unallocated		Total
	(in thousands)
Beginning balance, December 31, 2013	$	4,063		$	3,299		$	899		$	916		$	970		$	342		$	11		$	—	$	10,500
Charge-offs	(392		)	(749		)	(228		)	—			(32		)	(378		)	(30		)	—		(1,809		)
Recoveries	210			495			120			12			256			197			97			—		1,387
Provision (Credit)	(1,103		)	(699		)	(45		)	(2		)	(244		)	516			(71		)	417		(1,231		)
Allowance for loans transfered to held-for-sale	—			(247		)	—			—			—			—			—			—		(247		)
Ending balance, September 30, 2014	$	2,778		$	2,099		$	746		$	926		$	950		$	677		$	7		$	417	$	8,600

Allowance for Loan and Lease Losses

For the Three Months EndedSeptember 30, 2013

19

	Real estate: Residential 1-4 family			Real estate: Commercial			Real estate: Construction			Real estate: Multi-family and farmland			Commercial			Consumer			Other			Unallocated		Total
	(in thousands)
Beginning balance, June 30, 2013	$	5,167		$	3,516		$	1,230		$	1,128		$	1,071		$	159		$	29		$	—	$	12,300
Charge-offs	(256		)	(118		)	(34		)	(36		)	(4		)	(127		)	—			—		(575		)
Recoveries	46			248			182			5			14			64			48			—		607
Provision (Credit)	(723		)	(771		)	(30		)	(29		)	(61		)	37			(55		)	—		(1,632		)
Ending balance, September 30, 2013	$	4,234		$	2,875		$	1,348		$	1,068		$	1,020		$	133		$	22		$	—	$	10,700

Allowance for Loan and Lease Losses

For the Nine Months EndedSeptember 30, 2013

	Real estate: Residential 1-4 family			Real estate: Commercial			Real estate: Construction			Real estate: Multi-family and farmland			Commercial			Consumer			Other			Unallocated		Total
	(in thousands)
Beginning balance, December 31, 2012	$	6,207		$	3,736		$	667		$	741		$	2,103		$	272		$	74		$	—	$	13,800
Charge-offs	(1,324		)	(531		)	(503		)	(36		)	(31		)	(460		)	—			—		(2,885		)
Recoveries	281			313			312			15			218			289			137			—		1,565
Provision (Credit)	(930		)	(643		)	872			348			(1,270		)	32			(189		)	—		(1,780		)
Ending balance, September 30, 2013	$	4,234		$	2,875		$	1,348		$	1,068		$	1,020		$	133		$	22		$	—	$	10,700

The following table presents an analysis of the end of period balance of the allowance for loan and lease losses as of September 30, 2014.

As of September 30, 2014

	Real estate: Residential 1-4 family				Real estate: Commercial				Real estate: Construction				Real estate: Multi-family and farmland				Total Real Estate Loans
	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	253	$	9	$	1,281	$	—	$	—	$	—	$	—	$	—	$	1,534	$	9
Collectively evaluated	183,604		2,769		314,336		2,099		49,542		746		18,867		926		566,349		6,540
Total evaluated	$	183,857	$	2,778	$	315,617	$	2,099	$	49,542	$	746	$	18,867	$	926	$	567,883	$	6,549

20

	Commercial				Consumer				Other				Unallocated				Grand Total
(continued from above)	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	227	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	1,761	$	9
Collectively evaluated	67,774		950		26,382		677		4,462		7		—		417		664,967		8,591
Total evaluated	$	68,001	$	950	$	26,382	$	677	$	4,462	$	7	$	—	$	417	$	666,728	$	8,600

The following table presents an analysis of the end of period balance of the allowance for loan and lease losses as of December 31, 2013.

As of December 31, 2013

	Real estate: Residential 1-4 family				Real estate: Commercial				Real estate: Construction				Real estate: Multi-family and farmland				Total Real Estate Loans
	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	1,328	$	—	$	1,912	$	450	$	—	$	—	$	—	$	—	$	3,240	$	450
Collectively evaluated	180,660		4,063		260,023		2,849		39,936		899		17,663		916		498,282		8,727
Total evaluated	$	181,988	$	4,063	$	261,935	$	3,299	$	39,936	$	899	$	17,663	$	916	$	501,522	$	9,177

	Commercial				Consumer				Other				Unallocated				Grand Total
(continued from above)	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	320	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	3,560	$	450
Collectively evaluated	55,017		970		21,103		342		5,135		11		—		—		579,537		10,050
Total evaluated	$	55,337	$	970	$	21,103	$	342	$	5,135	$	11	$	—	$	—	$	583,097	$	10,500

The following table presents an analysis of the end of period balance of the allowance for loan and lease losses as of September 30, 2013.

As of September 30, 2013

	Real estate: Residential 1-4 family				Real estate: Commercial				Real estate: Construction				Real estate: Multi-family and farmland				Total Real Estate Loans
	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	1,424	$	—	$	358	$	—	$	26	$	—	$	—	$	—	$	1,808	$	—
Collectively evaluated	172,022		4,234		222,245		2,875		42,338		1,348		18,844		1,068		455,449		9,525
Total evaluated	$	173,446	$	4,234	$	222,603	$	2,875	$	42,364	$	1,348	$	18,844	$	1,068	$	457,257	$	9,525

21

	Commercial				Consumer				Other				Unallocated				Grand Total
(continued from above)	Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance		Carrying Value		Associated Allowance
	(in thousands)
Individually evaluated	$	756	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	2,564	$	—
Collectively evaluated	50,123		1,020		21,586		133		4,905		22		—		—		532,063		10,700
Total evaluated	$	50,879	$	1,020	$	21,586	$	133	$	4,905	$	22	$	—	$	—	$	534,627	$	10,700

The Company utilizes a risk rating system to evaluate the credit risk of its loan portfolio. The Company classifies loans as: pass, special mention, substandard/non-impaired, substandard/impaired, doubtful or loss. The following describes the Company's classifications and the various risk indicators associated with each rating.

A pass rating is assigned to those loans that are performing as contractually agreed and do not exhibit the characteristics of the criticized and classified risk ratings as defined below. The Company utilizes six grade classifications within the Pass rating based on the varying risk characteristics of the loan. Pass loan pools do not include the unfunded portions of binding commitments to lend, standby letters of credit, deposit secured loans or mortgage loans originated with commitments to sell in the secondary market. Loans that are not required to have an allowance reserve include: loans secured by segregated deposits held by FSGBank, loans held-for-sale, and the government guaranteed portion of SBA and USDA loans.

A special mention loan risk rating is considered criticized but is not considered as severe as a classified loan risk rating. Special mention loans contain one or more potential weakness(es), which if not corrected, could result in an unacceptable increase in credit risk at some future date. These loans may be characterized by the following risks and/or trends:

Loans to Businesses:

• Downward trend in sales, profit levels and margins

• Impaired working capital position compared to industry

• Cash flow strained in order to meet debt repayment schedule

• Technical defaults due to noncompliance with financial covenants

• Recurring trade payable slowness

• High leverage compared to industry average with shrinking equity cushion

• Questionable abilities of management

• Weak industry conditions

• Inadequate or outdated financial statements

Loans to Businesses or Individuals:

• Loan delinquencies and overdrafts may occur

• Original source of repayment questionable

• Documentation deficiencies may not be easily correctable

• Loan may need to be restructured

• Collateral or guarantor offers adequate protection

• Unsecured debt to tangible net worth is excessive

A substandard loan risk rating is characterized as having specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic, or managerial nature, and may warrant non-accrual status.

The Company segregates substandard loans into two classifications based on the Company’s allowance methodology for impaired loans. The Company defines a substandard/impaired loan as a substandard loan relationship in excess of $500 thousand that is individually reviewed. Substandard loans have a greater likelihood of loss and may require a protracted work-out plan. In addition to the factors listed for special mention loans, substandard loans may be characterized by the following risks and/or trends:

Loans to Businesses:

• Sustained losses that have severely eroded equity and cash flows

• Concentration in illiquid assets

• Serious management problems or internal fraud

• Chronic trade payable slowness; may be placed on COD or collection by trade creditor

• Inability to access other funding sources

• Financial statements with adverse opinion or disclaimer; may be received late

• Insufficient documented cash flows to meet contractual debt service requirements

22

Loans to Businesses or Individuals:

• Chronic or severe delinquency or has met the retail classification standards which is generally past dues greater than 90 days

• Frequent overdrafts

• Likelihood of bankruptcy exists

• Serious documentation deficiencies

• Reliance on secondary sources of repayment which are presently considered adequate

• Demand letter sent

• Litigation may have been filed against the borrower

Loans with a risk rating of doubtful are individually analyzed to determine the Company's best estimate of the loss based on the most recent assessment of all available sources of repayment. Doubtful loans are considered impaired and placed on nonaccrual. For doubtful loans, the collection or liquidation in full of principal and/or interest is highly questionable or improbable. The Company estimates the specific potential loss based upon an individual analysis of the relationship risks, the borrower’s cash flow, the borrower’s management and any underlying secondary sources of repayment. The amount of the estimated loss, if any, is then either specifically reserved in a separate component of the allowance or charged-off. In addition to the characteristics listed for substandard loans, the following characteristics apply to doubtful loans:

Loans to Businesses:

• Normal operations are severely diminished or have ceased

• Seriously impaired cash flow

• Numerous exceptions to loan agreement

• Outside accountant questions entity’s survivability as a “going concern”

• Financial statements may be received late, if at all

• Material legal judgments filed

• Collection of principal and interest is impaired

• Collateral/Guarantor may offer inadequate protection

Loans to Businesses or Individuals:

• Original repayment terms materially altered

• Secondary source of repayment is inadequate

• Asset liquidation may be in process with all efforts directed at debt retirement

• Documentation deficiencies not correctable

The consistent application of the above loan risk rating methodology ensures that the Company has the ability to track historical losses and appropriately estimate potential future losses in our allowance. Additionally, appropriate loan risk ratings assist the Company in allocating credit and special asset personnel in the most effective manner. Significant changes in loan risk ratings can have a material impact on the allowance and thus a material impact on the Company's financial results by requiring significant increases or decreases in provision expense. The Company individually reviews these relationships on a quarterly basis to determine the required allowance or loss, as applicable.

The following table presents the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of September 30, 2014:

As of September 30, 2014

	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	171,647	$	6,118	$	5,839	$	253	$	183,857
Real estate: Commercial	307,993		2,519		3,824		1,281		315,617
Real estate: Construction	45,114		3,744		684		—		49,542
Real estate: Multi-family and farmland	17,962		235		670		—		18,867
Commercial	61,531		1,864		4,379		227		68,001
Consumer	26,060		56		266		—		26,382
Other	4,428		—		34		—		4,462
Total Loans	$	634,735	$	14,536	$	15,696	$	1,761	$	666,728

23

The following table presents the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of December 31, 2013:

As of December 31, 2013
	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	162,444	$	9,490	$	8,726	$	1,328	$	181,988
Real estate: Commercial	247,096		3,873		9,054		1,912		261,935
Real estate: Construction	37,565		1,596		775		—		39,936
Real estate: Multi-family and farmland	17,236		173		254		—		17,663
Commercial	49,799		2,798		2,420		320		55,337
Consumer	20,741		71		291		—		21,103
Other	5,088		1		46		—		5,135
Total Loans	$	539,969	$	18,002	$	21,566	$	3,560	$	583,097

24

The following table presents the Company’s internal risk rating by loan classification as utilized in the allowance analysis as of September 30, 2013:

As of September 30, 2013
	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	152,115	$	9,182	$	10,725	$	1,424	$	173,446
Real estate: Commercial	207,015		5,206		10,024		358		222,603
Real estate: Construction	37,723		83		4,532		26		42,364
Real estate: Multi-family and farmland	16,947		999		898		—		18,844
Commercial	44,572		2,868		2,683		756		50,879
Consumer	21,228		79		279		—		21,586
Other	4,810		—		95		—		4,905
Total Loans	$	484,410	$	18,417	$	29,236	$	2,564	$	534,627

The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans were $1.8 million, $3.6 million and $2.6 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively. For impaired loans, the Company generally applies all payments directly to principal. Accordingly, the Company did not recognize any significant amount of interest income for impaired loans during the three and nine months endedSeptember 30, 2014 and 2013.

25

The following table presents additional information on the Company’s impaired loans as of September 30, 2014, December 31, 2013 and September 30, 2013:

	As of September 30, 2014								As of December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Balance of Recorded Investment		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Balance of Recorded Investment
	(in thousands)
Impaired loans with no related allowance recorded:
Real estate: Residential 1-4 family	$	143	$	143	$	—	$	312	$	1,328	$	1,328	$	—	$	2,603
Real estate: Commercial	1,281		1,281		—		760		718		718		—		6,503
Real estate: Construction	—		—		—		—		—		—		—		5,528
Real estate: Multi-family and farmland	—		—		—		—		—		—		—		694
Commercial	227		227		—		252		320		320		—		1,725
Consumer	—		—		—		—		—		—		—		109
Other	—		—		—		—		—		—		—		409
Total	$	1,651	$	1,651	$	—	$	1,324	$	2,366	$	2,366	$	—	$	17,571
Impaired loans with an allowance recorded:
Real estate: Residential 1-4 family	$	110	$	110	$	9	$	117	$	—	$	—	$	—	$	512
Real estate: Commercial	—		—		—		—		1,194		1,194		450		329
Real estate: Construction	—		—		—		—		—		—		—		1,190
Real estate: Multi-family and farmland	—		—		—		—		—		—		—		60
Commercial	—		—		—		—		—		—		—		572
Consumer	—		—		—		—		—		—		—		19
Other	—		—		—		—		—		—		—		48
Total	110		110		9		117		1,194		1,194		450		2,730
Total impaired loans	$	1,761	$	1,761	$	9	$	1,441	$	3,560	$	3,560	$	450	$	20,301

26

	As of September 30, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Balance of Recorded Investment
	(in thousands)
Impaired loans with no related allowance recorded:
Real estate: Residential 1-4 family	$	1,424	$	1,641	$	—	$	2,815
Real estate: Commercial	358		393		—		5,795
Real estate: Construction	26		472		—		4,635
Real estate: Multi-family and farmland	—		—		—		685
Commercial	756		1,894		—		1,911
Consumer	—		—		—		50
Other	—		—		—		367
Total	$	2,564	$	4,400	$	—	$	16,258
Impaired loans with an allowance recorded:
Real estate: Residential 1-4 family	$	—	$	—	$	—	$	306
Real estate: Commercial	—		—		—		334
Real estate: Construction	—		—		—		1,167
Real estate: Multi-family and farmland	—		—		—		71
Commercial	—		—		—		360
Consumer	—		—		—		—
Other	—		—		—		—
Total	—		—		—		2,238
Total impaired loans	$	2,564	$	4,400	$	—	$	18,496

Nonaccrual loans were $4.0 million, $7.2 million and $6.8 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively. The following table provides nonaccrual loans by type:

	As of September 30, 2014		As of December 31, 2013		As of September 30, 2013
	(in thousands)
Nonaccrual Loans by Classification
Real estate: Residential 1-4 family	$	955	$	2,727	$	3,464
Real estate: Commercial	1,281		2,653		939
Real estate: Construction	198		365		461
Real estate: Multi-family and farmland	65		57		57
Commercial	1,246		1,137		1,605
Consumer and other	255		264		257
Leases	—		—		20
Total Nonaccrual Loans	$	4,000	$	7,203	$	6,803

27

The Company monitors loans by past due status. The following table provides the past due status for all loans. Nonaccrual loans are included in the applicable classification.

As of September 30, 2014
	30-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total		Greater than 90 Days Past Due and Accruing
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	1,401	$	1,751	$	3,152	$	180,705	$	183,857	$	1,892
Real estate: Commercial	1,331		—		1,331		314,286		315,617		—
Real estate: Construction	156		162		318		49,224		49,542		—
Real estate: Multi-family and farmland	—		65		65		18,802		18,867		—
Subtotal of real estate secured loans	2,888		1,978		4,866		563,017		567,883		1,892
Commercial	2,593		262		2,855		65,146		68,001		22
Consumer	148		257		405		25,977		26,382		37
Other	—		—		—		4,462		4,462		—
Total Loans	$	5,629	$	2,497	$	8,126	$	658,602	$	666,728	$	1,951

As of December 31, 2013
	30-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total		Greater than 90 Days Past Due and Accruing
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	2,509	$	1,967	$	4,476	$	177,512	$	181,988	$	773
Real estate: Commercial	1,626		365		1,991		259,944		261,935		—
Real estate: Construction	878		705		1,583		38,353		39,936		11
Real estate: Multi-family and farmland	245		53		298		17,365		17,663		—
Subtotal of real estate secured loans	5,258		3,090		8,348		493,174		501,522		784
Commercial	403		583		986		54,351		55,337		68
Consumer	95		329		424		20,679		21,103		76
Other	—		—		—		5,135		5,135		—
Total Loans	$	5,756	$	4,002	$	9,758	$	573,339	$	583,097	$	928

28

As of September 30, 2013
	30-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total		Greater than 90 Days Past Due and Accruing
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	2,761	$	2,328	$	5,089	$	168,357	$	173,446	$	496
Real estate: Commercial	780		1,419		2,199		220,404		222,603		—
Real estate: Construction	37		496		533		41,831		42,364		—
Real estate: Multi-family and farmland	—		119		119		18,725		18,844		13
Subtotal of real estate secured loans	3,578		4,362		7,940		449,317		457,257		509
Commercial	120		1,303		1,423		49,456		50,879		—
Consumer	9		250		259		21,327		21,586		—
Other	—		42		42		4,863		4,905		—
Total Loans	$	3,707	$	5,957	$	9,664	$	524,963	$	534,627	$	509

As of September 30, 2014, the Company had five loans, not on non-accrual, that were considered troubled debt restructurings. Two residential loans of $94 thousand were restructured with lower interest rates and payments, two commercial real estate loans of $1.2 million were restructured short term extensions with lower interest rates and one consumer loan of $17 thousand was restructured with lower payments. As of September 30, 2014, these loans were performing under the modified terms.

The Company had $1.3 million, $1.1 million and $1.0 million in total troubled debt restructurings outstanding as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively. The Company has allocated no specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2014, December 31, 2013 and September 30, 2013. The Company has not committed to lend additional amounts as of September 30, 2014, December 31, 2013 and September 30, 2013 to customers with outstanding loans that are classified as troubled debt restructurings.

The Company completed one modification totaling $1.1 million that would qualify as a troubled debt restructuring during the three months endedSeptember 30, 2014 and completed two modifications totaling $1.2 million for the nine months endedSeptember 30, 2014. The Company completed five modifications totaling $797 thousand for the year endedDecember 31, 2013 that would qualify as a troubled debt restructuring, completed one modification totaling $22 thousand that would qualify as a troubled debt restructuring for the three months endedSeptember 30, 2013 and three modifications totaling $121 thousand that would qualify as troubled debt restructurings during the nine months endedSeptember 30, 2013.

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the three and nine months endedSeptember 30, 2014 and 2013 and the year endedDecember 31, 2013:

	Three Months Ended					Three Months Ended
	September 30, 2014					September 30, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
		(dollar amounts in thousands)					(dollar amounts in thousands)
Troubled Debt Restructurings That Subsequently Defaulted:	—	$	—	$	—	—	$	—	$	—

29

	Nine Months Ended					Nine Months Ended
	September 30, 2014					September 30, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollar amounts in thousands)						(dollar amounts in thousands)
Troubled Debt Restructurings That Subsequently Defaulted:
Residential real estate	—	$	—	$	—	1	$	70	$	70
Total	—	$	—	$	—	1	$	70	$	70

	Year Ended
	December 31, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollar amounts in thousands)
Troubled Debt Restructurings That Subsequently Defaulted:
Residential real estate	1	$	38	$	38
Commercial loan	1	22		22
Total	2	$	60	$	60

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

The troubled debt restructurings that subsequently defaulted described above had no impact on the allowance for loan losses or charge-offs during the three and nine months endedSeptember 30, 2014, the year endedDecember 31, 2013 and the three and nine months endedSeptember 30, 2013.

NOTE 8 – OTHER BORROWINGS

Other borrowings at September 30, 2014 and December 31, 2013 consist of short-term variable or fixed rate advances from the Federal Home Loan Bank of Cincinnati ("FHLB") totaling $43.5 million and $20.0 million, respectively. There were no other borrowings at September 30, 2014, December 31, 2013 or September 30, 2013. The Company also has a FHLB letter of credit totaling $9.0 million which reduces the FHLB borrowing capacity. The letter of credit was not in use as of September 30, 2014, December 31, 2013 or September 30, 2013.

Pursuant to the blanket agreement for advances and security agreements with the FHLB, advances as of September 30, 2014 and December 31, 2013 were secured by the Company’s unencumbered qualifying 1-4 family first mortgage loans subject to varying limitations determined by the FHLB, investment securities and by the FHLB stock owned by the Company. As of September 30, 2014 and December 31, 2013, the Company had loans totaling $182.7 million and $182.0 million, respectively, and investment securities totaling $100.8 million and $52.4 million, respectively, pledged as collateral at the FHLB.

As a member of FHLB, the Company must own FHLB stock. The amount of FHLB stock required to be held is subject the Company’s asset size and outstanding FHLB advances. At September 30, 2014, December 31, 2013 and September 30, 2013, the Company owned FHLB stock totaling $3.3 million, $2.3 million and $2.3 million, respectively. The FHLB stock is recorded in other assets on the Company’s consolidated balance sheet. Based on the collateral and the Company's holdings of FHLB stock, the Company is eligible to borrow up to a total of $171.6 million at September 30, 2014.

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The terms of the FHLB advances as of September 30, 2014 and December 31, 2013 are as follows:

Balance as of September 30, 2014
Maturity Year	Origination Date	Type	Principal (in thousands)		Rate		Maturity
2014	9/30/2014	FHLB variable rate advance	$	43,485	0.08	%	10/1/2014
Balance as of December 31, 2013
Maturity Year	Origination Date	Type	Principal (in thousands)		Rate		Maturity
2014	12/19/2013	FHLB fixed rate advance	$	20,000	0.15	%	1/17/2014

NOTE 9 – INCOME TAXES

The Company accounts for income taxes in accordance with ASC 740, which requires an asset and liability approach for the financial accounting and reporting of income taxes. Under this method, deferred income taxes are recognized for the expected future tax consequences of differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. These balances are measured using the enacted tax rates expected to apply in the year(s) in which these temporary differences are expected to reverse. The effect on deferred income taxes of a change in tax rates is recognized in income in the period when the change is enacted.

In accordance with ASC 740, the Company is required to establish a valuation allowance for deferred tax assets when it is “more likely than not” that a portion or all of the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions.

During 2010, the Company established a deferred tax asset valuation allowance after evaluating all available positive and negative evidence. A valuation allowance is required when it is "more likely than not" that the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions. For the three and nine months endedSeptember 30, 2014, the Company reported net income, which is positive evidence. Currently, the Company has determined that there is not sufficient positive evidence to reach a "more likely than not" conclusion that the deferred tax assets will be realized and as such, a full valuation allowance exist as of September 30, 2014. The Company evaluates the valuation allowance on a quarterly basis. As of September 30, 2014, the valuation allowance totals $62.4 million resulting in a net deferred tax asset of zero.

For the three months endedSeptember 30, 2014 and 2013, the Company recognized an income tax provision of $132 thousand and $322 thousand, respectively. For the nine months endedSeptember 30, 2014 and 2013, the Company recognized an income tax provision of $395 thousand and $358 thousand, respectively. The tax expense is directly related to the amortization of the Company's low income housing tax credit.

The Company evaluated its material tax positions as of September 30, 2014. Under the “more-likely-than-not” threshold guidelines, the Company believes it has identified all significant uncertain tax benefits. The Company evaluates, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be accrued, in accordance with Internal Revenue Service guidelines, and recorded as a component of income tax expense in the Company’s consolidated financial statements.

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NOTE 10 – SUPPLEMENTAL FINANCIAL DATA

Components of other noninterest income or other noninterest expense in excess of 1% of the aggregate of total interest income and noninterest income are shown in the following table.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Other noninterest income—	(in thousands)
Point-of-sale fees	436			401			1,276			1,171
Bank-owned life insurance income	234			238			820			723
Trust fees	233			193			668			527
Interest rate swap gain	138			17			375			33
All other items	260			225			768			664
Total other noninterest income	$	1,301		$	1,074		$	3,907		$	3,118
Other noninterest expense—
Professional fees	$	658		$	533		$	1,947		$	1,840
FDIC insurance	336			150			983			2,150
Data processing	577			628			1,671			1,697
Advertising	140			89			409			246
Printing & supplies	144			213			501			528
Write-downs on other real estate owned and repossessions	289			374			674			1,997
Gains on other real estate owned, repossessions and fixed assets	(113		)	(116		)	(118		)	(417		)
Non-performing asset expenses	204			488			609			3,506
Communications	129			141			426			411
ATM/Debit Card fees	244			207			734			625
Insurance	295			523			923			1,873
OCC Assessments	89			125			272			376
Intangible asset amortization	49			67			146			213
Interest rate swap loss	138			17			381			33
All other items	511			404			1,506			1,154
Total other noninterest expense	$	3,690		$	3,843		$	11,064		$	16,232

NOTE 11 –SHARE-BASED COMPENSATION

As of September 30, 2014, the Company has three share-based compensation plans, the 2012 Long-Term Incentive Plan (the "2012 LTIP"), the 2002 Long-Term Incentive Plan (the "2002 LTIP") and the 1999 Long-Term Incentive Plan (the "1999 LTIP" and, together with the 2012 LTIP and 2002 LTIP, the "Plans"). The Plans are administered by the Compensation Committee of the Board of Directors (the "Committee"), which selects persons eligible to receive awards and determines the number of shares and/or options subject to each award, the terms, conditions and other provisions of the award. The Plans are described in further detail below.

During the Company's participation in TARP CPP, the terms of awards were also subject to compliance with applicable TARP compensation regulations prior to the exchange of the TARP Preferred Stock on April 11, 2013.

The 2012 LTIP was approved by the shareholders of the Company at the Company's 2012 annual meeting as previously reported on a Current Report on Form 8-K filed June 26, 2012 and subsequently amended at the Company's 2013 annual meeting as reported on a Current Report on Form 8-K filed on July 26, 2013. The amendment increased the shares reserved for issuance from 175,000 shares to 6,250,000 shares and was effective on July 24, 2013. The 2012 Long-Term Incentive Plan permits the Committee to make a variety of awards, including incentive and nonqualified options to purchase shares of First Security's common stock, stock appreciation rights, other share-based awards which are settled in either cash or shares of First Security's common stock and are determined by reference to shares of stock, such as grants of restricted common stock, grants of rights to receive stock in the future, or dividend equivalent rights, and cash performance awards, which are settled in cash

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and are not determined by reference to shares of First Security's common stock ("Awards"). These discretionary Awards may be made on an individual basis or through a program approved by the Committee for the benefit of a group of eligible persons. As of September 30, 2014, the number of shares available under the 2012 LTIP for future grants was 2,646,500.

The 2002 LTIP was approved by the shareholders of the Company at the Company's 2002 annual meeting and subsequently amended by the shareholders of the Company at the Company's 2004 and 2007 annual meetings to increase the number of shares available for issuance under the 2002 LTIP by 480 thousand and 750 thousand shares, respectively. The total number of shares authorized for awards prior to the 10-for-1 reverse stock split was 1.5 million. As a result of the 10-for-1 reverse stock split in 2012, the total shares currently authorized under the 2002 LTIP is 151,800, of which not more than 20% may be granted as awards of restricted stock. Eligible participants include eligible employees, officers, consultants and directors of the Company or any affiliate. The exercise price per share of a stock option granted may not be less than the fair market value as of the grant date. The exercise price must be at least 110% of the fair market value at the grant date for options granted to individuals, who at the grant date, are 10% owners of the Company’s voting stock (each a 10% owner). Restricted stock may be awarded to participants with terms and conditions determined by the Committee. The term of each award is determined by the Committee, provided that the term of any incentive stock option may not exceed ten years (five years for 10% owners) from its grant date. Each option award vests in approximately equal percentages each year over a period of not less than three years from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 2002 LTIP or as provided in any award agreement. As of September 30, 2014, there are no shares available for future grants under the 2002 LTIP.

Participation in the 1999 LTIP is limited to eligible employees. The total number of shares of stock authorized for awards prior to the 10-for-1 reverse stock split was 936 thousand. As a result of the 10-for-1 reverse stock split in 2012, the total shares currently authorized under the 1999 LTIP is 93,600, of which not more than 10% could be granted as awards of restricted stock. Under the terms of the 1999 LTIP, incentive stock options to purchase shares of the Company’s common stock may not be granted at a price less than the fair market value of the stock as of the date of the grant. Options must be exercised within ten years from the date of grant subject to conditions specified by the 1999 LTIP. Restricted stock could also be awarded by the Committee in accordance with the 1999 LTIP. Generally, each award vests in approximately equal percentages each year over a period of not less than three years and vest from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 1999 LTIP or as provided in any award agreement. As of September 30, 2014, there are no shares available for future grants under the 1999 LTIP.

Stock Options

The following table illustrates the effect on operating results for share-based compensation for the three and nine months endedSeptember 30, 2014 and 2013.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2014		2013		2014		2013
	(in thousands)
Stock option compensation expense	$	150	$	88	$	462	$	149
Stock option compensation expense, net of tax 1	$	99	$	58	$	305	$	98
1 Due to the deferred tax valuation allowance, tax benefit is reversed through the valuation allowance.

During the nine months endedSeptember 30, 2014, no options were exercised. During the nine months endedSeptember 30, 2013, 5,000 options were exercised for total proceeds of $14 thousand.

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 following assumptions: expected dividend yield, expected volatility, risk-free interest rate, expected life of the option and the grant date fair value. Expected volatilities were based on historical volatilities of the Company's common stock. During 2014 and 2013, the Company utilized a regional bank index to determine expected volatilities. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and 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.

Options granted during the nine months endedSeptember 30, 2014 totaled 364 thousand. The fair value of options granted during the nine months endedSeptember 30, 2014 was determined using the following weighted-average assumptions as of the grant date. Options granted during the nine months endedSeptember 30, 2013 totaled 7 thousand. The fair value of options

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granted during the nine months endedSeptember 30, 2013 was determined using the following weighted-average assumptions as of the grant date.

	As of September 30, 2014		As of September 30, 2013
Risk-free interest rate	2.02	%	2.00	%
Expected term, in years	6.5		6.5
Expected stock price volatility	40.51	%	44.09	%
Dividend yield	—		—	%

The following table represents stock option activity for the nine months endedSeptember 30, 2014:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding, January 1, 2014	2,274,165		$	3.35
Granted	363,750		$	2.04
Exercised	—
Forfeited	(37,475	)	$	75.59
Outstanding, September 30, 2014	2,600,440		$	2.84	8.83	$	13,500
Exercisable, September 30, 2014	544,565		$	4.92	8.45	$	13,500

On February 27, 2014, as reported on a Current Report on Form 8-K filed on March 4, 2014, certain awards previously granted under the 2012 LTIP were modified effective February 28, 2014. The modification changed the vesting period from three years to five years. In addition, 96,250 supplemental stock options were authorized and will vest over a five year period in accordance with the modification. The supplemental stock options are exercisable at $2.33 per share and are otherwise identical to the original stock options and are subject to other terms and conditions of the 2012 LTIP and to the specific stock option awards.

As of September 30, 2014, shares available for future grants to employees and directors under existing Plans were zero, zero and 2,646,500 for the 1999 LTIP, 2002 LTIP and 2012 LTIP, respectively.

As of September 30, 2014, there was $2.0 million of total unrecognized compensation cost related to nonvested stock options granted under the Plans. The cost is expected to be recognized over a weighted-average period of 3.6 years.

Restricted Stock

The Plans described above allow for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The unearned share-based compensation related to these awards is being amortized to compensation expense over the period the restrictions lapse. The share-based expense for these awards was determined based on the market price of the Company’s stock at the grant date applied to the total number of shares that were anticipated to fully vest and then amortized over the vesting period.

As of September 30, 2014, unearned share-based compensation associated with these awards totaled $1.8 million. The Company recognized compensation expense (benefit), net of forfeitures, of $130 thousand and $330 thousand for the three and nine months endedSeptember 30, 2014 and $109 thousand and $(25) thousand for the three and nine months endedSeptember 30, 2013, respectively, related to the amortization of deferred compensation that was included in salaries and benefits in the accompanying consolidated statements of operations. The remaining cost is expected to be recognized over a weighted-average period of 3.6 years.

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The following table represents restricted stock activity for the period ended September 30, 2014:

	Shares			Weighted Average Grant-Date Fair Value
Nonvested shares at January 1, 2014	884,991		1	$	2.35
Granted	226,150			$	1.94
Vested	(197,439	)
Forfeited	(2,500	)
Nonvested, September 30, 2014	911,202		1	$	2.33

__________________

¹ Includes 23,250 shares issued as an inducement grant from available and unissued shares and not from the Plans.

NOTE 12 – FAIR VALUE MEASUREMENTS

The authoritative accounting guidance for fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Authoritative guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

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 can access as of the measurement date.

Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 - Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

The Company used the following methods and significant assumptions to estimate fair value:

Cash and cash equivalents: The carrying value of cash and cash equivalents approximates fair value.

Interest bearing deposits in banks: The carrying amounts of interest bearing deposits in banks approximate fair value.

Federal Home Loan Bank Stock and Federal Reserve Bank Stock: It is not practical to determine the fair value of FHLB stock or FRB Stock due to restrictions placed on their transferability. As such, these instruments are carried at cost.

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). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports

35

as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. Our municipal securities valuations are supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. As these securities are not rated by the rating agencies and trading volumes are thin, it was determined that these were valued using Level 2 inputs.

Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

Loans: For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans and other consumer loans are estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans and leases is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit ratings quality. Fair value for impaired loans and leases are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The fair value may not approximate the exit price.

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower's financial statements, or aging reports, adjusted or discounted based on management's historical knowledge, changes in market conditions from the time of the valuation, and management's expertise and knowledge of the client and client's business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed annually by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Special Assets Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with via independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value. The most recent analysis performed indicated that a discount of approximately 17% should be applied.

Loans Held For Sale: Fair value for loans originated to be held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2). Fair value of loans transferred to held for sale is determined using the carrying amount of the loans before they were transferred to loans held for sale net of any allowance for loan and lease loss, resulting in a Level 3 fair value classification.

Accrued interest receivable: The carrying value of accrued interest receivable approximates fair value.

Deposit liabilities: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value for fixed-rate certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregate expected maturities on time deposits.

Federal funds purchased and securities sold under agreements to repurchase: These borrowings generally mature in 90 days or less and, accordingly, the carrying amount reported in the consolidated balance sheets approximates fair value.

Accrued interest payable: The carrying value of accrued interest payable approximates fair value.

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Other borrowings: Other borrowings carrying amount reported in the consolidated balance sheets approximates fair value.

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

	Fair Value Measurements at
	September 30, 2014 Using:
	Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Securities available-for-sale—
Federal Agencies	$	—	$	—	$	—	$	—
Mortgage-backed—residential	—		82,848		—		82,848
Municipals	—		4,650		—		4,650
Other	—		11,116		63		11,179
Total securities available-for-sale	$	—	$	98,614	$	63	$	98,677
Loans held for sale	$	—	$	1,023	$	—	$	1,023
Zero premium collar	$	—	$	398	$	—	$	398
Financial liabilities
Forward loan sales contracts	$	—	$	7	$	—	$	7
Cash flow swap	$	—	$	398	$	—	$	398

	Fair Value Measurements at
	December 31, 2013 Using:
	Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Securities available-for-sale—
Federal agencies	$	—	$	4,156	$	—	$	4,156
Mortgage-backed—residential	—		115,979		—		115,979
Municipals	—		31,721		—		31,721
Other	—		20,918		56		20,974
Total securities available-for-sale	$	—	$	172,774	$	56	$	172,830
Loans held for sale	$	—	$	220	$	—	$	220
Financial liabilities
Forward loan sales contracts	$	—	$	9	$	—	$	9
Cash Flow Swap	$	—	$	15	$	—	$	15

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	Fair Value Measurements at
	September 30, 2013 Using:
	Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Securities available-for-sale—
Federal agencies	$	—	$	6,134	$	—	$	6,134
Mortgage-backed—residential	—		146,428		—		146,428
Municipals	—		33,380		—		33,380
Other	—		21,012		55		21,067
Total securities available-for-sale	$	—	$	206,954	$	55	$	207,009
Loans held for sale	$	—	$	1,661	$	—	$	1,661
Zero premium collar			$	33			$	33
Financial liabilities
Forward loan sales contracts			$	49			$	49
Cash flow swap	$	—	$	33	$	—	$	33

The following table presents additional information about changes in assets and liabilities measured at fair value on a recurring basis and for which the Company utilized Level 3 inputs to determine fair value as of September 30, 2014 and 2013.

September 30, 2014

	Balance as of December 31, 2013		Total Realized and Unrealized Gains or Losses	Sales	Net Transfers In and/or Out of Level 3	Balance as of September 30, 2014
	(in thousands)
Financial assets
Securities available-for-sale—
Other	$	56	7	—	—	$	63

September 30, 2013

	Balance as of December 31, 2012		Total Realized and Unrealized Gains or Losses	Sales	Net Transfers In and/or Out of Level 3	Balance as of September 30, 2013
	(in thousands)
Financial assets
Securities available-for-sale—
Other	$	41	14	—	—	$	55

At September 30, 2014, the Company also had assets and liabilities measured at fair value on a non-recurring basis. Items measured at fair value on a non-recurring basis include other real estate owned (OREO), and collateral-dependent impaired loans. Such measurements were determined utilizing Level 3 inputs.

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The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis for which impairment was recognized during the nine months ended September 30, 2014.

	Carrying Value as of September 30, 2014		Level 1 Fair Value Measurement		Level 2 Fair Value Measurement		Level 3 Fair Value Measurement		Valuation Allowance as of September 30, 2014
	(in thousands)
Other real estate owned –
Construction/development	$	2,783	$	—	$	—	$	2,783	$	(2,881	)
Residential real estate	427		—		—		427		(100		)
Commercial real estate	840		—		—		840		(461		)
Other real estate owned	4,050		—		—		4,050		(3,442		)
Collateral-dependent loans –
Real Estate: Residential 1-4 family	101		—		—		101		(9		)
Real Estate: Commercial	1,281		—		—		1,281		—
Real Estate: Construction	—		—		—		—		—
Real Estate: Multi-family and farmland	—		—		—		—		—
Commercial	227		—		—		227		—
Collateral-dependent loans	1,609		—		—		1,609		(9		)
Totals	$	5,659	$	—	$	—	$	5,659	$	(3,451	)

The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis for which impairment was recognized during the twelve months ended December 31, 2013.

	Carrying Value as of December 31, 2013		Level 1 Fair Value Measurement		Level 2 Fair Value Measurement		Level 3 Fair Value Measurement		Valuation Allowance as of December 31, 2013
	(in thousands)
Other real estate owned –
Construction/development	$	3,127	$	—	$	—	$	3,127	$	(2,851	)
Residential real estate	905		—		—		905		(255		)
Commercial real estate	1,983		—		—		1,983		(1,054		)
Multi-family and farmland	—		—		—		—		—
Commercial and industrial	—		—		—		—		—
Other real estate owned	6,015		—		—		6,015		(4,160		)
Collateral-dependent loans –
Real Estate: Residential 1-4 family	1,061		—		—		1,061		—
Real Estate: Commercial	316		—		—		316		—
Real Estate: Construction	—		—		—		—		—
Commercial	65		—		—		65		—
Collateral-dependent loans	1,442		—		—		1,442		—
Totals	$	7,457	$	—	$	—	$	7,457	$	(4,160	)

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The following table presents the carrying value and associated valuation allowance of those assets measured at fair value on a non-recurring basis for which impairment was recognized for during the nine months ended September 30, 2013.

	Carrying Value as of September 30, 2013		Level 1 Fair Value Measurement		Level 2 Fair Value Measurement		Level 3 Fair Value Measurement		Valuation Allowance as of September 30, 2013
	(in thousands)
Other real estate owned -
Construction/development	$	3,860	$	—	$	—	$	3,860	$	(3,914	)
Residential real estate	1,555		—		—		1,555		(570		)
Multi-family and farmland	381		—		—		381		(263		)
Commercial real estate	2,519		—		—		2,519		(1,930		)
Commercial and industrial	347		—		—		347		(150		)
Other real estate owned	8,662		—		—		8,662		(6,827		)
Collateral-dependent loans -
Real Estate: Residential 1-4 family	1,102		—		—		1,102		—
Real Estate: Commercial	358		—		—		358		—
Real Estate: Construction	26		—		—		26		—
Commercial	436		—		—		436		—
Collateral-dependent loans	1,922		—		—		1,922		—
Totals	$	10,584	$	—	$	—	$	10,584	$	(6,827	)

For the nine month period ended September 30, 2014, the Company decreased its valuation allowance on $4.1 million of other real estate owned. The Company recorded write-downs on other real estate owned of $289 thousand and $374 thousand during the three months endedSeptember 30, 2014 and 2013, respectively, and write-downs on other real estate owned of $674 thousand and $2.0 million during the nine months endedSeptember 30, 2014 and 2013, respectively. For collateral-dependent loans, no provision for loan loss was recorded during the three and nine months endedSeptember 30, 2014. No provision for loan loss was recorded during the three and nine months endedSeptember 30, 2013. Any changes in the valuation allowance for a collateral-dependent loan are included in the allowance analysis and may result in additional provision expense.

There have been no transfers into or out of Level 3 during 2014 or 2013. There were no transfers between Level 1 and Level 2 during 2014 or 2013.

For loans transferred to held for sale the carrying amount was estimated by the carrying amount of the loans before they were transferred to loans held for sale, net of of any associated allowance for loan and lease loss.

For impaired loans and OREO properties, the Company utilizes independent, third-party appraisals to determine fair value. Independent appraisals are ordered at least annually. As part of the normal appraisal process, the appraisers generally provide the appraised value using one of following techniques: the sales comparison approach, the income approach or a combination thereof.  Under the sales comparison approach, the appraiser may make certain adjustments from the sold property to the appraised property, including, but not limited to, differences in square footage, lot size, absorption rates or location. As of September 30, 2014, the adjustments between the appraised property and the comparison property range from (72.4)% to 175.2% with a weighted average adjustment of (12.8)%. Under the income approach, the appraiser may make certain adjustments including, but not limited to, capitalization rates and differences in operating income expectations.  The Company's current third-party appraisals provided capitalization rates up to 9.6% with a weighted average of 9.3%. The Company's current third-party appraisals do not provide a range of adjustments to net operating income expectations. The Company monitors the realization rate between proceeds received and appraised value for all sold OREO properties.  This discount, defined as the weighted average percentage difference between appraised values and proceeds, is then applied to all remaining appraisals associated with impaired loans and OREO properties.  The Company monitors and applies this adjustment to the Company's Level 3 properties. The weighted average discount is approximately 17.0% as of September 30, 2014.

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The following table presents quantitative information about Level 3 fair value measurements for significant financial instruments measured at fair value on a non-recurring basis at September 30, 2014.

	Fair value (in thousands)		Valuation technique(s)	Unobservable input(s)	Range				Weighted average
Impaired Loans - CRE	$	1,281	Sales comparison approach	Adjustment for differences between the comparable sales	(35.1	)%	5.8	%	(14.6	)%
Impaired Loans - Residential	101		Sales comparison approach	Adjustment for differences between the comparable sales	5.2	%	26.5	%	15.9	%
Impaired Loans - Commercial	227		Sales comparison approach	Adjustment for differences between the comparable sales	9.4	%	39.5	%	24.5	%
OREO-Residential	427		Sales comparison approach	Adjustment for differences between the comparable sales	(25.0	)%	15.4	%	1.44	%
OREO-Commercial	840		Sales comparison approach	Adjustment for differences between the comparable sales	(45.0	)%	113.7	%	1.4	%
			Income Approach	Capitalization rate	9.3	%	9.6	%	9.3	%
OREO-Construction	2,783		Sales comparison approach	Adjustment for differences between the comparable sales	(72.4	)%	175.2	%	(12.8	)%

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For impaired loans and OREO properties at December 31, 2013, the Company utilized independent, third-party appraisals to determine fair value. Independent appraisals are ordered at least annually. As part of the normal appraisal process, the appraisers generally provide the appraised value using one of following techniques: the sales comparison approach, the income approach or a combination thereof.  Under the sales comparison approach, the appraiser may make certain adjustments from the sold property to the appraised property, including, but not limited to, differences in square footage, lot size, absorption rates or location. The adjustments between the appraised property and the comparison property ranged from (80.0)% to 112.0% with a weighted average adjustment of 0.75%. Under the income approach, the appraiser may make certain adjustments including, but not limited to, capitalization rates and differences in operating income expectations.  The Company's third-party appraisals provided a range of capitalization rates up to 10.5% with a weighted average of 7.97%. The Company's third-party appraisals did not provide a range of adjustments to net operating income expectations. The Company monitors the realization rate between proceeds received and appraised value for all sold OREO properties.  This discount, defined as the weighted average percentage difference between appraised values and proceeds, is then applied to all remaining appraisals associated with impaired loans and OREO properties.  The Company monitors and applies this adjustment to the Company's Level 3 properties. The weighted average discount was approximately 17% as of December 31, 2013.

The following table presents quantitative information about Level 3 fair value measurements for significant items measured at fair value on a non-recurring basis at December 31, 2013.

	Fair value (in thousands)		Valuation technique(s)	Unobservable input(s)	Range				Weighted average
Impaired Loans - CRE	$	316	Sales comparison approach	Adjustment for differences between the comparable sales	(35.1	)%	5.8	%	(14.6	)%
			Income Approach	Capitalization rate	10.5	%	10.5	%	10.5	%
Impaired Loans - Residential	1,061		Sales Approach	Adjustment for differences between the comparable sales	(6.7	)%	74.5	%	29.7	%
Impaired Loans - Commercial and Industrial	65		Sales comparison approach	Adjustment for differences between the comparable sales	9.4	%	39.5	%	24.5	%
OREO-Residential	905		Sales comparison approach	Adjustment for differences between the comparable sales	(80.0	)%	112.0	%	(0.5	)%
OREO-Commercial	1,983		Sales comparison approach	Adjustment for differences between the comparable sales	(75.8	)%	100.0	%	(1.5	)%
			Income Approach	Capitalization rate	8.0	%	10.5	%	9.5	%
OREO-Construction	3,127		Sales comparison approach	Adjustment for differences between the comparable sales	(63.4	)%	90.0	%	2.5	%

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For impaired loans and OREO properties at September 30, 2013, the Company utilized independent, third-party appraisals to determine fair value. Independent appraisals are ordered at least annually. As part of the normal appraisal process, the appraisers generally provide the appraised value using one of following techniques: the sales comparison approach, the income approach or a combination thereof.  Under the sales comparison approach, the appraiser may make certain adjustments from the sold property to the appraised property, including, but not limited to, differences in square footage, lot size, absorption rates or location. The adjustments between the appraised property and the comparison property ranged from (75.8)% to 102.9% with a weighted average adjustment of 0.18%. Under the income approach, the appraiser may make certain adjustments including, but not limited to, capitalization rates and differences in operating income expectations.  The Company's third-party appraisals provided capitalization rates up to 11.0% with a weighted average of 7.12%. The Company's third-party appraisals did not provide a range of adjustments to net operating income expectations. The Company monitors the realization rate between proceeds received and appraised value for all sold OREO properties.  This discount, defined as the weighted average percentage difference between appraised values and proceeds, is then applied to all remaining appraisals associated with impaired loans and OREO properties.  The Company monitors and applies this adjustment to the Company's Level 3 properties. The weighted average discount was approximately 17% as of September 30, 2013.

The following table presents quantitative information about Level 3 fair value measurements for significant financial instruments measured at fair value on a non-recurring basis at September 30, 2013.

	Fair value (in thousands)		Valuation technique(s)	Unobservable input(s)	Range				Weighted average
Impaired Loans - CRE	$	358	Sales comparison approach	Adjustment for differences between the comparable sales	(70.0	)%	210.1	%	(14.3	)%
				Capitalization rate	9.0	%	12.5	%	10.1	%
Impaired Loans - Residential	1,102		Sales Approach	Adjustment for differences between the comparable sales	(68.0	)%	183.9	%	3.7	%
				Capitalization rate	9.2	%	10.8	%	9.8	%
Impaired Loans - Commercial	436		Sales comparison approach	Adjustment for differences between the comparable sales	(32.0	)%	30.0	%	(0.1	)%
OREO-Residential	1,555		Sales comparison approach	Adjustment for differences between the comparable sales	(80.0	)%	31.3	%	(1.0	)%
OREO-CRE	2,519		Sales comparison approach	Adjustment for differences between the comparable sales	(75.8	)%	100.0	%	(1.2	)%
				Capitalization rate	8.9	%	10.5	%	9.5	%
OREO-Construction	3,860		Sales comparison approach	Adjustment for differences between the comparable sales	(63.4	)%	90.0	%	2.4	%
OREO- Commercial and Industrial	347		Sales comparison approach	Adjustment for differences between the comparable sales	(63.9	)%	102.9	%	(2.6	)%
				Capitalization rate	9.5	%	11.0	%	10.5	%

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The following table presents the estimated fair values of the Company’s financial instruments at September 30, 2014, December 31, 2013 and September 30, 2013.

			Fair Value Measurements at
			September 30, 2014 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and due from banks	$	11,519	$	11,519	$	—	$	—	$	11,519
Interest bearing deposits in banks	7,344		7,344		—		—		7,344
Securities available-for-sale	98,677		—		98,614		63		98,677
Securities held-to-maturity	129,313		—		131,549		—		131,549
Federal Home Loan Bank stock	3,253		N/A		N/A		N/A		N/A
Federal Reserve Bank stock	2,325		N/A		N/A		N/A		N/A
Loans held for sale	46,904		—		1,023		45,881		46,904
Loans, net	658,128		—		—		665,097		665,097
Accrued interest receivable	2,845		—		887		1,958		2,845
Financial liabilities
Deposits	879,029		511,799		366,934		—		878,733
Federal funds purchased and securities sold under agreements to repurchase	12,878		12,878		—		—		12,878
Other borrowings	43,485		43,485						43,485
Accrued interest payable	647		9		638		—		647

			Fair Value Measurements at
			December 31, 2013 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and due from banks	$	10,742	$	10,742	$	—	$	—	$	10,742
Interest bearing deposits in banks	10,126		10,126		—		—		10,126
Securities available-for-sale	172,830		—		172,774		56		172,830
Securities held-to-maturity	132,568		—		132,104		—		132,104
Federal Home Loan Bank stock	2,276		N/A		N/A		N/A		N/A
Federal Reserve Bank stock	2,336		N/A		N/A		N/A		N/A
Loans held for sale	220		—		220		—		220
Loans, net	572,597		—		—		579,122		579,122
Accrued interest receivable	3,091		—		1,216		1,875		3,091
Financial liabilities
Deposits	857,269		446,048		413,477		—		859,525
Federal funds purchased and securities sold under agreements to repurchase	12,520		12,520		—		—		12,520
Other borrowings	20,000		20,000		—		—		20,000
Accrued interest payable	834		10		824		—		834

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			Fair Value Measurements at
			September 30, 2013 Using:
	Carrying Value		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and due from banks	$	10,357	$	10,357	$	—	$	—	$	10,357
Interest bearing deposits in banks	59,943		59,943		—		—		59,943
Securities available-for-sale	207,009		—		206,954		55		207,009
Securities held-to-maturity	129,164		—		130,170		—		130,170
Federal Home Loan Bank stock	2,276		N/A		N/A		N/A		N/A
Federal Reserve Bank stock	2,336		N/A		N/A		N/A		N/A
Loans held for sale	1,661		—		1,661		—		1,661
Loans, net	523,927		—		—		533,404		533,404
Accrued interest receivable	3,165		—		1,381		1,784		3,165
Financial liabilities
Deposits	909,848		455,266		458,257		—		913,523
Federal funds purchased and securities sold under agreements to repurchase	12,657		12,657		—		—		12,657
Accrued interest payable	1,039		9		1,030		—		1,039

NOTE 13 – COMMITMENTS AND CONTINGENCIES

The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and the issuance of financial guarantees in the form of financial and performance standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as they do for on-balance-sheet instruments.

The Company’s maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at September 30, 2014, December 31, 2013 and September 30, 2013 was as follows:

	September 30, 2014		December 31, 2013		September 30, 2013
	(in thousands)
Commitments to extend credit - fixed rate	$	33,300	$	36,273	$	29,464
Commitments to extend credit - variable rate	$	112,527	$	94,857	$	90,086
Total commitments to extend credit	$	145,827	$	131,130	$	119,550
Standby letters of credit	$	3,243	$	3,208	$	3,308

Commitments to extend credit are agreements to lend to customers. Standby letters of credit are contingent commitments issued by the Company to guarantee performance of a customer to a third party under a contractual non-financial obligation for which it receives a fee. Financial standby letters of credit represent a commitment to guarantee customer repayment of an outstanding loan or debt instrument. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company on extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.

The Company is subject to various legal proceedings and claims that arise in the ordinary course of its business. Additionally, in the ordinary course of business, the Company is subject to regulatory examinations, information gathering requests, inquiries, and investigations. The Company establishes accruals for litigation and regulatory matters when those

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matters present loss contingencies that the Company determines to be both probable and reasonably estimable. Based on current knowledge, advice of counsel and available insurance coverage, management does not believe that liabilities arising from legal claims, if any, will have a material adverse effect on the Company’s consolidated financial condition, results of operations, or cash flows. However, in light of the significant uncertainties involved in these matters, the early stage of various legal proceedings, and the indeterminate amount of damages sought in some of these matters, it is possible that the ultimate resolution of these matters, if unfavorable, could be material to the Company’s results of operations for any particular period.

The Company intends to vigorously pursue all available defenses to these claims. There are significant uncertainties involved in any litigation. Although the ultimate outcome of these lawsuits cannot be ascertained at this time, based upon information that presently is available to it, management is unable to predict the outcome of these cases and cannot determine the probability of an adverse result or reasonably estimate a range of potential loss, if any. In addition, management is unable to estimate a range of reasonably possible losses with respect to these claims.

NOTE 14 – RECENT ACCOUNTING PRONOUNCEMENTS

In January 2014, the FASB issued Accounting Standards Update 2014-04, "Receivables - Troubled Debt Restructuring by Creditors." This update clarifies when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The update is effective for annual and interim periods within those annual periods, beginning after December 15, 2014. The Company does not believe this update will have a significant impact to the consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers." This update is a joint project with the International Accounting Standards Board initiated to clarify the principles for recognizing revenue and to develop a common revenue standard that is meant to remove inconsistencies and weaknesses in revenue requirements, provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices, provide more useful information to users of financial statements and simplify the preparation of financial statements. The guidance in this update supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition" and most industry-specific guidance throughout the Industry Topics of Codification. This update is effective for annual and interim periods beginning after December 15, 2016. The Company does not believe this update will have a significant impact to the consolidated financial statements.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Form 10-Q, “First Security,” “we,” “us,” “the Company” and “our” refer to First Security Group, Inc.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the statements made under the caption “Management's Discussion and Analysis of Financial Condition and Results of Operations” ("MD&A") and elsewhere throughout this Form 10-Q are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to future events or our future financial performance and include statements about the Company's plans for raising capital, the Company's future growth and market position, and the execution of its business plans. When we use words like “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” and similar expressions, you should consider them as identifying forward-looking statements, although we may use other phrasing. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared.

These forward-looking statements involve risks and uncertainties and may not be realized due to a variety of factors. There can be no assurance that the results, performance or achievements of the Company will not differ materially from those expressed or implied by forward-looking statements. Factors that could cause actual events or results to differ significantly from those described in the forward-looking statements include, but are not limited to, the effects of future economic conditions, governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; the costs of evaluating possible acquisitions and the risks inherent in integrating acquisitions; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in First Security's market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and, the failure of assumptions underlying the establishment of reserves for possible loan losses. For details on these and other factors that could affect expectations, see the cautionary language included under the headings “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, subsequent Quarterly Reports on Form 10-Q and other filings with the SEC.

Many of these risks are beyond our ability to control or predict, and you are cautioned not to put undue reliance on such forward-looking statements. First Security does not intend to update or reissue any forward-looking statements contained in this release as a result of new information or other circumstances that may become known to First Security, and undertakes no obligation to provide any such updates.

All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by this Note. Our actual results and condition may differ significantly from those we discuss in these forward-looking statements.

THIRD QUARTER 2014 AND RECENT EVENTS

The following discussion and analysis sets forth the major factors that affected the results of operations and financial condition reflected in the unaudited financial statements for the three and nine months endedSeptember 30, 2014 and 2013. Such discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and the notes attached thereto, which are included in this Form 10-Q.

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Company Overview

First Security Group, Inc. is a bank holding company headquartered in Chattanooga, Tennessee, with $1.0 billion in assets as of September 30, 2014. Founded in 1999, First Security’s community bank subsidiary, FSGBank, N.A. ("FSGBank"), currently has 26 full-service banking offices, including its headquarters, along the interstate corridors of eastern and middle Tennessee and northern Georgia and 264 full-time equivalent employees. FSGBank provides retail and commercial banking services, trust and investment management, mortgage banking, financial planning and Internet banking (www.FSGBank.com) services.

Strategic Initiatives

Over the last two years, our primary mission has been to transform FSGBank into a premier community bank in East Tennessee. To accomplish this vision, three primary tasks were necessary: raising a significant amount of new capital, disposing of a large majority of our non-performing assets, and satisfying the Bank's Consent Order with the OCC. The successful execution of these three tasks would enable us to fully implement our business plan, return to profitability and expedite our transformation into a premier institution.

During 2013, we successfully completed a recapitalization by issuing 60,735,000 shares of our common stock for $91.1 million, or $1.50 per share, which included issuing common shares to the U.S. Treasury ("Treasury") for full satisfaction of our Preferred Stock issued as part of the Capital Purchase Program ("CPP") of Troubled Asset Relief Program ("TARP") (collectively, the "Recapitalization" ). Additionally, we issued 3,329,234 shares of common stock for $1.50 per share for gross proceeds of approximately $5.0 million to shareholders of record of the Company immediately preceding the Recapitalization (the "Rights Offering").

During 2013, we also executed a problem loan sale that was a pre-closing condition of the Recapitalization. During the fourth quarter of 2012, we identified $36.2 million of under- and non-performing loans to sell and recorded a $13.9 million loss to reduce the loan balance to the expected net proceeds. During the first quarter of 2013, we recorded $1.4 million in transaction expenses and another $671.1 thousand in the third quarter of 2013. The aggregate expense associated with the loan sale was $16.0 million.

On March 10, 2014, the Office of the Comptroller of the Currency (the "OCC") terminated the Consent Order with FSGBank. On October 3, 2014, the Federal Reserve Bank of Atlanta (the "Federal Reserve") terminated the Written Agreement with First Security Group, Inc.

With each of these tasks now complete, we are fully implementing our business plan that will position us appropriately for both short-term and long-term success and our mission of becoming a top-tier community bank within our markets. As a result of the progress achieved to date on our business plan, we returned to profitability during the second quarter of 2014 and further expanded our profitability in the third quarter.

Strategic Initiative—Balance Sheet Restructuring— Prior to the Recapitalization, we held a significant level of excess liquidity, primarily in cash, and as a result, our mix of earning assets produced an overall earning asset yield that was insufficient to support our cost infrastructure. Additionally, we held an elevated level of brokered deposits and higher rate CDs to maintain the excess liquidity required by our regulatory and financial condition. Subsequent to the Recapitalization, we began to restructure our balance sheet, as further described below.

Loans— While cost reductions and revenue enhancements are being implemented, the return to profitability was largely associated with increasing loans and shifting the mix of earning assets from excess cash and investment securities into loans with a target of loans accounting for approximately 75% of total earning assets. From September 30, 2013 to September 30, 2014, we increased loans, including those held-for-sale, by $177.3 million, or 33.1%, with $130.3 million of loan growth for the nine months endedSeptember 30, 2014. As of September 30, 2014, our loan to deposit ratio was 81.2% and our ratio of average loans to average earning assets for the three and nine months endedSeptember 30, 2014 was 74.6% and 71.7%, respectively.

Subsequent to the completion of the Recapitalization, various lending opportunities were evaluated to enhance and expedite loan growth while maintaining our commitment to asset quality. During 2013, the following four niche lending initiatives were implemented. First, TriNet is a division focused on national net lease lending and includes three full-time equivalent employees. This unit originates construction of pre-leased "build to suit" projects and provides interim and long-term financing to professional developers and private investors of commercial real estate on long-term leases to tenants that are investment grade or have investment grade attributes. As evidenced during 2014, we may, from time to time, evaluate a portion of the originated loans to sell in order to manage our overall interest rate risk and asset-liability sensitivity. Once management make the decision to sell a loan, generally represented by the execution of a letter of intent, the loans are transferred to held-for-sale. Second, we have an agreement with an unaffiliated third-party that originates small balance, unsecured consumer loans, primarily associated with home improvement additions, including financing new or replacement HVAC units, roofs, windows and other improvements. We are purchasing these consumer loans at a discount from the originator. During the third quarter of

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2014, we ceased additional purchases based on the loan production levels achieved by our commercial lenders and other lending channels. Third, we established a business credit sales and support team that originates structured loans secured by accounts receivable and inventory within our markets. The business credit department was implemented as we believe properly structured and monitored asset-based lending at the community bank level is an under-served market that can generate above-average return on a risk-adjusted basis. To date, this department has yet to make any significant contributions, however, it is maintaining an active and solid pipeline of potential loan opportunities. The fourth lending initiative was a unit focused on government lending, primarily originating and selling the guaranteed portion of SBA and USDA loans. This fourth initiative provides a greater impact on non-interest income through the premium and servicing revenue for sold loans.

Collectively, we believe that our traditional lending officers, supplemented by these lending initiatives, will continue to significantly impact our loan balances within the next twelve months and be the primary contributor to steadily increasing core profitability.

Deposits—A cornerstone of our business plan is to advance our deposit market share within our footprint through a focus on growth in pure deposits, defined as transaction accounts, and core deposits, defined as pure deposits plus CD's less than $100 thousand. In the preceding twelve months and over the next twelve months, we have and will experience significant maturities of legacy brokered deposits. These maturities provide an opportunity to restructure the deposit mix with a shift towards lower cost funding. To support this initiative, we established clearly defined pure deposit growth objectives for each of our 26 branch locations and aligned our retail and commercial incentive plans accordingly. Leveraging our branches to grow market share with pure deposits will reduce our cost of funds, increase our margin and assist us in increasing profitability as well as reducing interest rate risk.

We have generated positive results in implementing our deposit strategy. From September 30, 2013 to September 30, 2014, brokered deposits and higher rate customer CDs have declined by $100.7 million. This structured reduction in high cost deposits was funded with our excess liquidity as well as our growth in pure deposits. Pure deposits have increased by $65.8 million from December 31, 2013 to September 30, 2014. As of September 30, 2014, the ratio of pure deposits to total deposits was approximately 58.2%, compared to 52.0% as of December 31, 2013 and 50.3% as of September 30, 2013. Our goal is to achieve a ratio of pure deposits to total deposits of at least 60%. From December 31, 2013 to September 30, 2014, brokered deposits have increased by a net of $8.9 million. This includes $14.6 million in customer deposits placed and reciprocated through products provided by FSG in partnership with the network of banks associated with Promontory Interfinancial Network, LLC.

We expect to continue to grow pure deposits through increases in products per household and by acquiring new customer relationships, including through cross-selling to new loan customers.

Investment Securities and Liquidity—Beginning in 2009, we maintained excess liquidity to reduce our liquidity risk given our credit and financial condition prior to the Recapitalization. During the second quarter of 2013, we began deploying the excess liquidity to purchase approximately $83.6 million in investment securities between March 31, 2013 and September 30, 2013. During the second half of 2013, we transferred certain federal agency, mortgage-based and municipal securities with a fair value of approximately $143 million from the available-for-sale portfolio to the held-to-maturity portfolio. The securities identified primarily consisted of securities with excessive price risk in higher interest rate environments. As of the transfer date, the unrealized holding loss was approximately $8.9 million. This unrealized loss will continue to be reported as a separate component of shareholders' equity and will be amortized over the remaining life of the securities as an adjustment to the yield. The corresponding discount on these securities will offset this adjustment to yield to result in no income statement impact. Subject to prepayment speeds, we anticipate between $1.8 million and $2.0 million of the unrealized loss to be accreted back into shareholders' equity during 2014. For the three and nine months endedSeptember 30, 2014, approximately $497 thousand and $1.4 million, respectively, of the unrealized loss was accreted back into shareholders' equity. During the first nine months of 2014 and the fourth quarter of 2013, we sold approximately $66.5 million and $22.8 million, respectively, of investment securities to supplement existing liquidity sources to fund loan growth and to assist in maintaining our overall asset size. In addition, during the nine months ended September 30, 2014, we sold $2.9 million of certificates of deposit.

Net Interest Margin—As discussed above, solid progress has been achieved in restructuring our earning assets and deposit mix. As a result, our net interest margin has improved by 89 and 100 basis points from 2.71% and 2.38%, respectively, for the three and nine months ended September 30, 2013 to 3.60% and 3.38%, respectively, for the three and nine months ended September 30, 2014. During the third quarter of 2014, we recognized approximately $650 thousand in discount accretion through resolving multiple loans originally purchased at a discount. Adjusting for the discount accretion, the net interest margin was 3.33% in the third quarter of 2014. We anticipate additional margin improvement during the remainder of 2014. Overall, we believe a disciplined approach to managing our earning asset mix will improve our yield on earning assets, increase our margin and assist us in achieving steady growth in profitability.

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Strategic Initiative—Non-Interest Expense Management— As a result of the Recapitalization and the associated under- and non-performing loan sale, our financial and regulatory condition improved significantly. Accordingly, our costs associated with non-performing assets, FDIC insurance, and corporate insurance has materially declined in 2014 as compared to 2013. Additionally, we initiated a process following the Recapitalization to identify operational efficiencies and other cost saving strategies while maintaining a high level of customer service.

During the second quarter of 2013, we engaged a consultant to review and analyze all aspects of non-interest expense. The consultant facilitated a process that involved multiple employee teams. Each team reviewed a department or line of business and provided recommendations where appropriate. The process included the evaluation of the effectiveness and profit contribution of each branch, staffing levels throughout each department or line of business and various process improvements.

During the third quarter of 2013, we began the process of implementing the recommendations. In reviewing the retail branches, various efficiencies were identified that supported a reduction in staffing as well as a shift towards better utilizing part-time employees during peak transaction times as well as a call center to centralize and ensure consistency in customer service resolutions. Reductions in the special assets and certain administrative functions were also identified. Collectively, we have reduced our employee base by 15.7% from 313 to 264 from September 30, 2013 to September 30, 2014. We closed two branches during December 2013 and consolidated two additional branches during the second quarter of 2014. Various other cost savings were identified and are being implemented as appropriate.

Strategic Initiative—Non-Interest Income Enhancement— In the current interest rate environment, a consistent and appropriate level of non-interest income is necessary to provide adequate overall returns on assets and capital. Over the last two years, significant resources have been devoted to enhancing our ability to generate an appropriate level of recurring non-interest income. Our primary components of non-interest income include: deposit fees, including point-of-sale income, trust revenue, mortgage banking income, bank-owned life insurance and gains on sales of loans.

Treasury Management—In 2013, we created a dedicated treasury management department that provides both sales and support for all cash management products and services for our deposit customers with an emphasis on business accounts. The focus of this department is to actively solicit new business deposit relationships as well as to support and assist our current customers. As stated above, our goal is to capture additional deposit market share by increasing our pure deposits. We believe a dedicated treasury management department will assist in generating pure deposit growth and the related fee income from the various cash management products and services. While fee income has remained flat year-over-year, this department has assisted in growing our pure deposits, which is beneficial to our net interest margin.

Trust Fees—Our wealth management and trust department provides a full range of trust and estate services, investment management, including brokerage and insurance products, and private banking. Our revenues from this department are continuing to grow at a steady pace.

Mortgage Income—In the second half of 2013, our mortgage department transitioned to a dedicated underwriter model to increase our profitability and turnaround time. We are actively recruiting and hiring "purchase" originators with strong network connections to local real estate agents within our markets. While the overall mortgage landscape has changed dramatically over the last 12 months, we believe that our mortgage division can continue to generate a net profit as well as provide an important product to our customers. Additionally, we offer various private client mortgage products that we intend to classify as held-for-investment. From time-to-time, we may evaluate certain of these loans to sell on the secondary market based on our overall interest rate risk profile and our overall loan concentrations.

Gains on Loan Sales—In addition to the mortgage department, our dedicated Small Business Administration ("SBA")government lending department and our TriNet division may sell certain loans. Our government lending department offers SBA 7(a), SBA 504 and USDA B&I loans and is approved as an SBA Preferred and Express Lender. Through September 30, 2014, this department has generated $4.9 million in SBA loans with approximately $3.0 million of that amount guaranteed. The guaranteed portion that was sold resulting in a net gain of $86 thousand and $206 thousand, respectively, for the three and nine months ended September 30, 2014. We believe this department can generate significantly more volume in 2015 with additional resources that we anticipate adding in the next three months. From time-to-time, we may evaluate a portion of the TriNet loans to market for sale. During the first quarter of 2014, we identified a group of TriNet loans to sell that totaled approximately $33.6 million. The sale of these loans resulted in total gains of approximately $520 thousand. During the third quarter, we identified additional TriNet loans to sell totaling $45.6 million. We expect to sell these loans during the fourth quarter of 2014 or first quarter of 2015. Based on our concentration levels and interest rate risk profile, we may evaluate additional TriNet loans to sell. Currently, we have additional capacity within our internally established concentration limits to originate and hold additional TriNet loans.

Collectively, we believe that each of these departments can generate new or increased levels of non-interest income in 2014 and beyond.

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Strategic Initiative—Resolution of Regulatory Enforcement Actions— On March 10, 2014, the OCC terminated the Bank's Order that had been in place since April 28, 2010, when, pursuant to a Stipulation and Consent to the Issuance of a Consent Order, FSGBank consented and agreed to the issuance of a Consent Order by the OCC (the "Order"). The Order provided the areas of our operations that warranted improvement, including reviewing and revising various policies and procedures, including those associated with credit concentration risk management, the allowance for loan and lease losses, liquidity management, criticized assets, loan review and credit administration. The Order also required elevated minimum regulatory capital ratios, which meant that FSGBank could be deemed no stronger than "adequately capitalized" under the FDIC's prompt corrective action provisions. Effective with the termination of the Order and as of September 30, 2014, FSGBank is deemed to be "well capitalized."

On October 2, 2014, the Federal Reserve Bank of Atlanta (the "Federal Reserve") terminated the Company's Written Agreement (the "Agreement") that had been in place since September 7, 2010. The Agreement was designed to enhance our ability to act as a source of strength to FSGBank, including, but not limited to, taking steps to ensure that FSGBank gain compliance with the Order. While the Agreement has been terminated, we expect to continue to seek approval from the Federal Reserve prior to paying any dividends on our capital stock or incurring any additional indebtedness.

Overview

Market Conditions

Our financial results are impacted by both macro-economic and micro-economic conditions. We monitor key indicators on the national, regional and local levels and incorporate applicable trends into our risk tolerances.

As changes in interest rates have a direct impact on our financial results, we monitor the actions and guidance provided by the Federal Open Market Committee ("FOMC") as well as certain key rates. On October 29, 2014, the FOMC announced the conclusion of the Quantitative Easing 3 ("QE3") asset purchases and reiterated that the low interest rate environment would likely remain in place "for a considerable time" after the end of the asset purchases and after the FOMC stated thresholds for unemployment and inflation expectations. We are actively monitoring our interest rate sensitivity and investment duration as it relates to our cash deployment strategy and overall balance sheet. As shown in Item 3, we expect our net interest income would benefit in a rising rate environment. Specifically, our income simulation models indicate our net interest income would increase by approximately 5% based on a 200 basis point increase in rates over a twelve month period.

As of September 2014, the national unemployment rate improved to 5.9% from 7.2% as of September 2013. As of August 2014, the latest available state level data, the unemployment rates in Tennessee and Georgia were 6.4% and 8.3%, respectively. Our primary markets of Chattanooga and Knoxville, Tennessee currently have unemployment rates in line with the state average. As of August 2014, the unemployment rates for Chattanooga and Knoxville, Tennessee were 7.3% and 6.4%, respectively, both improvements from the rates as of September 2013 of 7.4% and 6.7%, respectively. Our Dalton, Georgia market continues to have a higher rate than the state average. As of August 2014, the unemployment rate for Dalton, Georgia was 10.7%, which has increased from 9.6% as of September 2013. While these elevated unemployment rates continue to depress local economic activity, merely returning to national averages could have a material positive impact on our markets.

In addition to key trends, we also monitor specific economic investments in our market area. The following are recent or significant announcements:

• Chattanooga, Tennessee - Volkswagen announced a major expansion to their current automotive production facility for the production of Volkswagen's new SUV vehicle for the North American markets. The total investment is expected to be $600 million and will create approximately 2,000 additional direct jobs with approximately 3,600 additional indirect jobs. The production facility began production of the Passat in May 2011. The original investment totaled $1 billion and created 3,200 direct jobs and an additional 9,500 indirect supplier jobs.

• Dalton, Georgia - Engineered Floors will invest $450 million to build two manufacturing complexes over the next five years that will create approximately 2,400 jobs. The new manufacturing complexes will be in Murray and Whitfield counties in Georgia.

• Knoxville, Tennessee - Alcoa Inc. is planning to expand their current Blount County plants with an investment of $275 million. Alcoa expect to add approximately 200 permanent jobs over the next three years. The new plant will support Tennessee's automotive industry by producing aluminum products.

• Chattanooga, Tennessee - Amazon.com opened two distribution centers in our markets in 2011 and subsequently expanded the center in Hamilton county. The initial $139 million investments created more than 2,000 full-time jobs and an additional 2,000 seasonal jobs in Hamilton and Bradley counties.

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• Cleveland, Tennessee - Wacker Chemical is building a $1.8 billion polysilicon production plant for the solar power industry near Cleveland, Tennessee. The plant is expected to create an additional 600 direct jobs for our market area, with the current staffing level of approximately 280.

We believe the positive economic impact of the above and other recently announced economic investments will be significant and provide a highly competitive economic growth rate.

Financial Results

As of September 30, 2014, we had total consolidated assets of $1.0 billion, total loans of $666.7 million, total deposits of $879.0 million and shareholders’ equity of $88.0 million. For the three and nine months endedSeptember 30, 2014, our net income was $927 thousand and $1.5 million, respectively, resulting in basic net income of $0.01 per share and diluted net income of $0.01 per share for the quarter and basic net income of $0.02 per share and diluted net income of $0.02 per share for the year-to-date period.

As of December 31, 2013, we had total consolidated assets of $977.6 million, total loans of $583.1 million, total deposits of $857.3 million and stockholders' equity of $83.6 million.

As of September 30, 2013, we had total consolidated assets of $1.0 billion, total loans of $534.6 million, total deposits of $909.8 million and shareholders’ equity of $83.4 million. For the three and nine months endedSeptember 30, 2013, our net income available (loss allocated) to common shareholders was $(1.4) million and $12.0 million, respectively, resulting in basic net loss of $0.02 per share and diluted net loss of $0.02 per share for the quarter and basic net income of $0.30 per share and diluted net income of $0.30 per share for the year-to-date period. During the second quarter of 2013, we recognized a gain of $26.2 million on the conversion of our Preferred Stock to common stock in connection with the Recapitalization.

For the three and nine months endedSeptember 30, 2014, net interest income increased by $2.3 million and $6.1 million, respectively, and noninterest income increased by $513 thousand and $2.0 million, respectively, compared to the same periods in 2013. For the three and nine months endedSeptember 30, 2014, noninterest expense decreased by $1.0 million and $6.8 million, respectively, compared to the same periods in 2013. The increase in net interest income for the three and nine months endedSeptember 30, 2014 is a direct result of our loan growth as well as reductions in our costs of funds. Noninterest income increased for the three months endedSeptember 30, 2014, primarily due a increase in the gain on sales of loans, and increased for the nine months endedSeptember 30, 2014, primarily due to the increase in gains on the sale of loans and securities. Noninterest expense decreased for the three and nine months endedSeptember 30, 2014, primarily due to reductions in our salary expense, insurance expense and non-performing asset expenses. Full-time equivalent employees were 264 at September 30, 2014, compared to 313 at September 30, 2013.

The provision for loan and lease losses totaled $11 thousand for the three months ended September 30, 2014. In the year-to-date period for 2014, the credit for loan and lease losses totaled $1.2 million. The provision expense, or credit, is based on the quarterly evaluation of the adequacy of the allowance for loan and lease losses, as described below.

Our efficiency ratio improved in the third quarter of 2014 to 90.5% compared to 132.4% in the same period of 2013 primarily due to an increase in net interest income combined with a decrease in noninterest expense. We anticipate our efficiency ratio to continue to improve during 2014 as we focus on enhancing revenue while continuing to reduce certain overhead expenses.

Net interest margin in the third quarter of 2014 was 3.60%, or 89 basis points higher than the prior year period of 2.71%. Net interest margin for the nine months endedSeptember 30, 2014 was 3.38%, or 100 basis points higher than the same period in 2013. During the third quarter of 2014, we recognized approximately $650 thousand in discount accretion through resolving multiple loans originally purchased at a discount. Adjusting for the discount accretion, the net interest margin was 3.33% in the third quarter of 2014. We anticipate that our margin will continue to improve, although at a slower pace, during the remainder of 2014 as higher cost brokered deposits mature and are replaced with lower cost core deposits as well as anticipated loan growth. The projected improvement of our net interest margin is dependent on multiple factors including our ability to raise core deposits, our growth or contraction in loans, our deposit and loan pricing, maturities of brokered deposits, and any possible action by the Federal Reserve Board to the target federal funds rate.

RESULTS OF OPERATIONS

We reported net income for the three and nine months endedSeptember 30, 2014 of $927 thousand and $1.5 million, respectively, compared to a net loss of $1.4 million and $12.8 million, respectively, for the same periods in 2013. For the three and nine months endedSeptember 30, 2014, basic income per share was $0.01 and $0.02, respectively, and diluted income per share was $0.01 and $0.02, respectively, on approximately 65.9 million weighted average shares outstanding for both basic and diluted.

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Net income for the three and nine months endedSeptember 30, 2014, increased by $2.4 million and $14.3 million, respectively, compared to the same periods for 2013. The increase in net income for the three and nine months ended September 30, 2014 was primarily due to our net interest margin. During 2013, we recorded a $26.2 million one-time gain associated with the exchange of our Preferred Stock to Common Stock during the Recapitalization to fully offset the net loss and provide net income allocated to common shareholders of $12.0 million. As of September 30, 2014, we had 26 banking offices, including the headquarters, and 264 full-time equivalent employees.

The following table summarizes the components of income and expense and the changes in those components for the three and nine month periods ended September 30, 2014 compared to the same periods in 2013.

CONDENSED CONSOLIDATED INCOME STATEMENT

	For the Three Months Ended		Change from Prior Year					For the Nine Months Ended			Change from Prior Year
	September 30, 2014		Amount			Percentage		September 30, 2014			Amount			Percentage
	(in thousands, except percentages)
Interest income	$	9,780	$	1,609		19.7	%	$	26,952		$	3,185		13.4	%
Interest expense	1,293		(713		)	(35.5	)%	3,995			(2,879		)	(41.9	)%
Net interest income	8,487		2,322			37.7	%	22,957			6,064			35.9	%
Provision (credit) for loan and lease losses	11		1,643			(100.7	)%	(1,231		)	549			(30.8	)%
Net interest income after provision (credit) for loan and lease losses	8,476		679			8.7	%	24,188			5,515			29.5	%
Noninterest income	2,805		513			22.4	%	8,470			1,973			30.4	%
Noninterest expense	10,222		(975		)	(8.7	)%	30,768			(6,846		)	(18.2	)%
Net income before income taxes	1,059		2,167			195.6	%	1,890			14,334			115.2	%
Income tax provision	132		(190		)	(59.0	)%	395			37			10.3	%
Net income	927		2,357			164.8	%	1,495			14,297			111.7	%
Preferred stock dividends	—		—			—	%	—			(929		)	100.0	%
Accretion on Preferred Stock Discount	—		—			—	%	—			(452		)	100.0	%
Effect of exchange of Preferred Stock to Common Stock	—		—			—	%	—			(26,179		)	100.0	%
Net income allocated to common shareholders	$	927	$	2,357		164.8	%	$	1,495		$	(10,501	)	(87.5	)%

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. For the quarter ended September 30, 2014, net interest income increased by $2.3 million, or 37.7%, to $8.5 million compared to $6.2 million for the same period in 2013. For the nine months ended September 30, 2014, net interest income increased by $6.1 million, or 35.9%, to $23.0 million compared to $16.9 million for the same period in 2013.

The level of net interest income is determined primarily by the average balances (volume) of interest earning assets and the various rate spreads between our interest earning assets and our funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest earning assets and interest bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.

53

The following tables summarize net interest income and average yields and rates paid for the quarters ended September 30, 2014 and 2013.

AVERAGE CONSOLIDATED BALANCE SHEETSAND NET INTEREST ANALYSIS

FULLY TAX EQUIVALENT BASIS

	For the Three Months Ended
	September 30,
	2014							2013
	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
	(in thousands, except percentages)
ASSETS
Earning assets:
Loans, net of unearned income (1)	$	702,271		$	8,805	4.97	%	$	529,406		$	6,461	4.84	%
Securities – taxable (2)	218,547			892		1.62	%	289,226			1,333		1.83	%
Securities – non-taxable (2)	11,750			131		4.42	%	40,159			475		4.69	%
Other earning assets	8,436			2		0.09	%	68,964			77		0.44	%
Total earning assets	941,004			9,830		4.14	%	927,755			8,346		3.57	%
Allowance for loan and lease losses	(9,357		)					(12,599		)
Intangible assets	217							405
Cash & due from banks	9,813							13,785
Premises & equipment	27,255							28,957
Other assets	48,699							58,616
TOTAL ASSETS	$	1,017,631						$	1,016,919
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing liabilities:
Interest bearing demand deposits	$	101,374		42		0.16	%	$	93,095		62		0.26	%
Money market accounts	201,885			183		0.36	%	175,276			179		0.41	%
Savings deposits	40,445			10		0.10	%	40,329			9		0.09	%
Time deposits of less than $100 thousand	161,186			253		0.62	%	198,665			466		0.93	%
Time deposits of $100 thousand or more	129,103			246		0.76	%	176,882			475		1.07	%
Brokered CDs and CDARS®	85,369			484		2.25	%	90,323			795		3.49	%
Repurchase agreements	13,596			9		0.26	%	14,206			20		0.56	%
Other borrowings	42,203			66		0.62	%	—			—		—	%
Total interest bearing liabilities	775,161			1,293		0.66	%	788,776			2,006		1.01	%
Net interest spread				$	8,537	3.48	%				$	6,340	2.56	%
Noninterest bearing demand deposits	150,003							145,679
Accrued expenses and other liabilities	4,810							3,082
Shareholders’ equity	95,482							88,285
Accumulated other comprehensive income (loss)	(7,825		)					(8,903		)
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,017,631						$	1,016,919
Impact of noninterest bearing sources and other changes in balance sheet composition						0.12	%						0.15	%
Net interest margin						3.60	%						2.71	%

__________________

(1) Nonaccrual loans have been included in the average balance. Only the interest collected on such loans has been included as income.

(2) Interest income from securities includes the effects of taxable-equivalent adjustments using a federal income tax rate of approximately 34% for both years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable equivalent adjustment amounts included in the above table were $50 thousand and $175 thousand for the quarters ended September 30, 2014 and 2013, respectively.

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The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO 2013

	Increase (Decrease) in Interest Income and Expense Due to Changes in:
	Volume			Rate			Total
	(in thousands)
Interest earning assets:
Loans, net of unearned income	$	2,160		$	184		$	2,344
Securities – taxable	(299		)	(142		)	(441		)
Securities – non-taxable	(318		)	(26		)	(344		)
Other earning assets	(38		)	(39		)	(77		)
Total earning assets	1,505			(23		)	1,482
Interest bearing liabilities:
Interest bearing demand deposits	5			(25		)	(20		)
Money market accounts	25			(22		)	3
Savings deposits	—			1			1
Time deposits of less than $100 thousand	(77		)	(135		)	(212		)
Time deposits of $100 thousand or more	(110		)	(119		)	(229		)
Brokered CDs and CDARS®	(42		)	(276		)	(318		)
Repurchase agreements	(1		)	(10		)	(11		)
Other borrowings	15			2			17
Total interest bearing liabilities	(185		)	(584		)	(769		)
Increase in net interest income	$	1,690		$	561		$	2,251

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The following tables summarize net interest income and average yields and rates paid for the year-to-date periods ended September 30, 2014 and 2013.

	For the Nine Months Ended
	September 30,
	2014							2013
	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
	(in thousands, except percentages)
ASSETS
Earning assets:
Loans, net of unearned income (1)	$	660,274		$	23,493	4.76	%	$	544,136		$	19,537	4.80	%
Securities – taxable (2)	227,626			2,899		1.70	%	262,184			3,169		1.62	%
Securities – non-taxable (2)	22,326			796		4.77	%	29,514			1,141		5.17	%
Other earning assets	10,343			52		0.67	%	137,291			338		0.33	%
Total earning assets	920,569			27,240		3.96	%	973,125			24,185		3.32	%
Allowance for loan and lease losses	(9,738		)					(13,581		)
Intangible assets	264							501
Cash & due from banks	9,541							12,271
Premises & equipment	27,805							29,151
Other assets	48,875							54,144
TOTAL ASSETS	$	997,316						$	1,055,611
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing liabilities:
Interest bearing demand deposits	$	100,212		137		0.18	%	$	89,465		213		0.32	%
Money market accounts	177,056			435		0.33	%	159,479			594		0.50	%
Savings deposits	40,888			32		0.10	%	40,066			34		0.11	%
Time deposits of less than $100 thousand	168,593			824		0.65	%	217,236			1,551		0.95	%
Time deposits of $100 thousand or more	137,641			793		0.77	%	196,004			1,558		1.06	%
Brokered CDs and CDARS®	79,920			1,576		2.64	%	125,299			2,873		3.07	%
Repurchase agreements	12,776			26		0.27	%	13,549			51		0.50	%
Other borrowings	42,719			172		0.54	%	—			—		—	%
Total interest bearing liabilities	759,805			3,995		0.70	%	841,098			6,874		1.09	%
Net interest spread				$	23,245	3.26	%				$	17,311	2.23	%
Noninterest bearing demand deposits	147,327							139,816
Accrued expenses and other liabilities	4,302							9,038
Shareholders’ equity	94,395							65,863
Accumulated other comprehensive income (loss)	(8,513		)					(204		)
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	997,316						$	1,055,611
Impact of noninterest bearing sources and other changes in balance sheet composition						0.12	%						0.15	%
Net interest margin						3.38	%						2.38	%

__________________

(1) Nonaccrual loans have been included in the average balance. Only the interest collected on such loans has been included as income.

(2) Interest income from securities includes the effects of taxable-equivalent adjustments using a federal income tax rate of approximately 34% for both years reported and where applicable, state income taxes, to increase tax-exempt interest income to a taxable-equivalent basis. The net taxable equivalent adjustment amounts included in the above table were $288 thousand and $419 thousand for the nine months ended September 30, 2014 and 2013, respectively.

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The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO 2013

	Increase (Decrease) in Interest Income and Expense Due to Changes in:
	Volume			Rate			Total
	(in thousands)
Interest earning assets:
Loans, net of unearned income	$	4,132		$	(176	)	$	3,956
Securities – taxable	(426		)	156			(270		)
Securities – non-taxable	(261		)	(84		)	(345		)
Other earning assets	(465		)	179			(286		)
Total earning assets	2,980			75			3,055
Interest bearing liabilities:
Interest bearing demand deposits	24			(99		)	(75		)
Money market accounts	61			(220		)	(159		)
Savings deposits	—			(2		)	(2		)
Time deposits of less than $100 thousand	(304		)	(423		)	(727		)
Time deposits of $100 thousand or more	(399		)	(366		)	(765		)
Brokered CDs and CDARS®	(933		)	(364		)	(1,297		)
Repurchase agreements	(3		)	(23		)	(26		)
Other borrowings	15			2			17
Total interest bearing liabilities	(1,539		)	(1,495		)	(3,034		)
Increase in net interest income	$	4,519		$	1,570		$	6,089

Net Interest Income – Volume and Rate Changes

Interest income on a fully-tax equivalent basis for the three and nine months ended September 30, 2014 was $9.8 million and $27.2 million, respectively, a 17.8% and 11.4% increase compared to the same periods in 2013. Average earning assets increased$13.2 million, or 1.4%, in the third quarter of 2014 compared to the same period in 2013, and decreased $52.6 million, or 5.4%, for the nine months ended September 30, 2014. The overall decline in average earning assets is a direct result of our balance sheet restructuring that included utilizing a sizable portion of our excess liquidity following the Recapitalization to pay off certain high rate deposits as they matured. The remaining excess liquidity has been used to fund loan growth. Average loans increased in the third quarter of 2014 by $172.9 million, or 32.7% as compared to the same period in the prior year. The net impact for changes in volumes and rates of interest earning assets for the three and nine months ended September 30, 2014 increased interest income by $1.5 million and $3.0 million, respectively, for changes in volume and decreased interest income by $23 thousand and increased income by $75 thousand, respectively, for changes in the rate of interest earning assets. The total impact on net interest income from changes in volume was an increase of $1.7 million and $4.5 million for the three and nine months ended September 30, 2014 when compared to the same periods in 2013.

The tax equivalent yield on average earning assets increased by 0.57% and 0.64% to 4.14% and 3.96%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013, largely driven by the increase in loans and reductions in excess cash. The yield on average loans increased by 0.13% and decreased 0.04%, respectively, to 4.97% and 4.76%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. The yields on average investment securities taxable, investment securities non-taxable and average other earning assets decreased by 0.21%, 0.27% and 0.40%, respectively, for the three months ended September 30, 2014 compared to the same period in 2013. For the nine months ended September 30, 2014, the yields on average investments securities taxable and average other earning assets increased by 0.08% and 0.34%, respectively, and the yield on investment securities non-taxable decreased by 0.40% when compared to the same period in 2013.

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Total interest expense was $1.3 million and $4.0 million for the three and nine months ended September 30, 2014, respectively, or 35.5% and 41.9%lower, respectively, than the same periods in 2013. Average interest bearing liabilities decreased by $13.6 million and $81.3 million for the three and nine month periods ended September 30, 2014, respectively, compared to the same periods in 2013, largely driven by our overall balance sheet restructuring initiative as well as our focus on increasing non-interest bearing deposit accounts. Comparing the third quarter of 2014 to the same period in 2013, average brokered deposits declined by $5.0 million while retail certificates of deposits declined by $37.5 million and jumbo certificates of deposit decreased $47.8 million, partially offset by an increase in other borrowings of $42.2 million. Comparing the nine months ended September 30, 2014 to the same period in 2013, average brokered deposits declined by $45.4 million while retail and jumbo certificates of deposit decreased by $48.6 million and $58.4 million, respectively, partially offset by an increase in other borrowing of $42.2 million. The reductions in volume reduced interest expense by $185 thousand and $1.5 million for the three and nine month period ended September 30, 2014, respectively. Further reducing interest expense $584 thousand and $1.5 million for the three and nine month period ended September 30, 2014, respectively, was the decline in rates paid on interest bearing liabilities, primarily in retail and jumbo certificates of deposits and brokered deposits. The decrease in rates is due primarily to term deposits maturing and repricing at lower current market rates.

Prior to the Recapitalization, we maintained above market rates on deposits to ensure that we maintained excess liquidity. Following the Recapitalization, we reduced our rates on all deposit products to market competitive rates. The reduction of rates on interest bearing liabilities reduced interest expense by $584 thousand and $1.5 million for the three and nine months ended September 30, 2014, respectively, when compared to the same periods in 2013. The average rate paid on interest bearing liabilities for the three and nine months ended September 30, 2014 decreased by 35 and 39 basis points, respectively, to 0.66% and 0.70%, respectively. For the three months ended September 30, 2014, the average rate paid on in-market retail CDs declined by 31 basis points and the average rate paid on jumbo CDs declined by 31 basis points, resulting in combined savings of approximately $254 thousand. For the nine months ended September 30, 2014, the average rate paid on in-market retail CDs declined by 30 basis points and the average rate paid on jumbo CDs declined by 29 basis points, resulting in a savings of approximately $789 thousand.

We expect average earning assets to grow throughout the remainder of 2014 as we anticipate continued strong loan growth. The average yield on loans for the remainder of 2014 is anticipated to be consistent with or decline compared to 2013 as we continue to operate in a highly competitive rate environment within our markets. We expect the level of brokered deposits to continue to decline through the remainder of 2014 while all other interest bearing liabilities are expected to increase to fund the expected asset growth. Rates paid on deposits are expected to continue to decline compared to 2013 rates as higher cost brokered CDs mature and are replaced with lower rate core deposits or funded from our excess liquidity.

Net Interest Income – Net Interest Spread and Net Interest Margin

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The net interest rate spread does not consider the impact of noninterest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing noninterest bearing deposits in earning assets.

Our net interest rate spread (on a tax equivalent basis) was 3.48% and 3.26% for the three and nine months ended September 30, 2014, respectively, compared to 2.56% and 2.23%, respectively, for the same periods in 2013. Our net interest margin was 3.60% and 3.38% for the three and nine months ended September 30, 2014, respectively, compared to 2.71% and 2.38% for the same periods in 2013. Excluding the previously discussed discount accretion, the net interest margin for the third quarter of 2014 was 3.33%. The increase in the net interest spread and net interest margin comparing 2014 to 2013 was a direct result of our balance sheet restructuring that included significant loan growth combined with reductions in high cost deposits. Noninterest bearing deposits contributed 12 basis points to the margin for both the three and nine months ended September 30, 2014, and 15 basis points for both the three and nine month period ended September 30, 2013.

We anticipate our adjusted net interest spread and net interest margin to continue improving during the remainder of 2014 and into 2015. However, improvement is dependent on multiple factors including our ability to grow loans and raise core deposits, maturities of brokered deposits, our deposit and loan pricing, and any possible further action by the Federal Reserve Board to adjust the target federal funds rate.

Provision (Credit) for Loan and Lease Losses

The provision (credit) for loan and lease losses during the three and nine month periods ended September 30, 2014, of $11 thousand and $(1.2) million, respectively, compared to a credit of $(1.6) million and $(1.8) million, respectively, for the same periods in 2013. Net charge-offs for the three and nine months ended September 30, 2014 were $664 thousand and $669 thousand, respectively, compared to net charge-offs (recoveries) of $(32) thousand and $1.3 million for the same periods in

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2013. Annualized net charge-offs as a percentage of average loans were 0.09% for the nine months ended September 30, 2014 compared to 0.32% for the same period in 2013. Our peer group’s average annualized net charge-offs as a percentage of average loans as reported in the Uniform Bank Performance Report at June 30, 2014, the most recent information available, was 0.15%.

The provision for loan and lease losses for the three and nine months of 2014 was based on our analysis of probable incurred losses in the loan portfolio, positive asset quality trends and net recoveries during 2014. As of September 30, 2014, specific reserves for impaired loans totaled $9 thousand compared to $450 thousand as of December 31, 2013 and zero as of September 30, 2013. At September 30, 2014, our ratio of the allowance to total loans was 1.29% compared to 1.80% at December 31, 2013 and 2.00% at September 30, 2013.

As of September 30, 2014, management determined our allowance of $8.6 million was adequate to provide for probable incurred credit losses, which we describe more fully below in the Allowance for Loan and Lease Losses section. We analyze the allowance on at least a quarterly basis, and the next review will be at December 31, 2014, or sooner if needed; the provision expense will be adjusted accordingly, if necessary.

We will provide provision expense as necessary to maintain an allowance level adequate to absorb known and probable incurred losses inherent in our loan portfolio. As the determination of provision expense, or reversal, is a function of the adequacy of the allowance for loan and lease losses, we cannot reasonably estimate the provision impact for the remainder of 2014. Furthermore, the provision expense could materially increase or decrease in 2014 depending on a number of factors, including, among others, the level of net charge-offs or recoveries, the amount of classified loans and value of collateral associated with impaired loans and the level of loan growth realized.

Noninterest Income

Noninterest income totaled $2.8 million and $8.5 million for the three and nine months ended September 30, 2014, an increase of $513 thousand and $2.0 million, respectively, or 22.4% and 30.4%, respectively, from the same periods in 2013. The increase for both the quarter and year-to-date periods in 2014 is primarily a result of net gains from sales of loans held-for-sale and the sale of securities available-for-sale.

The following table presents the components of noninterest income for the three and nine month periods ended September 30, 2014 and 2013.

NONINTEREST INCOME

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014		Percent Change		2013		2014		Percent Change		2013
	(in thousands, except percentages)
Service charges on deposit accounts	$	778	(2.5	)%	$	798	$	2,288	(0.4	)%	$	2,298
Point-of-sale (POS) fees	436		8.7	%	401		1,276		9.0	%	1,171
Bank-owned life insurance income	234		(1.7	)%	238		820		13.4	%	723
Mortgage banking income	462		10.0	%	420		921		(0.6	)%	927
Trust fees	233		20.7	%	193		668		26.8	%	527
Net gains on sales of securities available-for-sale	10		100.0	%	—		628		307.8	%	154
Net gains on sales of loans held-for-sale	254		100.0	%	—		726		100.0	%	—
Interest rate swap gain	138		711.8	%	17		375		1,036.4	%	33
Other income	260		15.6	%	225		768		15.7	%	664
Total noninterest income	$	2,805	22.4	%	$	2,292	$	8,470	30.4	%	$	6,497

Our largest sources of noninterest income are service charges and fees on deposit accounts. Total service charges, including NSF fees, were $778 thousand and $2.3 million for the three and nine months ended September 30, 2014, a decrease of $20 thousand, or 2.5%, and an decrease of $10 thousand, or 0.4%, respectively, from the same periods in 2013. While service charges and fees on deposit accounts typically correspond to the level and mix of our customer deposits, the continued implementation of the Dodd-Frank financial reform legislation may directly or indirectly impact the fee structure of our deposit products; therefore, we cannot reasonably estimate deposit fees for future periods.

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Point-of-sale fees increased 8.7% to $436 thousand and 9.0% to $1.3 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. POS fees are primarily generated when our customers use their debit cards for retail purchases. We anticipate POS fees to continue to grow as customer trends show increased use of debit cards, although it is unclear if certain provisions affecting interchange fees for card issuers included in the Dodd-Frank financial reform legislation will have a future material impact on this product and its revenue.

Bank-owned life insurance income was $234 thousand and $820 thousand for the three and nine months ended September 30, 2014, a decrease of $4 thousand or 1.7% and an increase of $97 thousand, or 13.4%, respectively, from 2013 levels. The increase in the nine months ended September 30, 2014 was related to a one-time interest bonus for certain policies that was recognized during the first quarter of 2014. The Company is the owner and beneficiary of these contracts. The income generated by the cash value of the insurance policies accumulates on a tax-deferred basis and is tax-free to maturity. In addition, the insurance death benefit will be a tax-free payment to the Company. On a fully tax-equivalent basis, the weighted average interest rate earned on the policies was approximately 5.14% for the nine months ended September 30, 2014.

Mortgage banking income for the three and nine months ended September 30, 2014 increased $42 thousand, or 10.0% and decreased $6 thousand, or 0.6%, respectively, to $462 thousand and $921 thousand, respectively, compared to $420 thousand and $927 thousand, respectively, in the same periods of 2013. Our process to originate and sell a conforming mortgage in the secondary market typically takes 30 to 60 days from the date of mortgage origination to the date the mortgage is sold to an investor in the secondary market. Due to the normal processing time, we will have a certain amount of held-for-sale loans at any time. Mortgages originated for sale in the secondary market totaled $16.4 million, $39.5 million, and $33.8 million as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively. Mortgages sold in the secondary market totaled $16.5 million, $42.9 million and $35.7 million as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively. We sell these loans with the right to service the loan being released to the purchaser for a fee. During the second half of 2013, we focused on recruiting and retaining mortgage originators with a focus on purchase originations due to the significant declines in refinancing activities. Mortgage fee income for the remainder of 2014 will be dependent on market conditions.

Trust and wealth management fee income increased by $40 thousand, or 20.7%, and $141 thousand, or 26.8%, for the three and nine months ended September 30, 2014 compared to $193 thousand and $527 thousand, respectively, for the same periods in 2013. We expect trust fee income to continue increasing during 2014.

Net gains on sales of securities available-for-sale for the three and nine months ended September 30, 2014 increased $10 thousand and $474 thousand, respectively, from zero and $154 thousand, respectively, when compared to the same periods in 2013.

Net gains on sales of loans transferred to held-for-sale for the three and nine months ended September 30, 2014 were $254 thousand and $726 thousand, respectively, compared to zero for the same periods in 2013.

Interest rate swap gains for the three and nine months ended September 30, 2014 were $138 thousand and $375 thousand, respectively, compared to $17 thousand and $33 thousand, respectively, for the same periods in 2013. We have entered into loan level swaps to provide our customers with long-term fixed rate loans while entering into associated derivatives to convert the fixed rate cash flows to variable rate cash flows. As shown below, the interest rate swap gains are typically offset by the associated derivatives, which are included in in non-interest expense.

Other income for the three and nine months ended September 30, 2014 was $398 thousand and $1.1 million, respectively, compared to $225 thousand and $697 thousand, respectively, for each of the same periods in 2013. The components of other income primarily consist of ATM fee income, underwriting revenue, safe deposit box fee income, repossessions, leased equipment and premises and equipment.

Noninterest Expense

Noninterest expense decreased $975 thousand, or 8.7%, and decreased $6.8 million, or 18.2%, to $10.2 million and $30.8 million for the three and nine months ended September 30, 2014, respectively, compared to $11.2 million and $37.6 million for the same periods in 2013. Total noninterest expense decreased for the three and nine months ended September 30, 2014, primarily due to decreases in salary expense, insurance expense and non-performing asset expenses.

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The following table represents the components of noninterest expense for the three and six month periods ended September 30, 2014 and 2013.

NONINTEREST EXPENSE

	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2014			Percent Change		2013			2014			Percent Change		2013
	(in thousands, except percentages)
Salaries & benefits	$	5,153		(11.3	)%	$	5,807		$	15,652		(8.4	)%	$	17,081
Occupancy	814			(8.6	)%	891			2,410			(3.7	)%	2,502
Furniture and equipment	565			(13.9	)%	656			1,642			(8.7	)%	1,799
Professional fees	658			23.5	%	533			1,947			5.8	%	1,840
FDIC insurance	336			124.0	%	150			983			(54.3	)%	2,150
Write-downs on OREO and repossessions	289			(22.7	)%	374			674			(66.2	)%	1,997
Gains on other real estate owned, repossessions and fixed assets	(113		)	(2.6	)%	(116		)	(118		)	(71.7	)%	(417		)
Non-performing asset expenses	204			(58.2	)%	488			609			(82.6	)%	3,506
Data processing	577			(8.1	)%	628			1,671			(1.5	)%	1,697
Communications	129			(8.5	)%	141			426			3.6	%	411
ATM/Debit card fees	244			17.9	%	207			734			17.4	%	625
Intangible asset amortization	49			(26.9	)%	67			146			(31.5	)%	213
Printing & supplies	144			(32.4	)%	213			501			(5.1	)%	528
Advertising	140			57.3	%	89			409			66.3	%	246
Insurance	295			(43.6	)%	523			923			(50.7	)%	1,873
OCC assessments	89			(28.8	)%	125			272			(27.7	)%	376
Interest rate swap loss	138			711.8	%	17			381			1,054.5	%	33
Other expense	511			26.5	%	404			1,506			30.5	%	1,154
Total noninterest expense	$	10,222		(8.7	)%	$	11,197		$	30,768		(18.2	)%	$	37,614

Salaries and benefits for the three and nine months ended September 30, 2014 decreased $654 thousand and $1.4 million, respectively, or 11.3%, and 8.4%, respectively, compared to the same periods in 2013. The decrease in salaries and benefits is primarily related to a reduction in the number of employees. The total savings provided by the reduction in the total number of employees was partially offset by the hiring of certain highly experienced in-market banking officers to assist in providing loan growth within our primary markets. As of September 30, 2014, we had 26 full-service banking offices with 264 full-time equivalent employees. As of September 30, 2013, we had 30 full-service banking offices with 313 full-time equivalent employees.

Occupancy expense decreased $77 and $92 thousand, or 8.6% and 3.7% for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, primarily as a result of fewer locations. As of September 30, 2014, First Security leased six facilities and the land for two branches. As a result, current period occupancy expense is higher than if we owned these facilities, including the real estate, but conversely, we have been able to deploy the capital into earning assets rather than capital expenditures for facilities.

Professional fees increased $125 thousand and $107 thousand for the three and nine months ended September 30, 2014, respectively, compared to the same period in 2013. Professional fees include fees related to investor relations, outsourcing internal audit and a portion of compliance, as well as external audit, tax services and legal and accounting advice related to, among other things, litigation, lending activities, employee benefit programs, foreclosures and regulatory matters.

FDIC deposit premium insurance decreased $1.2 million to $983 thousand for the nine months ended September 30, 2014 compared to the same period in 2013. The year-over-year decrease is a direct result of the bank's improved capital condition at during 2014.

Insurance expense decreased $228 thousand to $295 thousand and decreased $950 thousand to $923 thousand, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. In connection

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with the 2013 Recapitalization, we converted certain insurance policies into long-term tail policies with the payment of additional premiums. Additionally, our ongoing insurance expense has declined as a result of our improved financial condition.

At foreclosure or repossession, the fair value of the OREO property or repossession is determined and a charge-off to the allowance is recorded, if applicable. Any decreases in value subsequent to the initial determination of fair value are recorded as a write-down. As a general policy, we re-assess the fair value of OREO and repossessions on at least an annual basis or sooner if there are indicators that deterioration in value has occurred. Write-downs are based on property-specific appraisals or valuations. Additionally, we evaluate on an ongoing basis our realization rate compared to the appraised values. Write-downs have declined due to fewer properties currently in OREO. Write-downs on OREO and repossessions decreased $85 thousand, or 22.7%, and decreased $1.3 million, or 66.2%, respectively, for the three and nine month period ended September 30, 2014 compared to the same periods in 2013. Write-downs for the remainder of 2014 are dependent on multiple factors, including, but not limited to, the assumptions used by the independent appraisers, real estate market conditions, and our ability to liquidate properties.

Net gains on OREO, repossessions and fixed assets decreased $3 thousand to $113 thousand, or 2.6%, and decreased $299 thousand to $118 thousand, or 71.7%, respectively, for the three and nine month periods ended September 30, 2014 compared to the same periods in 2013. As discussed above, we continue to monitor our fair value assumptions and recognize additional write-downs when appropriate. Generally, gains and losses on the sale of OREO should be minimized by our initial fair value assumptions applied to OREO, as discussed above.

Non-performing asset expenses include, among other items, maintenance, repairs, utilities, taxes and storage costs. These costs decreased $284 thousand, or 58.2%, and $2.9 million, or 82.6%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. Historically, our holding costs have been commensurate with the level of nonperforming assets. We anticipate continued reductions in this category during 2014.

Data processing fees decreased 8.1% and 1.5% to $577 thousand and $1.7 million, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. The monthly fees associated with data processing are typically based on transaction volume but also reflect cost savings achieved in our data processing contract.

Advertising expense increased 57.3% and 66.3% to $140 thousand and $409 thousand, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. This increase was due to the implementation of our new branding and associated logo as well as various marketing campaigns.

Intangible asset amortization expense declined $18 thousand, or 26.9%, and declined $67 thousand, or 31.5%, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. Our core deposit intangible assets amortize on an accelerated basis in which the expense recognized declines over the estimated useful life of ten years. We anticipate slight decreases in amortization expense throughout the remainder of 2014.

Interest rate swap losses for the three and nine months ended September 30, 2014 were $138 thousand and $381 thousand, respectively, compared to $17 thousand and $33 thousand, respectively, for the same periods in 2013. We have entered into loan level swaps to provide our customers with long-term fixed rate loans while entering into associated derivatives to convert the fixed rate cash flows to variable rate cash flows. As shown in the non-interest income section above, the losses are typically offset in full.

Other expense increased $228 thousand and $700 thousand, respectively, for the three and nine months ended September 30, 2014 compared to the same periods in 2013. The increase in other expense is associated with several sub-components and was part of the normal course of conducting business.

Income Taxes

We recorded an income tax provision of $132 thousand and $395 thousand, respectively, for the three and nine months ended September 30, 2014 compared to an income tax provision of $322 thousand and $358 thousand, respectively, for the same periods in 2013. For the nine months ended September 30, 2014, we recorded $288 thousand in additional deferred tax valuation allowance to offset the tax benefits generated during the first three quarters of 2014, including changes in other comprehensive income.

A valuation allowance is required when it is “more likely than not” that the deferred tax assets will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions. We identified as positive evidence the improvement in current business trends and the existence of taxes paid in available carryback years. Negative evidence included a cumulative loss in recent years. As conditions change, we will evaluate the need to increase or decrease the valuation allowance. Currently, we anticipate increasing the valuation allowance to offset any future recorded tax benefit to result in minimal, if any, income tax expense or benefit. During the second quarter of 2014, we achieved taxable income with the return to core profitability and further expanded our profitability in the third quarter. Our

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ability to maintain and steadily improve our level of profitability, combined with forecasts of future income, will provide positive evidence in our quarterly evaluation and analysis of our valuation allowance. As positive evidence builds over multiple quarters, the valuation allowance may be reduced in part or in full.

At September 30, 2014, we evaluated our significant uncertain tax positions. Under the “more-likely-than-not” threshold guidelines, we believe we have identified all significant uncertain tax benefits. We evaluate, on a quarterly basis or sooner if necessary, to determine if new or pre-existing uncertain tax positions are significant. In the event a significant uncertain tax position is determined to exist, penalty and interest will be recorded as a component of income tax expense in our consolidated financial statements.

FINANCIAL CONDITION

As of September 30, 2014, we had total consolidated assets of $1.0 billion, total loans held-for-investment of $666.7 million, loans held-for-sale of $46.9 million, total deposits of $879.0 million and shareholders’ equity of $88.0 million. As of December 31, 2013, we had total consolidated assets of $977.6 million, total loans of $583.1 million, total deposits of $857.3 million and shareholders' equity of $83.6 million. As of September 30, 2013, we had total assets of $1.0 billion, total loans of $534.6 million, total deposits of $909.8 million and shareholders' equity of $83.4 million.

Loans

As we continue to implement our strategic initiatives and restructure the mix of earning assets, we expect to realize continued growth in our loan portfolio. As of September 30, 2014, total loans increased by $83.6 million, or 14.3% (19.2% annualized), from December 31, 2013 and increased by $132.1 million, or 24.7%, from September 30, 2013.

The following table presents our loan portfolio by type.

LOAN PORTFOLIO

										Percent change from
	September 30, 2014			December 31, 2013			September 30, 2013			December 31, 2013		September 30, 2013
	(in thousands, except percentages)
Loans secured by real estate –
Residential 1-4 family	$	183,857		$	181,988		$	173,446		1.0	%	6.0	%
Commercial	315,617			261,935			222,603			20.5	%	41.8	%
Construction	49,542			39,936			42,364			24.1	%	16.9	%
Multi-family and farmland	18,867			17,663			18,844			6.8	%	0.1	%
	567,883			501,522			457,257			13.2	%	24.2	%
Commercial loans	68,001			55,337			50,879			22.9	%	33.7	%
Consumer installment loans	26,382			21,103			21,586			25.0	%	22.2	%
Other	4,462			5,135			4,905			(13.1	)%	(9.0	)%
Total loans	666,728			583,097			534,627			14.3	%	24.7	%
Allowance for loan and lease losses	(8,600		)	(10,500		)	(10,700		)	(18.1	)%	(19.6	)%
Net loans	$	658,128		$	572,597		$	523,927		14.9	%	25.6	%

Loans year-to-date have incurred substantial growth with an increase of approximately $83.6 million when compared to December 31, 2013. This is mostly due to an increase in commercial real estate loans of $53.7 million, or 20.5%, an increase in construction real estate of $9.6 million, or 24.1%, and an increase in commercial and industrial loans of $12.7 million, or 22.9%.

Comparing September 30, 2014 to September 30, 2013, loans increased by $132.1 million, or 24.7%. This increase was primarily due to increases in residential 1-4 family real estate loans of $10.4 million, or 6.0%, commercial real estate loans of $93.0 million, or 41.8%, construction real estate loans of $7.2 million, or 16.9% and commercial and industrial loans of $17.1 million, or 33.7%.

As we develop and implement lending initiatives, we will focus on extending prudent loans to creditworthy consumers and businesses. We anticipate solid loan growth to continue during the remainder of 2014. Funding of future loans may be restricted by our ability to raise core deposits, although we may use current cash reserves and wholesale funding, as necessary and appropriate. Loan growth may also be restricted by the necessity to maintain appropriate capital levels.

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Allowance for Loan and Lease Losses

The allowance for loan and lease losses reflects our assessment and estimate of the risks associated with extending credit and our evaluation of the quality of the loan portfolio. We regularly analyze our loan portfolio in an effort to establish an allowance that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:

• our loan loss experience;

• specific known risks;

• the status and amount of past due and non-performing assets;

• underlying estimated values of collateral securing loans;

• current and anticipated economic conditions; and

• other factors which we believe affect the allowance for potential credit losses.

The allowance is composed of two primary components: (1) specific impairments for substandard/nonaccrual loans and leases and (2) general allocations for classified loan pools, including special mention and substandard/nonaccrual loans, as well as general allocations for the remaining pools of loans. We accumulate pools based on the underlying classification of the collateral. Each pool is assigned a loss severity rate based on historical loss experience and various qualitative and environmental factors, including, but not limited to, credit quality and economic conditions.

The following loan portfolio segments have been identified: (1) Real estate: Residential 1-4 family, (2) Real estate: Commercial, (3) Real estate: Construction, (4) Real estate: Multi-family and farmland, (5) Commercial, (6) Consumer, and (7) Other. We evaluate the risks associated with these segments based upon specific characteristics associated with the loan segments. The risk associated with the Real estate: Construction portfolio is most directly tied to the probability of declines in value of the residential and commercial real estate in our market area and secondarily to the financial capacity of the borrower. The risk associated with the Real estate: Commercial portfolio is most directly tied to the lease rates and occupancy rates for commercial real estate in our market area and secondarily to the financial capacity of the borrower. The other portfolio segments have various risk characteristics, including, but not limited to: the borrower’s cash flow, the value of the underlying collateral, and the capacity of guarantors.

An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan and lease losses is prepared jointly by our accounting and credit administration departments and presented to our Board of Directors or the Directors’ Loan Committee on at least a quarterly basis. Based on our analysis, we may determine that our future provision expense needs to increase or decrease in order for us to remain adequately reserved for probable, incurred loan losses. As stated earlier, we make this determination after considering both quantitative and qualitative factors under appropriate regulatory and accounting guidelines.

Our allowance for loan and lease losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance compared to a group of peer banks. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance methodology differ materially from the bank’s methodology. We believe our allowance methodology is in compliance with regulatory inter-agency guidance as well as applicable GAAP guidance.

While it is our policy to charge-off all or a portion of certain loans in the current period when a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because the assessment of these risks includes assumptions regarding local and national economic conditions, our judgment as to the adequacy of the allowance may change from our original estimates as more information becomes available and events change.

Allowance—Loan Pools

As indicated in the Allowance—Overview above, we analyze our allowance by segregating our portfolio into two primary categories: impaired loans and non-impaired loans. Impaired loans are individually evaluated, as further discussed below. Non-impaired loans are segregated first by loan risk rating and then into homogeneous pools based on loan type, collateral or purpose of proceeds. We believe our loan pools conform to regulatory and accounting guidelines.

Impaired loans generally include those loan relationships in excess of $500 thousand with a risk rating of substandard/nonaccrual or doubtful. For these loans, we determine the impairment based upon one of the following methods: (1) discounted cash flows, (2) observable market pricing or (3) the fair value of the collateral. The amount of the estimated loss, if any, is then specifically reserved in a separate component of the allowance unless the relationship is considered collateral dependent, in which case the estimated loss is charged-off in the current period.

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For non-impaired loans, we first segregate special mention and non-impaired substandard loans into two distinct pools. All remaining loans are further segregated into homogeneous pools based on loan type, collateral or purpose of proceeds. Each of these pools is evaluated individually and is assigned a loss factor based on our best estimate of the loss that potentially could be realized in that pool of loans. The loss factor is the sum of an objectively calculated historical loss percentage and a subjectively calculated risk percentage. The actual annual historical loss factor is typically a weighted average of each period’s loss. For the historical loss factor, we utilize a migration loss analysis. Each period may be assigned a different weight depending on certain trends and circumstances. The subjectively calculated risk percentage is the sum of eight qualitative and environmental risk categories. These categories are evaluated separately for each pool. The eight risk categories are: (1) underlying collateral value, (2) lending practices and policies, (3) local and national economies, (4) portfolio volume and nature, (5) staff experience, (6) credit quality, (7) loan review and (8) competition, regulatory and legal issues.

From time to time, we may include an unallocated component to the allowance. Generally, an unallocated allowance assists in mitigating inherent risks that cannot be quantitatively or qualitatively determined, including, but not limited to, new loan products for which insufficient history exists for a robust analysis.

Allowance—Loan Risk Ratings

A consistent and appropriate loan risk rating methodology is a critical component of the allowance. We classify loans as: pass, special mention, substandard/impaired, substandard/non-impaired, doubtful or loss. The following describes our loan classifications and the various risk indicators associated with each risk rating.

A pass rating is assigned to those loans that are performing as contractually agreed and do not exhibit the characteristics of the criticized and classified risk ratings as defined below. Pass loan pools do not include the unfunded portions of binding commitments to lend, standby letters of credit, deposit secured loans or mortgage loans originated with commitments to sell in the secondary market. Loans secured by segregated deposits held by FSGBank are not required to have an allowance reserve, nor are originated held-for-sale mortgage loans pending sale in the secondary market.

A special mention loan risk rating is considered criticized but is not considered as severe as a classified loan risk rating. Special mention loans contain one or more potential weakness(es), which if not corrected, could result in an unacceptable increase in credit risk at some future date. These loans may be characterized by the following risks and/or trends:

Loans to Businesses:

• Downward trend in sales, profit levels and margins

• Impaired working capital position compared to industry

• Cash flow strained in order to meet debt repayment schedule

• Technical defaults due to noncompliance with financial covenants

• Recurring trade payable slowness

• High leverage compared to industry average with shrinking equity cushion

• Questionable abilities of management

• Weak industry conditions

• Inadequate or outdated financial statements

Loans to Businesses or Individuals:

• Loan delinquencies and overdrafts may occur

• Original source of repayment questionable

• Documentation deficiencies may not be easily correctable

• Loan may need to be restructured

• Collateral or guarantor offers adequate protection

• Unsecured debt to tangible net worth is excessive

A substandard loan risk rating is characterized as having specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic, or managerial nature, and may warrant non-accrual status. Substandard loans have a greater likelihood of loss and may require a protracted work-out plan. Substandard/impaired loans are relationships in excess of $500 thousand and are individually reviewed. In addition to the factors listed for special mention loans, substandard loans may be characterized by the following risks and/or trends:

Loans to Businesses:

• Sustained losses that have severely eroded equity and cash flows

• Concentration in illiquid assets

• Serious management problems or internal fraud

• Chronic trade payable slowness; may be placed on COD or collection by trade creditor

• Inability to access other funding sources

• Financial statements with adverse opinion or disclaimer; may be received late

• Insufficient documented cash flows to meet contractual debt service requirements

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Loans to Businesses or Individuals:

• Chronic or severe delinquency or has met the retail classification standards which is generally past dues greater than 90 days

• Frequent overdrafts

• Likelihood of bankruptcy exists

• Serious documentation deficiencies

• Reliance on secondary sources of repayment which are presently considered adequate

• Demand letter sent

• Litigation may have been filed against the borrower

Loans with a risk rating of doubtful are individually analyzed to determine our best estimate of the loss based on the most recent assessment of all available sources of repayment. Doubtful loans are considered impaired and placed on nonaccrual. For doubtful loans, the collection or liquidation in full of principal and/or interest is highly questionable or improbable. We estimate the specific potential loss based upon an individual analysis of the relationship risks, the borrower’s cash flow, the borrower’s management and any underlying secondary sources of repayment. The amount of the estimated loss, if any, is then either specifically reserved in a separate component of the allowance or charged-off. In addition to the characteristics listed for substandard loans, the following characteristics apply to doubtful loans:

Loans to Businesses:

• Normal operations are severely diminished or have ceased

• Seriously impaired cash flow

• Numerous exceptions to loan agreement

• Outside accountant questions entity’s survivability as a “going concern”

• Financial statements may be received late, if at all

• Material legal judgments filed

• Collection of principal and interest is impaired

• Collateral/Guarantor may offer inadequate protection

Loans to Businesses or Individuals:

• Original repayment terms materially altered

• Secondary source of repayment is inadequate

• Asset liquidation may be in process with all efforts directed at debt retirement

• Documentation deficiencies not correctable

The consistent application of the above loan risk rating methodology ensures we have the ability to track historical losses and appropriately estimate potential future losses in our allowance. Additionally, appropriate loan risk ratings assist us in allocating credit and special asset personnel in the most effective manner. Significant changes in loan risk ratings can have a material impact on the allowance and thus a material impact on our financial results by requiring significant increases or decreases in provision expense.

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The following table presents an analysis of the changes in the allowance for loan and lease losses for the nine months ended September 30, 2014 and 2013. The provision (credit) for loan and lease losses in the table below does not include our provision for losses on unfunded commitments of $18 thousand for each of the nine month periods ended September 30, 2014 and 2013. The reserve for unfunded commitments totaled $300 thousand and $276 thousand as of September 30, 2014 and 2013, respectively, and is included in other liabilities in the accompanying consolidated balance sheets.

ANALYSISOF CHANGESIN ALLOWANCEFOR LOANAND LEASE LOSSES

	For the Nine Months Ended
	September 30,
	2014			2013
	(in thousands, except percentages)
Allowance for loan and lease losses –
Beginning of period	$	10,500		$	13,800
Credit for loan and lease losses	(1,231		)	(1,780		)
Sub-total	9,269			12,020
Charged-off loans:
Real estate – residential 1-4 family	392			1,324
Real estate – commercial	749			531
Real estate – construction	228			503
Real estate – multi-family and farmland	—			36
Commercial loans	32			31
Consumer installment and other loans	378			460
Leases, net of unearned income	30			—
Other loans	—			—
Total charged-off	1,809			2,885
Recoveries of charged-off loans:
Real estate – residential 1-4 family	210			281
Real estate – commercial	495			313
Real estate – construction	120			312
Real estate – multi-family and farmland	12			15
Commercial loans	256			218
Consumer installment and other loans	197			289
Leases, net of unearned income	95			133
Other	2			4
Total recoveries	1,387			1,565
Net charged-off	422			1,320
Decrease from transfer of loans held-for-investment to loans held-for-sale	(247		)	—
Allowance for loan and lease losses – end of period	$	8,600		$	10,700
Total loans – end of period	$	666,728		$	534,627
Average loans	$	660,274		$	544,136
Net loans charged-off to average loans, annualized	0.09		%	0.32		%
Credit for loan and lease losses to average loans, annualized	(0.25		)%	(0.44		)%
Allowance for loan and lease losses as a percentage of:
Period end loans	1.30		%	2.00		%
Nonperforming loans	144.51		%	146.33		%

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The following table presents the allocation of the allowance for loan and lease losses for each respective loan category with the corresponding percentage of loans in each category to total loans. The comprehensive allowance analysis developed by our financial reporting and credit administration group enables us to allocate the allowance based on risk elements within the portfolio.

ALLOCATIONOFTHE ALLOWANCEFOR LOANAND LEASE LOSSES

	As of September 30, 2014				As of December 31, 2013				As of September 30, 2013
	Amount		Percent of Portfolio1		Amount		Percent of Portfolio1		Amount		Percent of Portfolio1
	(in thousands, except percentages)
Real estate – residential 1-4 family	$	2,778	27.6	%	$	4,063	31.2	%	$	4,234	32.4	%
Real estate – commercial	2,099		47.3	%	3,299		44.9	%	2,875		41.6	%
Real estate – construction	746		7.4	%	899		6.8	%	1,348		7.9	%
Real estate – multi-family and farmland	926		2.8	%	916		3.1	%	1,068		3.5	%
Commercial loans	950		10.2	%	970		9.5	%	1,020		9.5	%
Consumer installment loans	677		4.0	%	342		3.6	%	133		4.0	%
Other	7		0.7	%	11		0.8	%	22		1.1	%
Unallocated	417		—	%	—		—	%	—		—	%
Total	$	8,600	100.0	%	$	10,500	100.0	%	$	10,700	100.0	%

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¹ Represents the percentage of loans in each category to total loans.

Throughout the economic downturn, the ratio of the allowance to total loans was significantly increased largely because of the level of nonperforming loans, the associated decline in real estate values, and the excessive level of charge-offs. These factors contributed to elevated levels of classified loans, which is a driving component of the allowance. Since March 31, 2013, we have experienced a significant decline in the level of non-performing loans. Nonperforming loans were $6.0 million, $8.1 million and $7.3 million at September 30, 2014, December 31, 2013, and September 30, 2013, respectively. When comparing September 2014 to December 2013, non-performing loans decreased $2.1 million, and when compared to September 2013, non-performing loans have decreased $1.3 million. During the fourth quarter of 2012, we identified approximately $36.2 million of under- and non-performing loans to sell and recorded a $13.9 million charge-off to reduce the balance to the estimated net proceeds. These loans were sold in the first quarter of 2013. Our ratio of non-performing loans to total loans was 0.89% as of September 30, 2014 as compared to 1.39% as of December 31, 2013 and 1.37% as of September 30, 2013. Additionally, our minimal level of net charge-offs during the first three quarters of 2014 has further supported our improving asset quality. Specifically, net charges-offs for the nine months ended September 30, 2014 were $422 thousand, or 0.09% of average loans on an annualized basis compared to $1.3 million, or 0.32% of average loans on an annualized basis for the same period in 2013.

The combination of positive asset quality trends as well as low loss rates for the prior year resulted in a reduction in our allowance-to-loans ratio to 1.30% at September 30, 2014, compared to 1.80% at December 31, 2013 and 2.00% at September 30, 2013. We anticipate that our allowance model may support a lower allowance-to-loans ratio with continuation of the current asset quality and charge-off trends; however, we may need to provide additional provision expense in the future due to the expected loan growth.

We utilize a risk rating system to evaluate the credit risk of our loan portfolio. We classify loans as: pass, special mention, substandard, doubtful or loss. We assign a pass rating to loans that are performing as contractually agreed and do not exhibit the characteristics of heightened credit risk. A special mention risk rating is assigned to loans that are criticized but not considered to have weaknesses as serious as those of a classified loan. Special mention loans generally contain one or more potential weaknesses, which if not corrected, could result in an unacceptable increase in the credit risk at some future date. A substandard risk rating is assigned to loans that have specifically identified weaknesses and deficiencies typically resulting from severe adverse trends of a financial, economic or managerial nature and may require nonaccrual status. Substandard loans have a greater likelihood of loss. We assign a doubtful risk rating to loans that the collection or liquidation in full of principal and/or interest is highly questionable or improbable. Any loans that are assigned a risk rating of loss are fully charged-off in the period of the downgrade.

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We segregate substandard loans into two classifications based on our allowance methodology for impaired loans. An impaired loan is defined as a substandard loan relationship in excess of $500 thousand that is also on nonaccrual status. These relationships are individually reviewed on a quarterly basis to determine the required allowance or loss, as applicable.

For the allowance analysis, the primary categories are: pass, special mention, substandard – non-impaired, and substandard – impaired. Loans in the substandard and doubtful loan categories are combined and impaired loans are segregated from non-impaired loans.

The following tables present our internal risk rating by loan classification as utilized in the allowance analysis as of September 30, 2014, December 31, 2013 and September 30, 2013:

As of September 30, 2014

	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	171,647	$	6,118	$	5,839	$	253	$	183,857
Real estate: Commercial	307,993		2,519		3,824		1,281		315,617
Real estate: Construction	45,114		3,744		684		—		49,542
Real estate: Multi-family and farmland	17,962		235		670		—		18,867
Commercial	61,531		1,864		4,379		227		68,001
Consumer	26,060		56		266		—		26,382
Other	4,428		—		34		—		4,462
Total Loans	$	634,735	$	14,536	$	15,696	$	1,761	$	666,728

As of December 31, 2013

	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	162,444	$	9,490	$	8,726	$	1,328	$	181,988
Real estate: Commercial	247,096		3,873		9,054		1,912		261,935
Real estate: Construction	37,565		1,596		775		—		39,936
Real estate: Multi-family and farmland	17,236		173		254		—		17,663
Commercial	49,799		2,798		2,420		320		55,337
Consumer	20,741		71		291		—		21,103
Other	5,088		1		46		—		5,135
Total Loans	$	539,969	$	18,002	$	21,566	$	3,560	$	583,097

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As of September 30, 2013

	Pass		Special Mention		Substandard – Non-impaired		Substandard – Impaired		Total
	(in thousands)
Loans by Classification
Real estate: Residential 1-4 family	$	152,115	$	9,182	$	10,725	$	1,424	$	173,446
Real estate: Commercial	207,015		5,206		10,024		358		222,603
Real estate: Construction	37,723		83		4,532		26		42,364
Real estate: Multi-family and farmland	16,947		999		898		—		18,844
Commercial	44,572		2,868		2,683		756		50,879
Consumer	21,228		79		279		—		21,586
Other	4,810		—		95		—		4,905
Total Loans	$	484,410	$	18,417	$	29,236	$	2,564	$	534,627

We classify a loan as 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 agreement. Impaired loans were $1.8 million at September 30, 2014, $3.6 million at December 31, 2013 and $2.6 million at September 30, 2013. For impaired loans, any payments made by the borrower are generally applied directly to principal.

The allowance associated with specific impaired loans totaled $9 thousand as of September 30, 2014, compared to $450 thousand as of December 31, 2013 and zero as of September 30, 2013. General reserves totaled $8.6 million as of September 30, 2014, compared to $10.1 million as of December 31, 2013 and $10.7 million as of September 30, 2013. Specific reserves are based on our evaluation of each impaired relationship. The general reserve is determined by applying the historical loss factor and qualitative and environmental factors to the applicable loan pools. Our allowance as a percentage of total loans has decreased mostly due to a credit to our provision for loan and lease loses and a decrease in non-performing loans. The ratio of the general reserves to the applicable loan pools has declined from 2.00% as of September 30, 2013 and 1.71% as of December 31, 2013 to 1.30% as of September 30, 2014.

We believe that the allowance for loan and lease losses as of September 30, 2014 is sufficient to absorb probable incurred losses in the loan portfolio based on our assessment of the information available, including the results of extensive internal and independent reviews of our loan portfolio, as discussed in the Asset Quality and Non-Performing Assets section below. Our assessment involves uncertainty and judgment; therefore, the level of the allowance as compared to total loans may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant.

Asset Quality and Non-Performing Assets

As of September 30, 2014, our allowance for loan and lease losses as a percentage of total loans was 1.30%, which is a decrease from the 1.80% as of December 31, 2013 and a decrease from the 2.00% as of September 30, 2013.  Net charge-offs as a percentage of average loans (annualized) improved to 0.09% for the nine months ended September 30, 2014 compared to 0.32% for the same period in 2013. As of September 30, 2014, non-performing assets decreased to $11.9 million, or 1.16% of total assets, from $16.3 million, or 1.67% of total assets as of December 31, 2013 and decreased from $16.0 million, or 1.58% of total assets as of September 30, 2013. Our total non-performing loans as of September 30, 2014 decreased by $2.2 million, or 26.8%, and $1.4 million, or 18.6%, respectively, when compared to December 31, 2013 and September 30, 2013. Our total nonperforming assets as of September 30, 2014 decreased by $4.4 million, or 27.1%, and $4.1 million, or 25.5%, respectively, when compared to December 31, 2013 and September 30, 2013. The allowance as a percentage of total non-performing loans was 144.51% as of September 30, 2014 compared to 129.14% at December 31, 2013 and 146.33% at September 30, 2013.

From December 31, 2013 to September 30, 2014, we have seen continued improvement in our asset quality and we believe that overall asset quality will continue to improve. Special mention loans decreased $3.5 million, or 19.3%, from $18.0 million as of December 31, 2013 to $14.5 million as of September 30, 2014. Comparing September 30, 2014 to September 30, 2013, special mention loans decreased by $3.9 million, or 21.1%. Substandard loans decreased $7.7 million, or 30.5%, from $25.1 million at December 31, 2013 to $17.5 million at September 30, 2014. Comparing September 30, 2014 to September 30, 2013, substandard loans decreased by $14.3 million, or 45.1%. We believe based on the trends in substandard loans, there is minimal additional migration to nonperforming loans from the performing loans. We have also achieved steady reductions in other real estate owned. OREO declined by $2.2 million, or 27.4%, from $8.2 million as of December 31, 2013 to $6.0 million

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as of September 30, 2014. Comparing September 30, 2014 to September 30, 2013, OREO declined by $2.7 million, or 31.3%. This is a direct result of our efforts to liquidate and sell our OREO properties as well as reduced inflows into OREO.

Nonperforming assets include nonaccrual loans, loans past-due over ninety days and still accruing, restructured loans, OREO and repossessed assets. We place loans on non-accrual status when we have concerns relating to our ability to collect the loan principal and interest, and generally when such loans are 90 days or more past due.  The following table, which includes both loans held-for-sale and loans held-for-investment, presents our non-performing assets and related ratios.

NON-PERFORMING ASSETS BY TYPE

	September 30, 2014			December 31, 2013			September 30, 2013
	(in thousands, except percentages)
Nonaccrual loans	$	4,000		$	7,203		$	6,803
Loans past due 90 days and still accruing	1,951			928			509
Total nonperforming loans, including loans 90 days and still accruing	$	5,951		$	8,131		$	7,312
Other real estate owned	$	5,952		$	8,201		$	8,662
Repossessed assets	8			12			16
Total nonperforming assets	$	11,911		$	16,344		$	15,990
Nonperforming loans as a percentage of total loans	0.89		%	1.39		%	1.37		%
Nonperforming assets as a percentage of total assets	1.16		%	1.67		%	1.58		%

The following table provides the classifications for nonaccrual loans and other real estate owned as of September 30, 2014, December 31, 2013 and September 30, 2013.

NON-PERFORMING ASSETS – CLASSIFICATIONAND NUMBEROF UNITS

	September 30, 2014			December 31, 2013			September 30, 2013
	Amount		Units	Amount		Units	Amount		Units
	(dollar amounts in thousands)
Nonaccrual loans
Construction/development loans	$	198	3	$	365	3	$	461	5
Residential real estate loans	955		35	2,727		45	3,464		51
Commercial real estate loans	1,346		12	2,710		13	996		8
Commercial and industrial loans	1,246		17	1,137		17	1,605		29
Commercial leases	—		—	—		—	20		3
Consumer and other loans	255		7	264		11	257		8
Total	$	4,000	74	$	7,203	89	$	6,803	104
Other real estate owned
Construction/development	$	2,940	130	$	3,806	242	$	3,860	241
Residential real estate	744		12	1,905		50	1,555		42
Commercial real estate	1,962		14	2,490		30	2,519		29
Multi-family and farmland	—		—	—		—	381		2
Commercial and industrial	306		1	—		—	347		2
Total	$	5,952	157	$	8,201	322	$	8,662	316

Nonaccrual loans totaled $4.0 million, $7.2 million and $6.8 million as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively.  We place loans on nonaccrual when we have concerns related to our ability to collect the loan principal and interest, and generally when loans are 90 or more days past due. As of September 30, 2014, we are not aware of any additional material loans that we have doubts as to the collectability of principal and interest that are not classified as nonaccrual. As previously described, we have individually reviewed each nonaccrual loan in excess of $500 thousand for

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possible impairment. We measure impairment by adjusting loans to either the present value of expected cash flows, the fair value of the collateral or observable market prices.

As of September 30, 2014, nonaccrual loans decreased by $3.2 million, or 44.5%, compared to December 31, 2013. Comparing September 30, 2014 to December 31, 2013, nonaccrual residential real estate loans decreased by $1.8 million and commercial real estate loans decreased by $1.3 million. The decreases were primarily due to successful workouts with minimal, if any, losses. We continue to actively pursue appropriate strategies to maintain or reduce the current level of nonaccrual loans.

OREO decreased$2.2 million from December 31, 2013 to September 30, 2014.  During the nine months endedSeptember 30, 2014, we sold 33 properties for $2.9 million. We expect continued OREO resolutions during 2014 due to marketing strategies and general stabilization in the real estate markets in our footprint.

Loans 90 days past due and still accruing increased $1.0 million for the nine months ending September 30, 2014 when compared to December 31, 2013. As of September 30, 2014, the $2.0 million in loans 90 days past due and still accruing was composed of $1.9 million in residential real estate loans, $22 thousand in commercial loans and $37 thousand of consumer loans.

Loans 90 days past due and still accruing were $928 thousand as of December 31, 2013. Of these past due loans as of December 31, 2013, residential real estate loans totaled $773 thousand, $68 thousand in commercial and industrial loans, $76 thousand in consumer loans and the remainder in other categories.

As of September 30, 2014, loans 90 days past due and still accruing increased $1.4 million when compared to the same period in 2013. As of September 30, 2013, the $332 thousand in loans 90 days past due and still accruing was composed of $496 thousand in residential real estate loans and $13 thousand in multifamily real estate loans.

Total non-performing assets as of the third quarter of 2014 were $11.9 million compared to $16.3 million at December 31, 2013 and $16.0 million at September 30, 2013.

As of September 30, 2014, our asset quality ratios are consistent with or more favorable than our peer group. As previously stated, we monitor our asset quality against our peer group, as defined by all commercial banks with $1 billion to $3 billion in total assets as presented in the UBPR. The following table provides our asset quality ratios and our UBPR peer group ratios as of June 30, 2014, which is the latest available information.

NONPERFORMING ASSET RATIOS

	First Security Group, Inc.		UBPR Peer Group
Nonperforming loans1 as a percentage of gross loans	0.89	%	1.14	%
Nonperforming loans1 as a percentage of the allowance	69.20	%	80.36	%
Nonperforming loans1 as a percentage of equity capital	6.77	%	6.83	%
Nonperforming loans1 plus OREO as a percentage of gross loans plus OREO	1.77	%	1.74	%

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¹ Nonperforming loans are nonaccrual loans plus loans 90 days past due and still accruing

Investment Securities and Other Earning Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of our consolidated balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. Currently, our investments are classified as either available-for-sale or held-to-maturity.  During the fourth quarter of 2013 and the first three quarters of 2014 we sold approximately $57.0 million and $63.5 million of investments primarily to redeploy the funds into loans. There may be additional sales of securities classified as available-for-sale in 2014 as deemed appropriate.

Available-for-sale securities totaled $98.7 million at September 30, 2014, $172.8 million at December 31, 2013 and $207.0 million at September 30, 2013. Held-to-maturity securities totaled $129.3 million at September 30, 2014, $132.6 million at December 31, 2013 and $129.2 million at September 30, 2013. The held-to-maturity securities were transferred from the available-for-sale securities in the third and fourth quarter of 2013. The transfer to the held-to-maturity classification was to minimize any further unrealized losses due to an increase in interest rates, which does not impact regulatory capital, but does impact total shareholders' equity and book value. We maintain a level of securities to provide an appropriate level of liquidity and to provide a proper balance to our interest rate and credit risk in our loan portfolio. The decrease in securities available-for-sale of $74.2 million at September 30, 2014 from December 31, 2013, reflects the sale of securities as noted above as well as

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the redeployment of cash flows principal payments into loans. At September 30, 2014, December 31, 2013 and September 30, 2013, the available-for-sale securities portfolio had gross unrealized gains of approximately $859 thousand, $2.0 million and $2.6 million, and gross unrealized losses of approximately $909 thousand, $2.7 million and $3.0 million, respectively. At September 30, 2014, December 31, 2013 and September 30, 2013, the held-to maturity securities had gross unrecognized gains of approximately $2.9 million, $656 thousand and $1.4 million and gross unrecognized losses of approximately $684 thousand, $1.1 million and $390 thousand, respectively. Our securities portfolio at September 30, 2014 consisted of tax-exempt municipal securities, federal agency bonds, federal agency issued Real Estate Mortgage Investment Conduits (REMICs), federal agency issued pools, collateralized loan obligations and corporate bonds.

The following tables provides the amortized cost of our available-for-sale and held-to-maturity securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the tax equivalent yields for each maturity range.

MATURITYOF AFS INVESTMENT SECURITIES – AMORTIZED COST

	Less than One Year			One to Five Years			Five to Ten Years			More Than Ten Years			Totals
	(in thousands, except percentages)
Municipal - tax exempt	$	725		$	2,338		$	—		$	—		$	3,063
Municipal - taxable	193			637			218			533			1,581
Agency bonds	—			—			—			—			—
Agency issued REMICs	949			26,003			4,940			—			31,892
Agency issued mortgage pools	—			22,679			16,567			448			39,694
Other	—			4,433			14,941			3,123			22,497
Total	$	1,867		$	56,090		$	36,666		$	4,104		$	98,727
Tax equivalent yield	4.51		%	1.78		%	1.50		%	2.74		%	1.77		%

MATURITYOF HTM INVESTMENT SECURITIES – AMORTIZED COST

	Less than One Year			One to Five Years			Five to Ten Years			More Than Ten Years			Totals
	(in thousands, except percentages)
Municipal - tax exempt	$	—		$	—		$	—		$	8,294		$	8,294
Municipal - taxable	—			93			15,854			2,899			18,846
Agency bonds	—			13,026			42,688			8,228			63,942
Agency issued REMICs	—			23,034			2,303			—			25,337
Agency issued mortgage pools	—			2,490			2,239			8,165			12,894
Total	$	—		$	38,643		$	63,084		$	27,586		$	129,313
Tax equivalent yield	—		%	1.59		%	1.87		%	2.63		%	1.95		%

We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. All securities held are historically traded in liquid markets, except for one bond, which is valued utilizing Level 3 inputs. The Level 3 security was a pooled trust preferred security with a book value of $63 thousand.

As of September 30, 2014, we performed an impairment assessment of the available-for-sale securities in the portfolio and the held-to-maturity portfolio that had an unrealized losses to determine whether the decline in the fair value of these securities below their cost was other-than-temporary. Under authoritative accounting guidance, impairment is considered other-than-temporary if any of the following conditions exists: (1) we intend to sell the security, (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (3) we do not expect to recover the security’s entire amortized cost basis, even if we do not intend to sell. Additionally, accounting guidance requires that for impaired available-for-sale securities that we do not intend to sell and/or that it is not more-likely-than-not that we will have to sell prior to recovery but for which credit losses exist, the other-than-temporary impairment should be separated between the total impairment related to credit losses, which should be recognized in current earnings, and the amount of impairment related to all other factors, which should be recognized in other comprehensive income. Losses related to held-to-maturity securities are not

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recorded, as these securities are carried at their amortized cost. If a decline is determined to be other-than-temporary due to credit losses, the cost basis of the individual available-for-sale or held-to-maturity security is written down to fair value, which then becomes the new cost basis. The new cost basis would not be adjusted in future periods for subsequent recoveries in fair value, if any.

In evaluating the recovery of the entire amortized cost basis, we consider factors such as (1) the length of time and the extent to which the market value has been less than cost, (2) the financial condition and near-term prospects of the issuer, including events specific to the issuer or industry, (3) defaults or deferrals of scheduled interest, principal or dividend payments and (4) external credit ratings and recent downgrades.

As of September 30, 2014, gross unrealized losses in our available-for-sale portfolio totaled $909 thousand, compared to $2.6 million as of December 31, 2013 and $3.0 million as of September 30, 2013. As of September 30, 2014, gross unrecognized losses in the held-to-maturity portfolio totaled $684 thousand compared to $1.1 million as of December 31, 2013 and $390 thousand as of September 30, 2013. As of September 30, 2014, the available-for-sale securities unrealized losses in mortgage-backed securities (consisting of twenty-seven securities), municipals (consisting of two securities) and the held-to-maturity unrecognized losses in mortgage-backed securities (consisting of twenty-four securities), municipals (consisting of sixty-six securities) and federal agencies (consisting of twenty-six securities) are primarily due to widening credit spreads and changes in interest rates subsequent to purchase. Between December 31, 2012 and September 30, 2014, the rate on the 10-year U.S. Treasury increased from approximately 1.76% to 2.52%. As this represented an increase in interest rates, the market valuation of our securities adjusted accordingly. The unrealized loss in other available-for-sale securities relates to one corporate note. The unrealized loss in the corporate note is primarily due to changes in interest rates subsequent to purchase. We do not intend to sell the available-for-sale investments with unrealized losses and it is not more likely than not that we will be required to sell the available-for-sale investments before recovery of their amortized cost basis, which may be maturity. Based on results of our impairment assessment, the unrealized losses related to the available-for-sale securities and the unrecognized losses related to the held-to-maturity securities at September 30, 2014 are considered temporary.

As of September 30, 2014 and December 31, 2013, we identified approximately $11.2 million of collateralized loan obligations ("CLOs") within our investment security portfolio that may be impacted by the Volcker Rule. If these securities are deemed to be prohibited bank investments, we would have to sell the securities prior to the compliance date of July 21, 2017. At this time, we continue to evaluate the additional regulatory guidance on the subject as well as the specific terms of the CLOs in our portfolio to determine whether such CLOs will remain permitted investments. The unrealized loss as of September 30, 2014 for the CLOs totaled $93 thousand.

As of September 30, 2014, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 5% of our shareholders’ equity. The following table presents the amortized cost and market value of the securities from each such issuer as of September 30, 2014.

	Amortized Cost		Market Value
	(in thousands)
Federal National Mortgage Association (FNMA)	$	56,194	$	55,533
Federal Home Loan Mortgage Corporation (FHLMC)	$	24,648	$	24,621
Government National Mortgage Association (GNMA)	$	30,583	$	30,060

We held no federal funds sold as of September 30, 2014, December 31, 2013 or September 30, 2013. As of September 30, 2014, we held $7.3 million in interest bearing deposits, primarily at the Federal Reserve Bank of Atlanta, compared to $10.1 million at December 31, 2013 and $59.9 million as of September 30, 2013. The yield on our account at the Federal Reserve Bank is approximately 25 basis points.

At September 30, 2014, we held $29.0 million in bank-owned life insurance, compared to $28.3 million at December 31, 2013 and $28.2 million at September 30, 2013.

Deposits and Other Borrowings

As of September 30, 2014, total deposits increased by 2.5% (3.4% annualized) from December 31, 2013 and decreased by 3.4% from September 30, 2013. The increase from December 31, 2013 was primarily due to the increase in savings and money market accounts as well as a slight increase in brokered deposits offset by reductions in our retail and jumbo certificates of deposit. The decrease from September 30, 2013 was principally because of planned reductions in brokered deposits and reductions in our retail and jumbo certificates of deposit. Excluding brokered deposits, our deposits increased by 1.6% (2.2% annualized) from December 31, 2013 and decreased 3.1% from September 30, 2013. In the first nine months of 2014,

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noninterest bearing demand and interest bearing demand deposits increased by 7.5% and 9.3%, respectively, compared to December 31, 2013. Retail and jumbo certificates of deposit declined by 13.6% and 18.3%, respectively, when comparing September 30, 2014 to December 31, 2013. We define our core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposit with denominations less than $100,000. Core deposits increased by $41.0 million, or 6.5% (8.7% annualized), from December 31, 2013. We consider our retail certificates of deposit to be a stable source of funding because they are in-market, relationship-oriented deposits. Core deposit growth is an important tenet of our business strategy.

Prior to the termination of the Bank's Order on March 10, 2014, the presence of a capital requirement restricted the rates that we could offer on deposit products. Currently, we have no restrictions on the rates that we can offer, although we believe that we can raise sufficient low-cost deposits without pricing above the prevailing market rates.

Brokered certificates of deposits decreased $34.3 million from September 30, 2013 to September 30, 2014 and decreased $20.4 million from December 31, 2013 to September 30, 2014 due to scheduled and called maturities. In addition to brokered certificates of deposits, we are a member bank of the Certificate of Deposit Account Registry Service® ("CDARS") and the Insured Cash Sweep® ("ICS") networks. CDARS is a network of banks that allows customers’ CDs to receive full FDIC insurance of up to $50 million. Additionally, members have the opportunity to purchase or sell one-way time deposits. ICS is a network of banks that allow customer transaction accounts to receive multi-million-dollar FDIC insurance coverage. As of September 30, 2014, our CDARS balance consists of $14.6 million in reciprocal customer accounts and $373 thousand in purchased time deposits. As of September 30, 2014, our ICS balance was $15.1 million in customer accounts.

Brokered deposits at September 30, 2014, December 31, 2013 and September 30, 2013 were as follows:

BROKERED DEPOSITS

	September 30, 2014		December 31, 2013		September 30, 2013
	(in thousands)
Brokered certificates of deposits	$	54,302	$	74,688	$	88,614
CDARS - Customer deposits	14,630		374		373
CDARS - Purchased deposits	—		—		—
ICS - Customer deposits	15,063		—		—
Total	$	83,995	$	75,062	$	88,987

Prior to the termination of the Bank's Order on March 10, 2014, and as discussed in Note 2 of our consolidated financial statements, the presence of a capital requirement in our Order previously restricted our ability to accept, renew, or roll over brokered deposits without prior approval of the FDIC. The excess liquidity over the last two years was in part to ensure we have adequate funding to meet our short-term contractual obligations as long as the Order remained in place.  While our desire is to fund loan growth with customer deposits, we anticipate supplementing with a certain level of brokered deposits or other wholesale funding. The table below is a maturity schedule for our brokered deposits as of September 30, 2014.

BROKERED DEPOSITS – BY MATURITY

	Less than three months		Three months to six months		Six months to twelve months		One to two years		Greater than two years
	(in thousands)
Brokered certificates of deposit	$	4,482	$	7,136	$	21,340	$	4,791	$	16,553
CDARS - Customer deposits	625		—		4,001		6,001		4,003
ICS - Customer deposits	15,063		—		—		—		—
Total	$	20,170	$	7,136	$	25,341	$	10,792	$	20,556

As of September 30, 2014, December 31, 2013 and September 30, 2013, we had no Federal funds purchased.

Securities sold under agreements to repurchase with commercial checking customers were $12.9 million as of September 30, 2014, compared to $12.5 million and $12.7 million as of December 31, 2013 and September 30, 2013, respectively.

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As a member of the Federal Home Loan Bank of Cincinnati ("FHLB"), we have the ability to acquire short and long-term advances through a blanket agreement secured by our unencumbered qualifying 1-4 family first mortgage loans and by pledging investment securities or individual, qualified loans, subject to approval of the FHLB. At September 30, 2014 and December 31, 2013, we had FHLB advances of $43.5 million and $20.0 million, respectively. We had no FHLB advances as of September 30, 2013.

The terms of the FHLB advance as of September 30, 2014 and December 31, 2013 are as follows:

Balance as of September 30, 2014
Maturity Year	Origination Date	Type	Principal (in thousands)		Rate		Maturity
2014	9/30/2014	FHLB variable rate advance	$	43,485	0.08	%	10/1/2014
Balance as of December 31, 2013
Maturity Year	Origination Date	Type	Principal (in thousands)		Rate		Maturity
2014	12/19/2013	FHLB fixed rate advance	$	20,000	0.15	%	1/17/2014

Liquidity

Liquidity refers to our ability to adjust future cash flows to meet the needs of our daily operations. We rely primarily on the operations and cash balance of FSGBank to fund the liquidity needs of our daily operations. Our cash balance on deposit with FSGBank, which totaled approximately $410 thousand as of September 30, 2014, is available for funding activities for which FSGBank will not receive direct benefit, such as shareholder relations and holding company operations. These funds should adequately meet our cash flow needs. As discussed in Note 2 to our consolidated financial statements, the Agreement with the Federal Reserve was terminated on October 2, 2014. Although the Agreement has been terminated we expect to continue to seek approval from the Federal Reserve prior to paying any dividends on our capital stock or incurring any additional indebtedness. If we determine that our cash flow needs will be satisfactorily met, we may deploy a portion of the funds into FSGBank.

The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate available-for-sale securities.

As of September 30, 2014, our interest bearing account at the Federal Reserve Bank of Atlanta totaled approximately $7.2 million. This liquidity is available to fund our contractual obligations and prudent investment opportunities.

As of September 30, 2014, FSGBank had $171.6 million of total borrowing capacity at FHLB with all 1-4 family residential mortgages and investment securities pledged as collateral as well as the amount of FHLB stock we own. The available borrowing capacity at December 31, 2013 totaled $125.2 million. FSGBank had no borrowing capacity with the FHLB as of September 30, 2013.

Another source of funding is loan participations sold to other commercial banks (in which we retain the servicing rights). As of quarter-end, we had approximately $13.9 million in loan participations sold. FSGBank may sell loan participations as a source of liquidity. An additional source of short-term funding would be to pledge investment securities against a line of credit at a commercial bank. As of quarter-end, FSGBank had $158.3 million in investment securities pledged for repurchase agreements, treasury tax and loan deposits, and public-fund deposits attained in the ordinary course of business. As of September 30, 2014, our unpledged available-for-sale and held-to-maturity securities totaled $32.4 million and $37.3 million, respectively.

Additionally, we had a $34.5 million in unsecured fed lines of credit as of September 30, 2014, that were fully available.

Historically, we have utilized brokered deposits to provide an additional source of funding. As of September 30, 2014, we had $54.3 million in brokered CDs outstanding with a weighted average remaining life of approximately 13 months, a weighted average coupon rate of 1.91% and a weighted average all-in cost (which includes fees paid to deposit brokers) of 1.93%. Our CDARS product had $14.6 million at September 30, 2014, with a weighted average coupon rate of 0.68% and a weighted average remaining life of approximately 22 months. Our certificates of deposit greater than $100 thousand were generated in our communities and are considered relatively stable. Prior to the termination of the Bank's Order, we were restricted in our ability to accept, renew or roll over brokered deposits without prior approval of the FDIC.

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Management believes that our liquidity sources are adequate to meet our current operating needs. We continue to study our contingency funding plans and update them as needed paying particular attention to the sensitivity of our liquidity and deposit base to positive and negative changes in our asset quality.

We also have contractual cash obligations and commitments, which include certificates of deposit, other borrowings, operating leases and loan commitments. Unfunded loan commitments and standby letters of credit totaled $149.1 million at September 30, 2014. The following table illustrates our significant contractual obligations at September 30, 2014 by future payment period.

CONTRACTUAL OBLIGATIONS

	Less than One Year		One to Three Years		Three to Five Years		More than Five Years		Total
	(in thousands)
Certificates of deposit 1	$	164,972	$	86,944	$	31,319	$	—	$	283,235
Brokered certificates of deposit 1	32,958		13,615		7,729		—		54,302
CDARS® 1	4,626		10,004		—		—		14,630
Federal funds purchased and securities sold under agreements to repurchase 2	12,878		—		—		—		12,878
FHLB borrowings 3	43,485		—		—		—		43,485
Operating lease obligations 3	840		2,040		1,498		1,976		6,354
Total	$	259,759	$	112,603	$	40,546	$	1,976	$	414,884

 __________________

1. Time deposits give customers rights to early withdrawal which may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. For more information regarding certificates of deposit, see “Deposits and Other Borrowings.”

2. We expect securities repurchase agreements to be re-issued and, as such, do not necessarily represent an immediate need for cash.

3. Operating lease obligations include existing and future property and equipment non-cancelable lease commitments.

Net cash provided by operations during the first nine months of 2014 totaled $1.5 million compared to net cash used in operations of $10.9 million for the same period in 2013. The increase in net cash provided by operations was primarily due to the change in other assets and liabilities. Net cash used in investing activities totaled $49.1 million for the nine months ended September 30, 2014, compared to net cash used in investing activities of $68.4 million for the same period in 2013. The decrease in cash used is primarily associated with a decrease in the purchase of securities of $176.8 million and an increase in proceeds from the sale of loans of $23.6 million, partially offset by an increase in loan originations of $177.2 million in 2014. Net cash provided by financing activities was $45.6 million for the first nine months of 2014 compared to net cash used in financing activities of $22.9 million in the comparable 2013 period. The increase in cash provided by financing activities is primarily related to the increase in deposits and FHLB borrowings.

Off-Balance Sheet Arrangements

We are party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making commitments as we do for on-balance sheet instruments.

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The following table discloses our maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at the dates indicated.

	As of
	September 30, 2014		December 31, 2013		September 30, 2013
	(in thousands)
Commitments to extend credit - fixed rate	$	33,300	$	36,273	$	29,464
Commitments to extend credit - variable rate	112,527		94,857		90,086
Total Commitments to extend credit	$	145,827	$	131,130	$	119,550
Standby letters of credit	$	3,243	$	3,208	$	3,308

Commitments to extend credit are agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral, if any, we obtain on an extension of credit is based on our credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.

Capital Resources

Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The OCC and the Federal Reserve, the primary federal regulators for FSGBank and First Security, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. Prior to the termination of the Consent Order on March 10, 2014, and as described in Note 2 to our consolidated financial statements, the OCC previously required FSGBank to achieve and maintain total capital to risk adjusted assets of at least 13% and a leverage ratio of at least 9%. We believe that the elevated ratios were required due to the risk profile of FSGBank when the Order was issued in April 2010. We believe our current capital levels are sufficient and appropriate for our risk profile and asset level. Currently, our capital ratios exceed the minimum capital requirements to be considered "well-capitalized."

On April 11, 2013, we completed a restructuring of the Company's Preferred Stock with the Treasury by issuing $14.9 million of new common stock for $1.50 per share for the full satisfaction of the Treasury's 2009 investment in the Company. Pursuant to the Exchange Agreement, as previously included in a Current Report on Form 8-K filed on February 26, 2013, we restructured the Company's Preferred Stock issued under the Capital Purchase Program by issuing new shares of common stock equal to 26.75% of the $33 million value of the Preferred Stock plus 100% of the accrued but unpaid dividends in exchange for the Preferred Stock, all accrued but unpaid dividends thereon, and the cancellation of stock warrants granted in connection with the CPP investment. Immediately after the issuance of the common stock to the Treasury, the Treasury sold all of the Company's common stock to investors previously identified by the Company at the same $1.50 per share price.

On April 12, 2013, we completed the issuance of an additional $76.2 million of new common stock in a private placement to accredited investors. The private placement was previously announced on a Current Report on Form 8-K filed on February 26, 2013, in which we announced the execution of definitive stock purchase agreements with institutional investors as part the Recapitalization. In total, we issued 60,735,000 shares of common stock at $1.50 per share for gross proceeds of $91.1 million. See Note 2 to our Consolidated Financial Statements for additional information.

On September 27, 2013, we completed the issuance of an additional $5.0 million of new common stock through the Rights Offering. The Rights Offering was previously announced on a Current Report on Form 8-K filed on February 26, 2013. Under the Rights Offering each Legacy Shareholder received one non-transferable subscription right to purchase two shares of our common stock at the subscription price of $1.50 per share for every one share of common stock owned by such Legacy Shareholder as of the record date of April 10, 2013. Additionally, each Legacy Shareholder that fully exercised such Legacy Shareholder's subscription rights had the ability to submit an over-subscription request to purchase additional shares of common stock, subject to certain limitations and subject to allotment under the Rights Offering. On September 27, 2013, we completed the Rights Offering issuing 3,329,234 shares of common stock for $1.50 per share for gross proceeds of approximately $5.0 million. We downstreamed the net proceeds to supplement the capital of FSGBank.

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The following table compares the required capital ratios maintained by First Security and FSGBank:

CAPITAL RATIOS
September 30, 2014	FSGBank Consent  Order (1)		Minimum Capital Requirements to be "Well Capitalized"			Minimum Capital Requirements		First Security		FSGBank
Tier 1 capital to risk adjusted assets	N/A		6.0	%		4.0	%	12.0	%	11.3	%
Total capital to risk adjusted assets	N/A		10.0	%		8.0	%	13.1	%	12.5	%
Leverage ratio	N/A		5.0	%	(2)	4.0	%	9.4	%	8.9	%
December 31, 2013
Tier 1 capital to risk adjusted assets	N/A		6.0	%		4.0	%	13.6	%	12.8	%	(3)
Total capital to risk adjusted assets	13.0	%	10.0	%		8.0	%	14.9	%	14.1	%	(3)
Leverage ratio	9.0	%	5.0	%	(2)	4.0	%	9.4	%	8.7	%	(3)
September 30, 2013
Tier 1 capital to risk adjusted assets	N/A		6.0	%		4.0	%	14.6	%	13.7	%	(3)
Total capital to risk adjusted assets	13.0	%	10.0	%		8.0	%	15.8	%	14.9	%	(3)
Leverage ratio	9.0	%	5.0	%	(2)	4.0	%	9.0	%	8.3	%	(3)
(1) The Order was terminated on March 10, 2014 and accordingly, FSGBank is no longer subject to the elevated capital requirements and is considered "well capitalized."
(2) The Federal Reserve Board definition of well capitalized for bank holding companies does not include a leverage ratio component; accordingly, the leverage ratio requirement for well capitalized status only applies to FSGBank.
(3) Effective March 10, 2014 with the termination of the Consent Order, FSGBank was considered well capitalized.

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Federal Reserve. The final rules implement the “Basel III” regulatory capital reforms, as well as certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

The final rules include new or increased risk-based capital requirements that will be phased in from 2015 to 2019. The rules add a new common equity Tier 1 capital to risk-weighted assets ratio minimum of 4.5%, increase the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, and decrease the Tier 2 capital that may be included in calculating total risk-based capital from 4.0% to 2.0%. The final rules also introduce a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and total risk-based capital requirements. The required minimum ratio of total capital to risk-weighted assets will remain 8.0% and the minimum leverage ratio will remain 4.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for the Company on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers.

The following chart compares the risk-based capital ratios required under existing Federal Reserve rules to those prescribed under the new final rules described above:

	Current Rules	Final Rules
Common Equity Tier 1	not present	4.5%
Tier 1	4.0%	6.0%
Total Risk-Based Capital	8.0%	8.0%
Common Equity Tier 1 Capital Conservation Buffer	not present	2.5%

The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The final rules also set forth certain changes for the calculation of risk-weighted assets that the Company will be required to implement beginning January 1, 2015.

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In addition to the updated capital requirements, the final rules also contain revisions to the prompt corrective action framework. Beginning January 1, 2015, the minimum ratios for the Bank to be considered well-capitalized will be updated as follows:

	Current Rules	Final Rules
Total Capital	10.0%	10.0%
Tier 1 Capital	6.0%	8.0%
Common Equity Tier 1 Capital	not present	6.5%
Leverage Ratio	5.0%	5.0%

Management is currently evaluating the provisions of the final rules and their expected impact on the Company. Based on the Company's current capital composition and levels, management does not presently anticipate that the final rules present a material risk to the Company's financial condition or results of operations.

EFFECTS OF GOVERNMENTAL POLICIES

We are affected by the policies of regulatory authorities, including the Federal Reserve Board and the OCC. An important function of the Federal Reserve Board is to regulate the national money supply.

Among the instruments of monetary policy used by the Federal Reserve Board are: purchases and sales of U.S. Government securities in the marketplace; changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve Board; and changes in the reserve requirements of depository institutions. These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation.

The monetary policies of the Federal Reserve Board and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the national and international economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels or loan demand or whether the changing economic conditions will have a positive or negative effect on operations and earnings.

Legislation from time to time is introduced in the United States Congress and the Tennessee General Assembly and other state legislatures, and regulations are proposed by the regulatory agencies that could affect our business. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which our business may be affected thereby.

Dodd-Frank Act.

The bank regulatory landscape was dramatically changed by the Dodd-Frank Act, which was enacted on July 21, 2010 and which implements far-reaching regulatory reform. Its provisions include significant regulatory and compliance changes that are designed to improve the supervision, oversight, safety and soundness of the financial services sector. Additionally, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the OCC and the FDIC.

Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole or on the Company’s and the Bank’s business, results of operations, and financial condition. Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally. However, it is likely that the Dodd-Frank Act will increase the regulatory burden, compliance costs and interest expense for the Company and Bank. Some of the rules that have been adopted to comply with the Dodd-Frank Act's mandates are discussed below.

Consumer Financial Protection Bureau (“CFPB”). The Dodd-Frank Act created a new, independent federal agency, the CFPB, which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the laws referenced above, fair lending laws and certain other statutes

The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets, their service providers and certain non-depository entities such as debt collectors and consumer reporting agencies. Although FSGBank has less than $10 billion in assets, the impact of the formation of the CFPB has caused a ripple effect across all bank regulatory agencies, and placed a renewed focus on consumer protection and compliance efforts. For examples of this new authority, the CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for

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the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

The CFPB has concentrated much of its rulemaking efforts on a variety of mortgage-related topics required under the Dodd-Frank Act, including mortgage origination disclosures, minimum underwriting standards and ability to repay, high-cost mortgage lending, and servicing practices. During 2012, the CFPB issued three proposed rulemakings covering loan origination and servicing requirements, which were finalized in January 2013, along with other rules on mortgages. The ability to repay and qualified mortgage standards rules, as well as the mortgage servicing rules, became effective in January 2014. The escrow and loan originator compensation rules became effective in June 2013. A final rule integrating disclosures required by the Truth in Lending Act and the Real Estate Settlement and Procedures Act became effective in January 2014. We continue to analyze the impact that such rules have on our business model, particularly with respect to our mortgage banking business.

UDAP and UDAAP.Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address "unethical" or otherwise "bad" business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act-the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce ("UDAP" or "FTC Act"). "Unjustified consumer injury" is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to "unfair, deceptive or abusive acts or practices" ("UDAAP"), which has been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.

Interchange Fees. The Federal Reserve has issued final rules limiting the amount of any debit card interchange fee that an issuer may receive or charge with respect to electronic debit card transactions to be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

Volcker Rule. On December 10, 2013, the federal regulators adopted final regulations to implement the proprietary trading and private fund prohibitions of the Volcker Rule under the Dodd-Frank Act. Under the final regulations, which will become effective on April 1, 2014, banking entities are generally prohibited, subject to significant exceptions from: (i) short-term proprietary trading as principal in securities and other financial instruments, and (ii) sponsoring or acquiring or retaining an ownership interest in private equity and hedge funds. The Federal Reserve has granted an extension for compliance with the Volcker Rule until July 21, 2015. On April 7, 2014, the Federal Reserve Board announced that it is granting an additional two year extension until July, 21, 2017 for compliance with the Volcker Rule with respect to certain collateralized loan obligations. The Company is reviewing the impact of the Volcker Rule on its investment portfolio.

Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates or require the adoption of further implementing regulations and, therefore, their impact on the Company’s operations cannot be fully determined at this time.

Restrictions on Transactions with Affiliates

First Security and FSGBank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

• a bank’s loans or extensions of credit to affiliates;

• a bank’s investment in affiliates;

• assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;

• loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

• a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. We must also comply with other provisions designed to avoid the taking of low-quality assets.

First Security and FSGBank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

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The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.

FSGBank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders, and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Effective July 21, 2011, an insured depository institution is prohibited from engaging in asset purchases or sales transactions with its officers, directors or principal shareholders unless (1) the transaction is on market terms and (2) if the transaction represents greater than 10% of the capital and surplus of the bank, a majority of disinterested directors has approved the transaction.

Limitations on Senior Executive Compensation

In June of 2010, federal banking regulators issued guidance designed to help ensure that incentive compensation policies at banking organizations do not encourage excessive risk-taking or undermine the safety and soundness of the organization. In connection with this guidance, the regulatory agencies announced that they will review incentive compensation arrangements as part of the regular, risk-focused supervisory process.

Regulatory authorities may also take enforcement action against a banking organization if its incentive compensation arrangement or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and the organization is not taking prompt and effective measures to correct the deficiencies. To ensure that incentive compensation arrangements do not undermine safety and soundness at insured depository institutions, the incentive compensation guidance sets forth the following key principles:

• incentive compensation arrangements should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose the organization to imprudent risk;

• incentive compensation arrangements should be compatible with effective controls and risk management; and

• incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the board of directors.

Proposed Legislation and Regulatory Action

New regulations and statutes are regularly proposed that contain wide-ranging potential changes to the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Effect of Governmental Monetary Policies

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Board’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board, including its ongoing "Quantitative Easing" program, affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2014, the FASB issued Accounting Standards Update 2014-04, "Receivables - Troubled Debt Restructuring by Creditors." This update clarifies when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The update is effective for annual and interim periods within those annual periods, beginning after December 15, 2014. We do not believe this update will have a significant impact to our consolidated financial statements.

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In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers." This update is a joint project with the International Accounting Standards Board initiated to clarify the principles for recognizing revenue and to develop a common revenue standard that is meant to remove inconsistencies and weaknesses in revenue requirements, provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices, provide more useful information to users of financial statements and simplify the preparation of financial statements. The guidance in this update supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition" and most industry-specific guidance throughout the Industry Topics of Codification. This update is effective for annual and interim periods beginning after December 15, 2016. The Company does not believe this update will have a significant impact to the consolidated financial statements.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk, with respect to us, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate risks. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. We do not deal in international instruments, and therefore are not exposed to risks inherent to foreign currency. Additionally, as of September 30, 2014, we had no trading assets that exposed us to the risks in market changes.

Oversight of our interest rate risk management is the responsibility of the Asset/Liability Committee ("ALCO"). ALCO has established policies and limits to monitor, measure and coordinate our sources, uses and pricing of funds. Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with our interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both static gap and income simulation reports to quantify the estimated exposure of net interest income to a sustained change in interest rates.

Our income simulation analysis projected net interest income based on a decline in interest rates of 100 basis points (i.e. 1.00%) and an increase of 100 basis points, 200 basis points and 300 basis points (1.00%, 2.00% and 3.00%, respectively) over a twelve-month period. Given this scenario, as of September 30, 2014, we had an exposure to falling rates and a benefit from rising rates. More specifically, our model forecasts a decline in net interest income of $1.7 million, or 5.5%, as a result of a 100 basis point decline in rates based on annualizing our financial results through September 30, 2014. The model predicts a $734 thousand, or 2.4%, increase in net interest income resulting from a 100 basis point increase in rates. The model also forecasts an $1.5 million increase in net interest income, or 5.0%, as a result of a 200 basis point increase in rates. Finally, the model forecasts an $2.3 million increase in net interest income, or 7.3%, as a result of a 300 basis point increase in rates.

The following chart reflects our sensitivity to changes in interest rates as indicated as of September 30, 2014. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvested in like instruments at current interest rates.

INTEREST RATE RISK

INCOME SENSITIVITY SUMMARY

	Down 100 BP			Current			Up 100 BP			Up 200 BP			Up 300 BP
	(in thousands, except percentages)
Annualized net interest income1	$	28,996		$	30,693		$	31,427		$	32,222		32,946
Dollar change net interest income	(1,697		)	—			734			1,529			2,253
Percentage change net interest income	(5.53		)%	0.00		%	2.39		%	4.98		%	7.34	%

 __________________

^1.  Annualized net interest income is a twelve month projection based on year-to-date results.

The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, 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, we cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that we might take in responding to or anticipating changes in interest rates.

We use the Sendero Vision Asset/Liability system, which is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration and income simulations using a wide range of scenarios including interest rate shocks and rate ramps. The system also models derivative instruments.

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ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have evaluated the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Our CEO and CFO have concluded that our Disclosure Controls were effective at a reasonable assurance level as of September 30, 2014.

Changes in Internal Controls

There have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of business, we are at times subject to pending and threatened legal actions. Although we are not able to predict the outcome of such actions, after reviewing pending and threatened actions with counsel, we believe that the outcome of any or all such actions will not have a material adverse effect on our business, financial condition and/or operating results.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

EXHIBIT NUMBER	DESCRIPTION
31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934
101	Interactive Data Files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 in XBRL (eXtensible Business Reporting Language).

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed by the undersigned, thereunto duly authorized.

	FIRST SECURITY GROUP, INC.
	(Registrant)
November 5, 2014	/s/ D. MICHAEL KRAMER
	D. Michael Kramer
	Chief Executive Officer
November 5, 2014	/s/ JOHN R. HADDOCK
	John R. Haddock
	Chief Financial Officer

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