10-K 1 avnu-10k_20151231.htm 10-K avnu-10k_20151231.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2015

Commission File Number: 001-36839

 

AVENUE FINANCIAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

Tennessee

 

20-5556885

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

111 10TH Avenue South

Suite 400

Nashville, Tennessee

 

37203

(Address of principal executive offices)

 

(zip code)

Registrant’s telephone number, including area code (615) 736-6940

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

None

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

No par value common stock

 

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

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

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

Indicate by check mark whether the registrant had submitted electronically and posted on its corporate 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 such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

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. (check one)

 

Large accelerated filer

¨

 

Accelerated filer

¨

 

 

 

 

 

Non-Accelerated filer

x

 

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   x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $92.5 million as of June 30, 2015.

As of March 25, 2016, Avenue Financial Holdings, Inc., had 10,357,750 shares of common stock outstanding.

 

 

 


 

AVENUE FINANCIAL HOLDINGS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2015

TABLE OF CONTENTS

 

Part I

 

 

 

 

 

 

 

 

 

Item 1

 

Business

 

5

Item 1A

 

Risk Factors

 

19

Item 1B

 

Unresolved Staff Comments

 

36

Item 2

 

Properties

 

36

Item 3

 

Legal Proceedings

 

36

Item 4

 

Mine Safety Disclosures

 

36

 

 

 

 

 

Part II

 

 

 

 

 

 

 

 

 

Item 5

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

37

Item 6

 

Selected Financial Data

 

38

Item 7

 

Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

40

Item 7A

 

Quantitative and Qualitative Disclosures about Market Risk

 

64

Item 8

 

Financial Statements and Supplementary Data

 

65

Item 9

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

115

Item 9A

 

Controls and Procedures

 

115

Item 9B

 

Other Information

 

117

 

 

 

 

 

Part III

 

 

 

 

 

 

 

 

 

Item 10

 

Directors, Executive Officers and Corporate Governance

 

117

Item 11

 

Executive Compensation

 

123

Item 12

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

128

Item 13

 

Certain Relationships, Related Transactions and Director Independence

 

130

Item 14

 

Principal Accountant Fees and Services

 

131

 

 

 

 

 

Part IV

 

 

 

 

 

 

 

 

 

Item 15

 

Exhibits and Financial Statement Schedules

 

132

Exhibit Index 

 

133

Signatures 

 

135

 

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K contain forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would,” and “outlook,” or the negative version of those words or other comparable words of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.

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

 

·

the ability of Avenue Financial Holdings, Inc. (the Company) and Pinnacle Financial Partners, Inc., (Pinnacle) to consummate the transaction or satisfy the conditions to the completion of the Merger described under the heading “Significant Recent Development” contained in Item 1 “Business” of Part I of this Report;

 

·

the failure of the Company’s shareholders to approve the Merger;

 

·

the receipt of regulatory approvals required for the Merger in the timeframe and on the terms expected;

 

·

the ability of the Company and Pinnacle to meet expectations regarding the timing, completion and accounting and tax treatments of the Merger;

 

·

the possibility that any of the anticipated benefits of the proposed Merger will not be realized by the Company or Pinnacle or will not be realized within the expected time period;

 

·

the risk that integration of the Company’s operations with those of Pinnacle will be materially delayed or will be more costly or difficult than expected;

 

·

the failure of the proposed Merger to close for any other reason;

 

·

the possibility that the Merger may be more expensive to complete than anticipated, including as a result of unexpected factors or events; the diversion of management time on transaction related issues;

 

·

disruption from the Merger with customers, suppliers or employee relationships;

 

·

market and economic conditions (including interest rate environment, levels of public offerings, mergers and acquisitions, or M&A, and venture capital financing activities) and the associated impact on us;

 

·

changes in management personnel;

 

·

deterioration of our asset quality;

 

·

our overall management of interest rate risk, including managing the sensitivity of our interest-earning assets and interest-bearing liabilities to interest rates, and the impact to earnings from a change in interest rates;

 

·

our ability to execute our strategy and to achieve organic loan and deposit growth;

 

·

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

 

·

volatility and direction of market interest rates;

 

·

the sufficiency of our capital, including sources of capital (such as funds generated through retained earnings) and the extent to which capital may be used or required;

 

·

our overall investment plans, strategies and activities, including our investment of excess cash/liquidity;

 

·

operational, liquidity and credit risks associated with our business;

 

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·

increased competition in the financial services industry, nationally, regionally or locally, which may adversely affect pricing and terms;  

 

·

the level of client investment fees and associated margins;

 

·

changes in the regulatory environment;

 

·

changes in trade, monetary and fiscal policies and laws;

 

·

governmental legislation and regulation, including changes in accounting regulation or standards, the nature and timing of the adoption and effectiveness of new requirements under the Dodd-Frank Act, Basel guidelines, capital requirements and other applicable laws and regulations;

 

·

changes in interpretation of existing law and regulation;

 

·

further government intervention in the U.S. financial system; and

 

·

other factors that are discussed in Part I, Item 1A of this Report, titled “Risk Factors.

The foregoing factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in this report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New risks and uncertainties arise from time to time, and it is not possible for us to predict those events or how they may affect us. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

 

 


 

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PART I

ITEM 1.

BUSINESS

Our Company

Avenue Financial Holdings, Inc. (the Company) is headquartered in Nashville, Tennessee. We were formed as a single-bank holding company in October 2006 and operate primarily through our subsidiary, Avenue Bank (the Bank). Our operations are concentrated in the Nashville metropolitan statistical area (MSA) and provide a range of financial services through our five locations (four of which are retail branches) and a limited deposit courier service (mobile branch) for select commercial banking clients.

Founded by a team of executives and banking professionals having substantial experience with large regional institutions in the middle Tennessee market, our strategy is to serve Nashville’s rapidly growing need for local banking services. As a company of more than 147 employees, we are woven into the very fabric of our community, through the widespread service and leadership of our employees in non-profit and civic engagement. We believe this genuine passion and engagement in our community, across the board in our company, provides us with the ability to capture a disproportionate amount of business.

Our growth strategy focuses primarily on commercial and private banking. We provide products and services that compete with large, national competitors, but with the personalized attention and nimbleness of a community bank. We believe we provide unparalleled levels of client service through the talent and expertise of our people, the responsiveness of our credit processes, and the efficiency with which we conduct business. This leads to the development of significant, long-term relationships with many of Nashville’s leading individuals and businesses.

While our lines of business reflect a traditional business strategy, we approach them in non-traditional ways through our people, our culture, and our brand. We have built our company on a corporate culture focused on creating a team of highly capable bankers with a depth of leadership and banking talent who provide exceptional service to our customers. We strive to create an environment to encourage personal and professional success, a company where achievements are celebrated and challenges are shared.

Our culture is a critical component of attracting and retaining experienced banking talent as well as clients. We believe our culture has enabled us to build a brand within the Nashville market for being not just “another bank,” but a significant contributor to the financial well-being of our community. We also believe that the alignment of our culture and brand provides a consistent and differentiating message to our clients, in addition to being a significant contributor to increasing shareholder value.

Significant Recent Development

On January 28, 2016, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Pinnacle Financial Partners, Inc., a Tennessee corporation (Pinnacle) providing for the merger of the Company with and into Pinnacle, with Pinnacle being the surviving entity. On January 28, 2016, our Bank entered into an Agreement and Plan of Merger providing for the merger of our Bank with and into Pinnacle Bank, a Tennessee banking corporation and wholly owned subsidiary of Pinnacle, with Pinnacle Bank being the surviving entity.

At the effective time of the Merger (the Effective Time), each share of common stock of the Company (including shares of restricted stock) that is issued and outstanding as of immediately prior to the Effective Time (other than shares held by the Company, Pinnacle or any of their respective subsidiaries other than in a trust or fiduciary capacity or in satisfaction of debts previously contracted) will be automatically converted into the right to receive (i) 0.36 shares of Pinnacle common stock, plus (ii) $2.00 in cash, without interest (such per share amount, the Merger Consideration). As of the Effective Time, all such converted shares of common stock of the Company shall no longer be outstanding and shall automatically be canceled and shall cease to exist.

Each issued and outstanding option to purchase shares of Company common stock will vest in full as of immediately prior to and contingent on the closing of the Merger, and each holder of an option that has an exercise price per share that is less than the Merger Consideration will be entitled to receive after the Effective Time an amount in cash equal to the excess of $20.00 per share over such exercise price per share, multiplied by the number of shares of Company common stock underlying the option. Additionally, all restricted shares of Company common stock that are subject to vesting or forfeiture conditions (whether time-based or performance-based) that are outstanding as of immediately prior to the Effective Time shall become fully vested immediately prior to and contingent on the closing of the Merger and shall be converted into the right to receive the Merger Consideration.

Our Board of Directors (the Board), based on the recommendation of a special committee of certain disinterested members of the Board, unanimously approved the Merger Agreement and the transactions contemplated thereby, including the Merger. In connection with such approval, Keefe Bruyette & Woods, Inc. rendered its opinion to the Board that, as of the date of the opinion and subject to the various assumptions and qualifications set forth therein, the Merger Consideration to be received by the Company’s stockholders is fair, from a financial point of view, to such stockholders.

The consummation of the Merger is subject to the satisfaction of certain customary conditions, including: (i) the approval by the holders of at least a majority of the outstanding shares of Company common stock entitled to vote on the Merger Agreement and the transactions contemplated thereby, including the Merger; (ii) receipt of any required governmental regulatory approvals or expiration

 

5


 

or termination of the applicable waiting periods under applicable law; and (iii) the absence of any law or order prohibiting or otherwise making illegal the Merger. Moreover, each party’s obligation to consummate the Merger is subject to certain other conditions, including, without limitation, (i) the accuracy of the representations and warranties made by the other party to the Merger Agreement, subject to customary materiality qualifiers, and (ii) the compliance by the other party with its obligations and preclosing covenants thereunder, subject to customary materiality qualifiers.

The Merger Agreement contains customary representations and warranties of the parties. The Merger Agreement also contains customary covenants, including covenants requiring: (i) each of the parties to use reasonable best efforts to cause the Merger to be consummated; and (ii) the Company to call and hold a stockholders’ meeting at which the Board will recommend, subject to certain exceptions based on its fiduciary duties, that the stockholders approve the Merger Agreement and the transactions contemplated thereby, including the Merger. The Merger Agreement also requires the Company to conduct its operations in the ordinary course of business consistent with past practice during the period between the execution of the Merger Agreement and the Effective Time.

Under the terms of the Merger Agreement, the Company will be subject to customary “no-shop” restrictions on its ability to solicit alternative acquisition proposals from third parties and to provide information to and engage in discussions with third parties. The “no-shop” restrictions in the Merger Agreement are also subject to a customary “fiduciary-out” provision which allows the Company under certain circumstances to provide information to and participate in discussions with third parties with respect to an unsolicited alternative acquisition proposal that the Board has determined is or would reasonably be expected to result in a Superior Proposal (as defined in the Merger Agreement). Notwithstanding the foregoing, the Company is required to provide Pinnacle with certain information regarding its discussions with third parties, and under specified circumstances to negotiate in good faith with Pinnacle in the event of other acquisition proposals and/or certain other developments.

The Merger Agreement also contains certain termination rights in favor of each party, including rights allowing the Company to terminate the Merger Agreement in order to accept a Superior Proposal. Upon termination of the Merger Agreement under certain specified circumstances, the Company will be required to pay to Pinnacle a termination fee of $8.0 million.

The Merger Agreement is attached to the Company’s Current Report on Form 8-K that was filed with the Securities and Exchange Commission (SEC) on January 29, 2016, to provide the Company’s stockholders with information regarding the terms of the Merger Agreement and is not intended to modify or supplement any factual disclosures about the Company in the Company’s public reports filed with the SEC. In particular, the Merger Agreement and this summary of terms are not intended to be, and should not be relied upon as, disclosures regarding any facts or circumstances relating to the Company, Pinnacle, their respective subsidiaries and affiliates or any other party. The representations and warranties contained in the Merger Agreement have been negotiated only for the purpose of the Merger Agreement and are intended solely for the benefit of the parties thereto. In many cases, these representations, warranties and covenants are subject to limitations agreed upon by the parties and are qualified by certain supplemental disclosures provided by the Company to Pinnacle in connection with the execution of the Merger Agreement. Furthermore, many of the representations and warranties in the Merger Agreement are the result of a negotiated allocation of contractual risk among the parties and, taken in isolation, do not necessarily reflect facts about the Company, Pinnacle, their respective subsidiaries and affiliates or any other party. Likewise, any references to materiality contained in the representations and warranties may not correspond to concepts of materiality applicable to investors or stockholders. Finally, information concerning the subject matter of the representations and warranties may change after the date of the Merger Agreement, and these changes may not be fully reflected in the Company’s public disclosures.

AS A RESULT OF THE FOREGOING, INVESTORS AND STOCKHOLDERS ARE STRONGLY ENCOURAGED NOT TO RELY ON THE REPRESENTATIONS, WARRANTIES AND COVENANTS CONTAINED IN THE MERGER AGREEMENT, OR ON ANY DESCRIPTIONS THEREOF, AS ACCURATE CHARACTERIZATIONS OF THE STATE OF FACTS OR CONDITION OF THE COMPANY OR ANY OTHER PARTY. INVESTORS AND STOCKHOLDERS ARE LIKEWISE CAUTIONED THAT THEY ARE NOT THIRD-PARTY BENEFICIARIES UNDER THE MERGER AGREEMENT AND DO NOT HAVE ANY DIRECT RIGHTS OR REMEDIES PURSUANT TO THE MERGER AGREEMENT.

The foregoing description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Merger Agreement, a copy of which was filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K on January 29, 2016. Nothing herein limits or otherwise affects the rights or obligations under the Merger Agreement of any party thereto.

Our Competitive Strengths

Concierge Banking Model

Our concept and practice of concierge banking is a unique, differentiating factor and a highly successful service model for us. At the core of our concierge banking model is our people. We believe that our culture creates an attractive environment, not only for recruiting purposes, but also for retention and higher employee engagement, which in turn contributes to lower turnover and higher employee productivity resulting in our high level of client service.

 

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Concierge banking is a concept that runs throughout our entire organization, not just in our retail branches. This idea of exceptional personalized service is embodied by every team in the Bank. Each banker is empowered to help every client solve his or her problems by looking for innovative, creative solutions. We encourage and incentivize our bankers to focus on our client’s holistic banking needs, stressing the gathering of loans, deposits and cross-department referrals. Furthermore, we are able to serve a wide variety of client needs by engaging bankers from our multiple business lines in a relationship.

Our concierge banking model is further enhanced through our Concierge Banking Group in our retail branches, which are designed to reflect a highly sophisticated, hospitality-inspired atmosphere, while simultaneously mirroring the creative spirit of Nashville. For example, we play music at a slightly elevated volume, serve fresh cookies and coffee, and decorate our branches with local art and designer furniture. Our bankers are seated in the front of the branch dressed in business attire. We do not employ teller lines. We staff each of our branches with service-oriented people who undergo an extensive training program to ensure they are capable of handling any client need, from transactions to account openings to loans, all with an exceptional level of service. Just like our advertising, we avoid bank jargon and instead use common language with honesty, sincerity, and a personal touch. These factors result in the creation of a very different atmosphere from a traditional community bank.

The resulting high-end experience we believe encourages our clients to promote our Bank, generating significant account growth from word-of-mouth recommendations. With very limited investment in retail product advertising, our four branches opened approximately 3,500 new accounts in 2015.  We believe our concept and practice of concierge banking has proven to differentiate us from competitors and resulted in high levels of customer satisfaction, retention, and the formation of broad client relationships.

Industry Verticals

Our organic growth has been powered by traditional lines of business, including commercial banking, commercial real estate, and private banking, further complemented by substantive knowledge of and visibility in two of Nashville’s prominent industries: music and entertainment and healthcare. These industry verticals are formed by teams of experienced bankers across departmental lines. This collaboration allows us to cater to a client’s every banking need, from individual deposits to large corporate loans and spanning a diverse range of industry functions. Our bankers, along with our senior management and members of our board of directors, have extensive experience and contacts in the Nashville music and entertainment and healthcare industries. Our industry-specific knowledge, products expertise and engagement increases our profile within these two industry verticals and enables us to successfully identify, select and compete for credit-worthy borrowers and attractive financing projects. This vertical banking focus results in deep client relationships with multiple bankers, which generates both earning assets and funding sources, and allows us to provide an uncommonly high level of customer service that is relevant for each business’ specific industry segment. In addition to our two established industry verticals, we are also developing a growing specialty area in the not-for-profit industry.

Credit Culture

One of the primary success factors for our continuous loan growth and high asset quality is our credit culture. We serve our clients with a consultative approach to credit. Rather than presuming the weaknesses of a credit and placing the burden of proof on our client, our approach is to understand the fundamental credit need of the client and provide a consultation of how we can meet that need. We believe that the tone and responsiveness of this approach results in a competitive advantage for our Bank. We strive to establish open communications at the inception of each loan opportunity. Our process of credit evaluation and structuring during the underwriting process is highly collaborative and solutions-based. Decisions are made via credit committee, characterized by consensus-building and a healthy balance of art and science.

Our Lines of Business

While our lines of business remain largely traditional, the extensive careers of our management and senior bankers in the Nashville area give us a significant competitive advantage in terms of market insight, familiarity with clients, loan decision-making and product and service delivery. This leads to the development of significant long-term relationships with many of Nashville’s leading individuals and businesses. We therefore focus on building our Bank on core low-cost deposit relationships, high credit quality loans, and fee income generated by value-added services. By employing a tailored, consultative approach to providing services to our clients, paired with client service, our clients become our most enthusiastic promoters.

We continue to seek and build relationships with reputable, sophisticated and market-leading clients, particularly in our commercial and private banking departments. We bank many of Nashville’s centers of influence who shape the future of our community. In limited cases, we participate with other peer banks in larger transactions when the basis of a true banking relationship exists.

We believe we provide unparalleled levels of client service through the talent and expertise of our people, the responsiveness of our credit processes, and the efficiency with which we conduct business. We provide products and services that compete with large, national competitors, such as interest rate derivatives, wealth advisory services, mobile deposit, and a suite of treasury management services including remote deposit capture and lockbox services. For our largest depositors, we offer the Certificate of Deposit Account Registry Service (CDARS) and the Insured Cash Sweep service (ICS) products to provide fully FDIC-insured depository services. By

 

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combining the sophisticated product catalog of a larger institution with the personalized attention and customer service found at a community bank, we believe we create a premier middle market institution able to win and keep market share.

We believe our portfolio of loans and deposits is well-balanced and diversified, reflecting the diverse economic market we serve, while simultaneously mitigating risk. For example, despite over doubling our loan growth since inception, the mix of our loan portfolio has remained relatively consistent.

The operations of our business to date have remained focused on the Nashville MSA. Of our Bank’s total loan portfolio of $845.8 million at December 31, 2015, we consider approximately $699.4 million (83% of total) to have a degree of dependence on the Nashville MSA market area and economy, and a substantial portion of those loans are considered commercial real estate (including owner occupied real estate), construction and development, or residential mortgage loans. As such, a substantial majority of our loan portfolio remains in Nashville’s residential and commercial real estate market, particularly within our CRA assessment area of Davidson and Williamson Counties.

We consider certain loan types to carry a higher inherent risk profile compared to other loan types. These higher risk loan types include commercial construction and development (Commercial C&D) loans, home equity lines of credit (or HELOC) loans, consumer residential construction loans, the non-guaranteed portion of SBA loans, and residential lot loans. The inherent risks associated with these loans are as follows:

 

·

Commercial C&D loans – risk of completion, lack of historical lease/sale metrics, market fluctuation during construction

 

·

HELOC loans – second lien position

 

·

Consumer residential construction loans – risk of completion, alterations to home after appraisal

 

·

Non-guaranteed portion of SBA loans – risk of longer credit terms and amortization schedules

 

·

Residential lot loans – risk of infrastructure completion, market fluctuation

For these types of loans, our Bank manages and mitigates the elevated level of risk with additional underwriting, monitoring, and portfolio controls.

We are organized into the following banking teams:

Commercial Banking

The commercial banking group maintains the largest portfolio of loans and deposits in our Bank, comprising approximately $550.0 million of our total loans and $297.8 million of our total deposits as of December 31, 2015. The loans are a mix of commercial real estate, owner-occupied real estate, working capital lines of credit, and other traditional commercial loans. The deposit base consists largely of the operating accounts of our commercial clients, with heavy use of treasury management products. We have a team of thirteen bankers to service this portfolio.

Music and Entertainment Banking

We have a team dedicated to the music and entertainment industry, established with the formation of our Bank in 2006. Our music and entertainment team consists of four bankers, representing $164.7 million our Bank’s deposit base and $98.9 million of our loan portfolio as of December 31, 2015. Given the unique nature and the business models employed within the music industry, we serve these clients through bankers with what we believe to be uncommon expertise and specific music and entertainment experience. We have bankers capable of serving all of a client’s varying needs, from personal deposits to large commercial loans.

Our clients consist of a diverse range of participants within the industry, including artists, songwriters, labels, recording studios, publishing companies, management firms, tour managers, performance rights organizations, and equipment companies.

We not only bank clients in the music and entertainment industry, such as numerous musicians, producers, and Nashville professional athletes, but we continue to be actively engaged in the industry ourselves. In the music industry in particular, we sponsor and attend all of Broadcast Music Incorporated’s “#1 Parties,” celebrating the artist and songwriters of country radio’s hit songs. We also have had multiple bankers selected for Leadership Music in past years, participating in a highly selective leadership program for the industry. As a result of our activism, we have become one of Nashville’s preeminent banks to the industry and subsequently created inroads to markets such as New York City and Los Angeles.

Private Banking

The private banking team maintains the second largest portfolio of loans and deposits in our bank, comprising approximately $120.5 million of our loan balances and $231.2 million of our deposit balances as of December 31, 2015. The loans are a mix of consumer home-equity, portfolio mortgage, and commercial-purpose loans. The deposit base consists largely of consumer checking and money market accounts. We have a team of eight bankers and two assistants to service this portfolio. We also have a wealth

 

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management banker to support the offerings of the private banking team, providing consultation and investment strategies to their clients.

Business Banking

Business banking is a relatively new area of expertise for our Bank. In 2012, we successfully recruited one of Nashville’s leading business bankers, who has created and is growing our new business banking department comprised of three additional bankers. This department focuses on businesses that are slightly below the middle market threshold, with some activity in the small business / SBA market. As of December 31, 2015, business banking represented approximately $41.8 million of total deposits and $61.9 million of total loans.

Mortgage Banking

The mortgage banking team consists of seven mortgage loan officers producing mortgage loans that we typically sell to the secondary market. Portfolio mortgage loans originated by this team are typically referred to other loan officers in the Bank for the purpose of developing a more complete relationship with the client, and such loans totaled $3.8 million as of December 31, 2015.

Concierge Banking (Retail Branches)

We differentiate ourselves through our retail channel with a unique delivery model called concierge banking. We staff our branches with service-motivated and fully cross-trained bankers capable of handling any consumer client need, from transactions to account openings to loans. We also designed our branches to reflect a highly sophisticated, hospitality-inspired atmosphere. The resulting high-end experience compels our clients to promote the bank, generating significant account growth from word-of-mouth recommendations. Loans and deposits generated through this team totaled $11.4 million and $103.5 million, respectively as of December 31, 2015.

Industry Focus

Our business is organized into cross-departmental industry verticals that pull from the private banking, mortgage, and commercial banking teams listed above to serve the diverse needs of our clients. These areas of industry focus are:

 

·

Music and entertainment

 

·

Healthcare

 

·

Not-for-profit banking

As noted above, our organic growth has been further complemented by substantive knowledge of and visibility in two of Nashville’s prominent industries, music and entertainment and healthcare, and an emerging specialty area in not-for-profit banking. These industry verticals are formed by teams of experienced bankers across departmental lines. This collaboration allows us to cater to a client’s every banking need, from individual deposits to large corporate loans and spanning a diverse range of industry functions.

Employees

As of December 31, 2015, we had 147 total employees and 145 full-time equivalent employees. None of our employees are represented by any collective bargaining unit or are parties to a collective bargaining agreement. We believe that our relations with our employees are good.

Material Legal Actions

We are sometimes party to legal actions that are routine and incidental to our business. In management’s opinion, the outcome of such matters, individually and in the aggregate, will not have a material effect on our results of operations or financial position.

Corporate Information

We were incorporated in the state of Tennessee in 2006. Our operations are conducted through Avenue Bank, which holds a charter dating to 1911. Our principal executive offices are located at 111 10th Avenue South, Suite 400, Nashville, Tennessee 37203, and our telephone number is (615) 252-2265. We also maintain an Internet site at www.avenuenashville.com. Our website and the information contained therein or limited thereto is not incorporated into this report.

We completed our initial round of funding in February 2007, raising $75 million in capital and acquired a state charter. This was accomplished by the acquisition of a two-branch bank in rural western Tennessee having approximately $25 million in total assets. We immediately moved the headquarters to Nashville, and 23 months later completed the divestiture of the acquired bank’s assets and liabilities. In July 2007, we opened a branch in Nashville’s historic Cummins Station building. In the same year, we opened our corporate headquarters in Nashville’s historic Union Station Baggage Building. Since then, we have opened three additional branches as well as a limited deposit courier service. In February 2015 we raised an additional, $14.5 million in net new capital through our initial public offering.  

 

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SUPERVISION AND REGULATION

Both we and our Bank are subject to extensive federal and state banking laws and regulations that impose restrictions on and provide for general regulatory oversight of our operations. These laws and regulations require compliance with various consumer protection provisions applicable to lending, deposits, brokerage and fiduciary activities. They also impose capital adequacy requirements and restrict our ability to repurchase our stock and receive dividends from our Bank. These laws and regulations generally are intended to protect the safety and soundness of the bank and its customers, rather than shareholders. The following discussion describes material elements of the regulatory framework that applies to us. However, the description below is not intended to summarize all laws and regulations applicable to us.

Bank Holding Company Regulation

Since we own all of the capital stock of our Bank, we are a bank holding company under the Bank Holding Company Act of 1956 (BHC Act). As a result, we are primarily subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.

Acquisition of Banks

The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:

 

·

acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will, directly or indirectly, own or control more than 5% of the bank’s voting shares;

 

·

acquiring all or substantially all of the assets of any bank; or

 

·

merging or consolidating with any other bank holding company.

Additionally, the BHC Act provides that the Federal Reserve may not approve any of these transactions if such transaction would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources includes a focus on capital adequacy, which is discussed in the section titled “Bank Regulation and Supervision – Capital Adequacy.” The Federal Reserve also is required to consider the effectiveness of the institutions in combating money laundering, including a review of the anti-money laundering program of the acquiring bank holding company and the anti-money laundering compliance records of a bank to be acquired as part of the transaction. Finally, the Federal Reserve takes into consideration the extent to which the proposal transaction would result in greater or more concentrated risks to the stability of the U.S. banking or financial system.

Under the BHC Act, if well-capitalized and well-managed, we or any other bank holding company located in Tennessee may purchase a bank located outside of Tennessee. Conversely, a well-capitalized and well-managed bank holding company located outside of Tennessee may purchase a bank located inside Tennessee. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in concentrations of deposits exceeding limits specified by statute. For example, Tennessee law currently prohibits a bank holding company from acquiring control of a Tennessee-based financial institution until the target financial institution has been in operation for at least three years.

Change in Bank Control

Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Under a rebuttable presumption established by the Federal Reserve pursuant to the Change in Bank Control Act, the acquisition of 10% or more of a class of voting stock of a bank holding company would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, any person or group of persons must obtain the approval of the Federal Reserve under the BHC Act before acquiring 25% (5% in the case of an acquirer that is already a bank holding company) or more of the outstanding voting stock of a bank holding company, the right to control in any manner the election of a majority of the company’s directors, or otherwise obtaining control or a “controlling influence” over the bank holding company.

 

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Permitted Activities

Under the BHC Act, a bank holding company is generally permitted to engage in or acquire direct or indirect control of the voting shares of any company engaged in the following activities:

 

·

banking or managing or controlling banks; and

 

·

any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

 

·

factoring accounts receivable;

 

·

making, acquiring, brokering or servicing loans and usual related activities;

 

·

leasing personal or real property;

 

·

operating a non-bank depository institution, such as a savings association;

 

·

trust company functions;

 

·

financial and investment advisory activities;

 

·

discount securities brokerage activities;

 

·

underwriting and dealing in government obligations and money market instruments;

 

·

providing specified management consulting and counseling activities;

 

·

performing selected data processing services and support services;

 

·

acting as an agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and

 

·

performing selected insurance underwriting activities.

The Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.

In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, thereby permitting the bank holding company to engage in activities that are financial in nature or incidental or complementary to financial activity. The BHC Act expressly lists the following activities as financial in nature:

 

·

lending, trust and other banking activities;

 

·

insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;

 

·

providing financial, investment, or economic advisory services;

 

·

issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;

 

·

underwriting, dealing in or making a market in securities;

 

·

other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;

 

·

foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;

 

·

merchant banking through securities or insurance affiliates; and

 

·

insurance company portfolio investments.  

For us to qualify to become a financial holding company, we must be well-capitalized and well-managed. In addition, our Bank and any other depository institution subsidiary of ours must be well-capitalized and well-managed and must have a CRA rating of at least “satisfactory.” Additionally, we must file an election with the Federal Reserve to become a financial holding company and must

 

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provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. We have not elected to become a financial holding company at this time.

Support of Subsidiary Institutions

The Federal Deposit Insurance Act and Federal Reserve policy require a bank holding company to serve as a source of financial and managerial strength to its bank subsidiaries. In addition, where a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions is responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result of a bank holding company’s source of strength obligation, a bank holding company may be required to loan money to a bank subsidiary in the form of subordinate capital notes or other instruments which qualify as capital under bank regulatory rules. However, any loans from the holding company to such subsidiary banks likely will be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of the bank.

Repurchase or Redemption of Securities

A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of its own then-outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. The Federal Reserve has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain conditions.

Bank Regulation and Supervision

Our Bank is subject to extensive federal and state banking laws and regulations that impose restrictions on and provide for general regulatory oversight of our operations. These laws and regulations are generally intended to protect the safety and soundness of our Bank and our Bank’s customers, rather than our shareholders. The following discussion describes the material elements of the regulatory framework that applies to our Bank.

Since our Bank is a commercial bank chartered under the laws of the state of Tennessee and is not a member of the Federal Reserve System, it is primarily subject to the supervision, examination and reporting requirements of the FDIC and the Tennessee Department of Financial Institutions (TDFI). The FDIC and the TDFI regularly examine our Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to take enforcement action to prevent the development or continuance of unsafe or unsound banking practices or other violations of law. Our Bank’s deposits are insured by the FDIC to the maximum extent provided by law. Our Bank is also subject to numerous federal and state statutes and regulations that affect its business, activities and operations.

Branching

Under current Tennessee law, our bank may open branch offices throughout Tennessee with the prior approval of the TDFI. In addition, with prior regulatory approval, our Bank may acquire branches of existing banks located in Tennessee. While prior law imposed various limits on the ability of banks to establish new branches in states other than their home state, the Dodd-Frank Act allows a bank to branch into a new state by acquiring a branch of an existing institution or by setting up a new branch, without merging with an existing institution in the target state, if, under the laws of the state in which the branch is to be located, a state bank chartered by that state would be permitted to establish the branch. This makes it much simpler for banks to open de novo branches in other states.

FDIC Insurance Assessments

Our bank’s deposits are insured by the FDIC to the full extent provided in the Federal Deposit Insurance Act (currently $250,000 per deposit account), and our bank pays assessments to the FDIC for that coverage. Under the FDIC’s risk-based deposit insurance assessment system, an insured institution’s deposit insurance premium is computed by multiplying the institution’s assessment base by the institution’s assessment rate.

 

·

Assessment Base. An institution’s assessment base equals the institution’s average consolidated total assets during a particular assessment period, minus the institution’s average tangible equity capital (that is, Tier 1 capital) during such period.

 

·

Assessment Rate. An institution’s assessment rate is assigned by the FDIC on a quarterly basis. To assign an assessment rate, the FDIC designates an institution as falling into one of four risk categories, or as being a large and highly complex financial institution. The FDIC determines an institution’s risk category based on the level of the institution’s capitalization and on supervisory evaluations provided to the FDIC by the institution’s primary federal regulator. Each risk category designation contains upward and downward adjustment factors based on long-term unsecured debt and brokered deposits.

 

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In addition to its risk-based insurance assessments, the FDIC also imposes Financing Corporation (FICO) assessments to help pay the $780 million in annual interest payments on the $8 billion of bonds issued in the late 1980s as part of the government rescue of the savings and loan industry.

The FDIC is responsible for maintaining the adequacy of the Deposit Insurance Fund, and the amount our Bank pays for deposit insurance is affected not only by the risk our Bank poses to the Deposit Insurance Fund, but also by the adequacy of the fund to cover the risk posed by all insured institutions. In recent years, systemic economic problems and changes in law have put pressure on the Deposit Insurance Fund. In this regard, from 2008 to 2013, the United States experienced an unusually high number of bank failures, resulting in significant losses to the Deposit Insurance Fund. Moreover, the Dodd-Frank Act permanently increased the standard maximum deposit insurance amount from $100,000 to $250,000, and raised the minimum required Deposit Insurance Fund reserve ratio (i.e., the ratio of the amount on reserve in the Deposit Insurance Fund to the total estimated insured deposits) from 1.15% to 1.35%. To support the Deposit Insurance Fund in light of these types of pressures, the FDIC took several actions in 2009 to supplement the revenues received from its annual deposit insurance premium assessments. Such actions included imposing a one-time special assessment on insured institutions and requiring that insured institutions prepay their regular quarterly assessments for the fourth quarter of 2009 through 2012. The FDIC’s possible need to increase assessment rates, charge additional one-time assessment fees, and take other extraordinary actions to support the Deposit Insurance Fund is generally considered to be greater in the current economic climate. If the FDIC were to take these types of actions in the future, they could have a negative impact on the Bank’s earnings.

Termination of Deposit Insurance

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

Liability of Commonly Controlled Depository Institutions

Under the Federal Deposit Insurance Act, an FDIC-insured depository institution can be held liable for any loss incurred by, or reasonably expected, to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution, or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution in danger of default. “Default” is defined generally as the appointment of a conservator or receiver, and “in danger of default” is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC’s claim for damage is superior to claims of shareholders of the insured depository institution but is subordinate to claims of depositors, secured creditors, other general and senior creditors, and holders of subordinated debt (other than affiliates) of the institution.

Community Reinvestment Act

The Community Reinvestment Act (CRA) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies will evaluate the record of each financial institution in meeting the needs of its local community, including low and moderate-income neighborhoods. Our record of performance under the CRA is publicly available. These factors are also considered in evaluating applications seeking approval for mergers, acquisitions, and new offices or facilities. Failure to adequately meet these criteria could impose additional requirements and limitations on the bank. Additionally, we must publicly disclose the terms of various CRA-related agreements.

Interest Rate Limitations

Interest and other charges collected or contracted for by our Bank are subject to state usury laws and federal laws concerning interest rates.

Federal Laws Applicable to Consumer Credit and Deposit Transactions

Our Bank’s loan and deposit operations are subject to a number of federal consumer protection laws, including:

 

·

the Federal Truth in Lending Act, governing disclosures of credit terms to consumer borrowers;

 

·

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

 

·

the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, color, religion, national origin, sex, marital status or certain other prohibited factors in all aspects of credit transactions;

 

·

the Fair Credit Reporting Act (FCRA) governing the use and provision of information to credit reporting agencies;

 

·

the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by debt collectors;

 

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·

the Service members Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service;  

 

·

the Gramm-Leach-Bliley Act, governing the disclosure and safeguarding of sensitive nonpublic personal information of our customers;

 

·

the Right to Financial Privacy Act, imposing a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

·

the Electronic Funds Transfer Act governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

 

·

the rules and regulations of the Consumer Financial Protection Bureau and various federal agencies charged with the responsibility of implementing these federal laws.

Capital Adequacy

The federal banking regulators view capital levels as important indicators of an institution’s financial soundness. In this regard, we and our Bank are required to comply with the capital adequacy standards established by the Federal Reserve (in the case of Avenue Financial Holdings, Inc.) and the FDIC and the TDFI (in the case of our Bank). The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The FDIC has established substantially similar measures for banks.

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement actions, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. Significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

The current risk-based capital guidelines, commonly referred to as Basel I, are based upon the 1988 capital accord of the Basel Committee on Banking Supervision, or Basel Committee, an international committee of central banks and bank supervisors, as implemented by the U.S. federal banking agencies. As discussed further below, the federal banking agencies have adopted separate risk-based capital guidelines for so-called “core banks” based upon the Revised Framework for the International Convergence of Capital Measurement and Capital Standards, or Basel II, issued by the Basel Committee in November 2005, and recently adopted rules implementing the revised standards referred to as Basel III.

Basel I

Under Federal Reserve regulations implementing the Basel I standards, the minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 capital and Tier 2 capital. Tier 1 capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 capital must equal at least 6% of risk-weighted assets. Tier 2 capital generally consists of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The total amount of Tier 2 capital is limited to 100% of Tier 1 capital. At December 31, 2015, our consolidated ratio of total capital to risk-weighted assets was 12.25% and our ratio of Tier 1 capital to risk-weighted assets was 9.28%.

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2015, our leverage ratio was 8.17%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

As of December 31, 2015, we were well-capitalized under the regulatory framework for prompt corrective action. To remain categorized as well-capitalized, our Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios of 10%, 8%, and 5%, respectively. In addition to the foregoing federal requirements, Tennessee state banks are required to have the capital structure that the TDFI deems adequate and the Commissioner may require a state bank to increase its capital structure to the point deemed adequate by the Commissioner before granting approval of a branch application or charter amendment.

 

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Basel II

Under the final U.S. Basel II rules issued by the federal banking agencies, there are a small number of “core” banking organizations that have been required to use the advanced approaches under Basel II for calculating risk-based capital related to credit risk and operational risk, instead of the methodology reflected in the regulations effective prior to adoption of Basel II. The rules also require core banking organizations to have rigorous processes for assessing overall capital adequacy in relation to their total risk profiles, and to publicly disclose certain information about their risk profiles and capital adequacy. Neither we nor our bank are among the core banking organizations required to use Basel II advanced approaches.

Basel III

On December 16, 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, known as Basel III. The Basel III calibration and phase-in arrangements were previously endorsed by the Seoul G20 Leaders Summit in November 2010. Under these standards, when fully phased-in on January 1, 2019, banking institutions would be required to satisfy three risk-based capital ratios:

 

·

A new common equity tier 1 capital to risk-weighted assets ratio of at least 7.0%, inclusive of a 4.5% minimum common equity tier 1 capital ratio, net of regulatory deductions, and a new 2.5% “capital conservation buffer” of common equity to risk-weighted assets;

 

·

A tier 1 capital ratio of at least 8.5%, inclusive of the 2.5% capital conservation buffer; and

 

·

A total capital ratio of at least 10.5%, inclusive of the 2.5% capital conservation buffer.

Basel III places more emphasis than current capital adequacy requirements on common equity tier 1 capital (CET1) which is predominately made up of retained earnings and common stock instruments. Basel III also introduces a capital conservation buffer, which is designed to absorb losses during periods of economic stress. Banking institutions with a CET1 ratio above the minimum but below the capital conservation buffer may face constraints on dividends, equity repurchases, and compensation based on the amount of such shortfall. The Basel Committee also announced that a “countercyclical buffer” of 0% to 2.5% of CET1 or other loss-absorbing capital “will be implemented according to national circumstances” as an “extension” of the conservation buffer during periods of excess credit growth.

Basel III also introduced a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets.

United States Implementation of Basel III

In July 2013, the federal banking agencies published final rules, or the Basel III Capital Rules that revised their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to implement, in part, agreements reached by the Basel Committee and certain provisions of the Dodd-Frank Act. The Basel III Capital Rules will apply to banking organizations, including us and our Bank.

Among other things, the Basel III Capital Rules: (i) introduce CET1; (ii) specify that tier 1 capital consists of CET1 and additional financial instruments satisfying specified requirements that permit inclusion in tier 1 capital; (iii) define CET1 narrowly by requiring that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions or adjustments from capital as compared to the existing regulations. The Basel III Capital Rules also provide a permanent exemption from the proposed phase out of existing trust preferred securities and cumulative perpetual preferred stock from regulatory capital for banking organizations with less than $15 billion in total consolidated assets as of December 31, 2009.

The Basel III Capital Rules provide for the following minimum capital to risk-weighted assets ratios:

 

·

4.5% based upon CET1;

 

·

6.0% based upon tier 1 capital; and

 

·

8.0% based upon total regulatory capital.

A minimum leverage ratio (tier 1 capital as a percentage of total assets) of 4.0% is also required under the Basel III Capital Rules (even for highly rated institutions). The Basel III Capital Rules additionally require institutions to retain a capital conservation buffer of 2.5% above these required minimum capital ratio levels. Banking organizations that fail to maintain the minimum 2.5% capital conservation buffer could face restrictions on capital distributions or discretionary bonus payments to executive officers.

As a result of the enactment of the Basel III Capital Rules, we and our Bank could be subject to increased required capital levels. The Basel III Capital Rules became effective as applied to us and our Bank on January 1, 2015, with a phase-in period that generally extends through January 1, 2019.

 

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The ultimate impact of the new capital standards on us and our bank is currently being reviewed and will depend on a number of factors, including the implementation of the new Basel III Capital Rules and any additional related rulemaking by the U.S. banking agencies.

Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of “prompt corrective action” to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) into which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital thresholds for each of those categories. When effective, the Basel III Capital Rules will amend those thresholds to reflect both (i) the generally heightened requirements for regulatory capital ratios, and (ii) the introduction of the CET1 capital measure. At December 31, 2015, our Bank qualified for the well-capitalized category.

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. For example, institutions in all three undercapitalized categories are automatically restricted from paying distributions and management fees, whereas only an institution that is significantly undercapitalized or critically undercapitalized is restricted in its compensation paid to senior executive officers. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of (i) 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized and (ii) the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

Liquidity

Financial institutions are subject to significant regulatory scrutiny regarding their liquidity positions. This scrutiny has increased during recent years, as the economic downturn that began in the late 2000s negatively affected the liquidity of many financial institutions. Various bank regulatory publications, including FDIC Financial Institution Letter FIL-13-2010 (Funding and Liquidity Risk Management) and FDIC Financial Institution Letter FIL-84-2008 (Liquidity Risk Management), address the identification, measurement, monitoring and control of funding and liquidity risk by financial institutions.

Basel III also addresses liquidity management by proposing two new liquidity metrics for financial institutions. The first metric is the “Liquidity Coverage Ratio,” and it aims to require a financial institution to maintain sufficient high quality liquid resources to survive an acute stress scenario that lasts for one month. The second metric is the “Net Stable Funding Ratio,” and its objective is to require a financial institution to maintain a minimum amount of stable sources relative to the liquidity profiles of the institution’s assets, as well as the potential for contingent liquidity needs arising from off-balance sheet commitments, over a one-year horizon.

In the Basel III Capital Rules, the federal banking regulators did not address either the Liquidity Coverage Ratio or the Net Stable Funding Ratio. However, on November 29, 2013, the Federal Reserve, FDIC and Office of the Comptroller of the Currency jointly issued a proposed rule implementing a Liquidity Coverage Ratio requirement in the United States for larger banking organizations. Neither we nor our Bank would be subject to such requirement as proposed.

The Liquidity Coverage Ratio and the Net Stable Funding Ratio continue to be monitored for implementation, and we cannot yet provide concrete estimates as to how those requirements, or any other regulatory positions regarding liquidity and funding, might affect us or our Bank. However, we note that increased liquidity requirements generally would be expected to cause our Bank to invest its assets more conservatively – and therefore at lower yields – than it otherwise might invest. Such lower-yield investments likely would reduce the Bank’s revenue stream, and in turn its earnings potential.

Payment of Dividends

We are a legal entity separate and distinct from our Bank. Our principal source of cash flow, including cash flow to pay dividends to our shareholders, is dividends our Bank pays to us as our Bank’s sole shareholder. Statutory and regulatory limitations apply to our Bank’s payment of dividends to us as well as to our payment of dividends to our shareholders. The requirement that a bank holding company must serve as a source of strength to its subsidiary banks also results in the position of the Federal Reserve that a bank holding company should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of its bank subsidiaries or that can be funded only through additional borrowings or other arrangements that may undermine the bank

 

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holding company’s ability to serve as such a source of strength. Our ability to pay dividends is also subject to the provisions of Tennessee corporate law which prevents payment of dividends if, after giving effect to such payment, we would not be able to pay our debts as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus any amounts needed to satisfy any preferential rights if we were dissolving. In addition, in deciding whether or not to declare a dividend of any particular size, our board of directors must consider our and our Bank’s current and prospective capital, liquidity, and other needs.

The TDFI also regulates our Bank’s dividend payments. Under Tennessee law, a state-chartered bank may not pay a dividend without prior approval of the Commissioner if the total of all dividends declared by its board of directors in any calendar year will exceed (i) the total of its retained net income for that year, plus (2) its retained net income for the preceding two years.

Our Bank’s payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividends if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

Restrictions on Transactions with Affiliates and Insiders

We are subject to Section 23A of the Federal Reserve Act, which 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;

 

·

loans or extensions of credit made by a bank to third parties collateralized by the securities or obligations of affiliates;

 

·

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

 

·

a bank’s transactions with an affiliate involving the borrowing or lending of securities to the extent they create credit exposure to the affiliate; and

 

·

a bank’s derivative transactions with an affiliate to the extent they create credit exposure to the affiliate.

Subject to various exceptions, 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, the above transactions also must meet specified collateral requirements and safety and soundness requirements. Our Bank must also comply with provisions prohibiting the acquisition of low-quality assets from an affiliate.

We are also subject to Section 23B of the Federal Reserve Act, which, among other things, prohibits an institution from engaging in the above transactions with affiliates, as well as other types of transactions set forth in Section 23B, 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.

Our Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (i) 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 (ii) must not involve more than the normal risk of repayment or present other unfavorable features. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

Commercial Real Estate Concentration Limits

In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in commercial real estate (CRE) loans. The guidance describes the criteria the agencies will use as indicators to identify institutions potentially exposed to CRE concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total CRE loans representing 300% or more of the institution’s capital, and the outstanding balance of the institutions CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level and nature of its CRE concentration risk. As of December 31, 2015, our Bank’s total CRE loans represented 269% of its capital, below the 300% target.

 

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Privacy

Financial institutions are required to disclose their policies for collecting and protecting non-public personal information of their customers. Customers generally may prevent financial institutions from sharing nonpublic personal information with nonaffiliated third parties except under certain circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly offering a product or service with a nonaffiliated financial institution. Additionally, financial institutions generally are prohibited from disclosing consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.

Consumer Credit Reporting

The FCRA imposes, among other things:

 

·

requirements for financial institutions to develop policies and procedures to identify potential identity theft and, upon the request of a consumer, to place a fraud alert in the consumer’s credit file stating that the consumer may be the victim of identity theft or other fraud;

 

·

requirements for entities that furnish information to consumer reporting agencies to implement procedures and policies regarding the accuracy and integrity of the furnished information and regarding the correction of previously furnished information that is later determined to be inaccurate;

 

·

requirements for mortgage lenders to disclose credit scores to consumers in certain circumstances; and

 

·

limitations on the ability of a business that receives consumer information from an affiliate to use that information for marketing purposes.

\Anti-Terrorism and Money Laundering Legislation

Our Bank is subject to the Bank Secrecy Act, USA Patriot Act, and the requirements of Office of Foreign Assets Control (OFAC). These statutes and related rules and regulations impose requirements and limitations on specified financial transactions and accounts and other relationships intended to guard against money laundering and terrorism financing. Our Bank has established an anti-money laundering program pursuant to the Bank Secrecy Act and customer identification program pursuant to the USA Patriot Act. The bank also maintains records of cash purchases of negotiable instruments, files reports of certain cash transactions exceeding $10,000 (daily aggregate amount), and reports suspicious activity that might signify money laundering, tax evasion, or other criminal activities pursuant to the Bank Secrecy Act. Our Bank has implemented policies and procedures to comply with the foregoing requirements.

Effect of Governmental Monetary Policies

Our Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’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 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, and have no control over, the nature or impact of future changes in monetary and fiscal policies.

Sarbanes-Oxley Act

The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered, or that file reports, under the Exchange Act. In particular, the act established (i) requirements for audit committees, including independence, expertise and responsibilities; (ii) responsibilities regarding financial statements for the chief executive officer and chief financial officer of the reporting company and new requirements for them to certify the accuracy of periodic reports; (iii) standards for auditors and regulation of audits; (iv) disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) civil and criminal penalties for violations of the federal securities laws. The legislation also established a new accounting oversight board to enforce auditing standards and restrict the scope of services that accounting firms may provide to their public company audit clients.

Overdraft Fees

Federal Reserve Regulation E restricts banks’ abilities to charge overdraft fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions.

 

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The Dodd-Frank Act

On July 21, 2010, the Dodd-Frank Act was signed into law. As final rules and regulations implementing the Dodd-Frank Act have been adopted, this new law has significantly changed and is significantly changing the bank regulatory framework and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act will depend on the rules and regulations that implement it.

A number of the effects of the Dodd-Frank Act are described or otherwise accounted for in various parts of this “Supervision and Regulation” section. The following items provide a brief description of certain other provisions of the Dodd-Frank Act that may be relevant to us and our Bank.

 

·

The Dodd-Frank Act created the new Consumer Financial Protection Bureau (Bureau) with broad powers to supervise and enforce consumer financial protection laws. The Bureau now has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau has examination and enforcement authority with respect to enumerated consumer financial protection laws over all banks with more than $10.0 billion in assets. Institutions with less than $10.0 billion in assets will continue to be examined for compliance with consumer financial protection laws by their primary bank regulator.

 

·

The Dodd-Frank Act imposed new requirements regarding the origination and servicing of residential mortgage loans. The law created a variety of new consumer protections, including limitations, subject to exceptions, on the manner by which loan originators may be compensated and an obligation on the part of lenders to verify a borrower’s “ability to repay” a residential mortgage loan. Final rules implementing these latter statutory requirements became effective in 2014.

 

·

The Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits effective one year after the date of its enactment, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.

 

·

The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act (i) requires publicly traded companies to give shareholders a non-binding vote on executive compensation and golden parachute payments; (ii) enhances independence requirements for compensation committee members; (iii) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers; (iv) authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials; and (v) directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks.

 

·

While insured depository institutions have long been subject to the FDIC’s resolution regime, the Dodd-Frank Act creates a new mechanism for the FDIC to conduct the orderly liquidation of certain “covered financial companies,” including bank holding companies and systemically important non-bank financial companies. Upon certain findings being made by the U.S. Secretary of the Treasury, in consultation with the President of the United States, the FDIC may be appointed receiver for a covered financial company, and would conduct an orderly liquidation of the entity. The FDIC liquidation process is modeled on the existing Federal Deposit Insurance Act process for resolving insured banks. The FDIC has issued final rules implementing certain aspects of its orderly liquidation authority.

As noted above, 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 us. However, compliance with the Dodd-Frank Act and its implementing regulations clearly will result in additional operating and compliance costs that could have a material adverse effect on our business, financial condition and results of operations.

Interchange Fees

The Dodd-Frank Act, through a provision known as the Durbin Amendment, required the Federal Reserve to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. Institutions like the Bank with less than $10 billion in assets generally are exempt from these interchange fee standards. However, while we are under the $10 billion level that caps interchange fees, we have been affected by federal regulations that prohibit network exclusivity arrangements and routing restrictions.

The Volcker Rule

On December 10, 2013, five U.S. financial regulators, including the Federal Reserve and the FDIC, adopted a final rule implementing the “Volcker Rule.” The Volcker Rule was created by Section 619 of the Dodd-Frank Act and prohibits “banking entities” from engaging in “proprietary trading.” Banking entities also are prohibited from sponsoring or investing in private equity or hedge funds, or extending credit to or engaging in other covered transactions with affiliated private equity or hedge funds. The

 

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fundamental prohibitions of the Volcker Rule generally apply to banking entities of any size, including us and the bank. The final rule became effective April 1, 2014, but the Federal Reserve has extended the conformance period for all banking entities until July 21, 2016.

ITEM 1A.

RISK FACTORS

Our business involves a significant degree of risk. Any of the following risks, as well as risks that we do not know or currently deem immaterial, could materially and adversely affect our business, prospects, financial condition, results of operations and cash flow. Further, to the extent that any of the information in this document constitutes forward-looking statements, the risk factors below also are cautionary statements identifying important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. See “Cautionary Note Regarding Forward-Looking Statements.”

Risks Related To Our Business

The Company has entered into the Merger which is subject to shareholder approval, regulatory approval and the performance of the parties to the Merger Agreement.

As discussed in Part 1. — Item 1. “Business — Significant Recent Development”, on January 28, 2016, the Company entered into the Merger Agreement. Management of the Company is unable to predict what effect the Merger may have on its business, financial condition, results of operations or stock price. The material factors that could have an effect on the Company’s business, financial condition, results of operations or stock price include, without limitation, the following: (1) the inability to complete the Merger in a timely manner; (2) the inability to complete the Merger due to the failure to obtain stockholder approval or the failure to satisfy other conditions to completion of the Merger, including obtaining necessary regulatory approvals; (3) the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement; (4) the occurrence of events that adversely effect the price of Pinnacle common stock; (5) the possibility that competing offers will be made; (6) the effect of the announcement of the transaction on the Company’s business relationships, operating results and business generally, either before or after the consummation of the transaction; (7) diversion of management’s attention from ongoing business concerns as a result of the pendency or consummation of the Merger; and (8) general economic or business conditions and other factors.

As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by weak economic conditions.

Our businesses and operations, which primarily consist of lending money to customers in the form of loans, borrowing money from customers in the form of deposits and investing in securities, are sensitive to general business and economic conditions in the U.S. If the U.S. economy weakens, our growth and profitability from our lending, deposit and investment operations could be constrained. Uncertainty about the federal fiscal policymaking process, the medium and long-term fiscal outlook of the federal government, and future tax rates is a concern for businesses, consumers and investors in the U.S. In addition, economic conditions in foreign countries, including uncertainty over the stability of the euro and other currencies, could affect the stability of global financial markets, which could hinder U.S. economic growth. Weak economic conditions are characterized by deflation, fluctuations in debt and equity capital markets, a lack of liquidity and/or depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and commercial loans, residential and commercial real estate price declines and lower home sales and commercial activity. The current economic environment is also characterized by interest rates at historically low levels, which impacts our ability to attract deposits and to generate attractive earnings through our loan and investment portfolios. All of these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our decisions regarding credit risk could be inaccurate and our allowance for loan losses may be inadequate, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our earnings are affected by our ability to make loans, and thus we could sustain significant loan losses and consequently significant net losses if we incorrectly assess either the creditworthiness of our borrowers resulting in loans to borrowers who fail to repay their loans in accordance with the loan terms or the value of the collateral securing the repayment of their loans, or we fail to detect or respond to a deterioration in our loan quality in a timely manner. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses that we consider adequate to absorb losses inherent in the loan portfolio based on our assessment of the information available. As of December 31, 2015 and December 31, 2014, the allowance for loan losses was $10.1 million and $8.5 million, respectively. Non-accruing loans totaled $550,000 and $695,000 as of December 31, 2015 and December 31, 2014, respectively. The amount of the allowance for loan losses is determined by our management through periodic reviews. Maintaining an adequate allowance for loan losses is critical to our financial results and condition. In determining the size of our allowance for loan losses, we rely on an analysis of our loan portfolio considering historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-

 

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accruals, economic conditions and other pertinent information. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risks and future trends, all of which may undergo material changes.

As a result of continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, inaccurate management assumptions, identification of additional problem loans and other factors, both within and outside of our control, we may incur loan losses in excess of our current allowance for loan losses and be required to make material additions to our allowance for loan losses, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

In addition, federal and state regulators periodically review our allowance for loan losses and could require us to materially increase our allowance for loan losses or recognize further loan charge-offs based on judgments different than those of our management. Further, if actual charge-offs in future periods exceed the amounts allocated to our allowance for loan losses; we may need additional provisions for loan losses to restore the adequacy of our allowance for loan losses. Any material increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a material adverse effect on our business, financial condition, results of operations and prospects.

Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future.

As a result of our growth over the past several years, as of December 31, 2015 approximately $790.5 million (including unfunded commitments) of the loans in our loan portfolio were originated during the past two years. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because a large portion of our portfolio is relatively new, the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned and may not serve as a reliable basis for predicting the health and nature of our loan portfolio, including net charge-offs and the ratio of nonperforming assets in the future. Our limited experience with these loans does not provide us with a significant payment history pattern with which to judge future collectability. As a result, it may be difficult to predict the future performance of our loan portfolio. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our high concentration of large loans to certain borrowers may increase our credit risk.

Our growth over the last several years has been partially attributable to our ability to originate and retain large loans. We have established an informal, internal limit on loans to one borrower, principal or guarantor. Our limit is based on “total exposure” which represents the aggregate exposure of economically related borrowers for approval purposes. However, we may, under certain circumstances, consider going above this internal limit in situations where management’s understanding of the industry and the credit quality of the borrower are commensurate with the increased size of the loan. Many of these loans have been made to a small number of borrowers, resulting in a high concentration of large loans to certain borrowers. As of December 31, 2015, our 10 largest borrowing relationships accounted for approximately 13.8% of our total loan portfolio. Along with other risks inherent in these loans, such as the deterioration of the underlying businesses or property securing these loans, this high concentration of borrowers presents a risk to our lending operations. If any one of these borrowers becomes unable to repay its loan obligations as a result of economic or market conditions, or personal circumstances, such as divorce or death, our non-accruing loans and our provision for loan losses could increase significantly, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our commercial real estate loan portfolio exposes us to credit risks that may be greater than the risks related to other types of loans.

Our loan portfolio includes $202.1 million of non-owner-occupied commercial real estate (CRE) loans, for individuals and businesses for various purposes, which are secured by commercial properties, as well as real estate construction and development loans. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. The availability of such income for repayment may be adversely affected by changes in the economy or local market conditions. These loans expose us to greater credit risk than loans secured by other types of collateral because the collateral securing these loans is typically more difficult to liquidate. Additionally, non-owner-occupied CRE loans generally involve relatively large balances to single borrowers or related groups of borrowers. Unexpected deterioration in the credit quality of our non-owner-occupied commercial real estate loan portfolio could require us to increase our provision for loan losses, which would reduce our profitability and have a material adverse effect on our business, financial condition, results of operations and prospects.

A prolonged downturn in the real estate market could result in losses and adversely affect our profitability.

As of December 31, 2015, approximately 62% of our loan portfolio was composed of commercial and consumer real estate loans. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. The last recession adversely affected real estate market values across the country and values may continue to decline. A further decline in real estate values could further impair the value of our collateral and

 

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our ability to sell the collateral upon any foreclosure, which would likely require us to increase our provision for loan losses. In the event of a default with respect to any of these loans, the amounts we receive upon sale of the collateral may be insufficient to recover the outstanding principal and interest on the loan. If we are required to re-value the collateral securing a loan to satisfy the debt during a period of reduced real estate values or to increase our allowance for loan losses, our profitability could be adversely affected, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

We target small and medium-sized businesses as loan customers, who may have greater credit risk than larger borrowers.

We target small and medium-sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. If loan losses occur at a level where the loan loss reserve is not sufficient to cover actual loan losses, our earnings will decrease.

We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate, subjecting us to the costs associated with the ownership of the real property.

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. As of December 31, 2015, we held $508,000 in other real estate owned. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to:

 

·

general or local economic conditions;

 

·

environmental cleanup liability;

 

·

neighborhood assessments;

 

·

interest rates;

 

·

real estate tax rates;

 

·

operating expenses of the mortgaged properties;

 

·

supply of and demand for rental units or properties;

 

·

ability to obtain and maintain adequate occupancy of the properties;

 

·

zoning laws;

 

·

governmental and regulatory rules;

 

·

fiscal policies; and

 

·

natural disasters.

Our inability to manage the amount of costs or size of the risks associated with the ownership of real estate, or further write-downs in the value of other real estate owned, could have a material adverse effect on our business, financial condition, results of operations and prospects.

We are dependent on the services of our management team and board of directors, and the unexpected loss of key officers or directors may adversely affect our business and operations.

We are led by an experienced core management team with substantial experience in the markets that we serve, and our operating strategy focuses on providing products and services through long-term relationship managers. Accordingly, our success depends in large part on the performance of our key personnel, as well as on our ability to attract, motivate and retain highly qualified senior and middle management. Competition for employees is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. If any of our or our Bank’s executive officers, other key personnel, or directors leaves us or our Bank, our operations may be adversely affected. In particular, we believe that Ronald L. Samuels and G. Kent Cleaver are extremely important to our success and the success of our Bank. Mr. Samuels has extensive executive-level banking experience and is the Chairman and Chief Executive Officer of us and our Bank. Mr. Cleaver has extensive operating banking experience and is the President and Chief Operating Officer of us and our Bank. If either of Mr. Samuels or Mr. Cleaver leaves his position for any reason, our financial condition and results of operations may suffer because of their skills, knowledge of our market, years of industry experience and difficulty of promptly finding qualified replacement personnel. We have employment agreements and non-competition agreements with Mr. Samuels and Mr. Cleaver, as well as other named executive officers and a number of other officers and employees. Additionally, our directors’ community involvement and diverse and extensive local business relationships are important to our success. Any material change in the composition of our board of directors or our management could have a material adverse effect on our business, financial condition, results of operations and prospects as we may not be able to identify and hire qualified persons on terms acceptable to us.

 

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Damage to our reputation could negatively impact our business.

A key differentiating factor for our business is the strong brand we are building in the Nashville MSA market. Through our branding, we send very clear communication to the market about what we stand for as a company. Maintaining a positive reputation is critical to our attracting and retaining customers and employees. In the course of making business decisions, we face reputational risk in the potential changes to client sentiment that may occur as a result of our decisions. In particular, adverse perceptions regarding our reputation could make it more difficult for us to execute on our strategy. Harm to our reputation can arise from many sources, including employee misconduct, misconduct by our outsourced service providers or other counterparties, litigation or regulatory actions, failure by us to meet the standards of service and quality we have set and compliance failures. Negative publicity regarding us or our Bank, whether or not accurate, may damage our reputation, which could have a material adverse effect on our business, results of operations, financial condition and prospects.

We are subject to interest rate risk, which could adversely affect our profitability.

Our profitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowings. We have positioned our asset portfolio to benefit in a higher interest rate environment, but this may not remain true in the future. We have managed the growth of our Bank since inception in an economic environment characterized by declining interest rates. Our ability to continue that performance in a rising rate environment is not a certainty. Our interest sensitivity profile was asset sensitive on a growth balance sheet as of December 31, 2015, meaning that our net interest income would increase more from rising interest rates than from falling interest rates. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System, or the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could also affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our business, financial condition, results of operations and prospects.

In addition, an increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also necessitate further increases to the allowance for loan losses which could have a material adverse effect on our business, financial condition, results of operations and prospects.

As a recently formed financial institution, we have not operated in a rising interest rate environment.

Interest rates dropped to historically low rates in 2009 and have remained at historically low levels since that time. Since we commenced operations in 2007, we have never operated in a rising interest rate environment. Our Asset Liability Management Committee periodically evaluates various financial models that are designed to demonstrate the rate sensitivity of our assets and liabilities over various assumed time periods. Because we do not have a history of operating in a rising interest rate environment, we have no historical data on which to model the actual effect of rising interest rates on our assets and liabilities. As a result, these models may not be an accurate indicator of how our interest income will be affected by changes in interest rates.

Unpredictable local economic, political, or environmental conditions in the Nashville MSA and other markets may have a material adverse effect on our financial performance.

Substantially all of our borrowers and depositors are individuals and businesses located and doing business in the Nashville MSA. Substantially all of the real estate loans in our loan portfolio are secured by properties located in the Nashville MSA. Therefore, our success will depend on the general economic conditions in this area, which we cannot predict with certainty. Unlike with many of our larger competitors, the majority of our borrowers are commercial firms, professionals and affluent consumers located and doing business in our local market. As of December 31, 2015, approximately 83% of the loans in our loan portfolio (measured by dollar amount) were made to borrowers who live or conduct business in the Nashville MSA. As a result, our operations and profitability may be more adversely affected by a local economic downturn or natural disaster in the Nashville MSA, than those of larger, more geographically diverse competitors. For example, a downturn in the economy in the Nashville MSA could make it more difficult for our borrowers in that market to repay their loans and may lead to loan losses that are not offset by operations in other markets. Any regional or local economic downturn, or natural or man-made disaster, that affects the Nashville MSA, or existing or prospective property or borrowers in the Nashville MSA may affect us and our profitability more significantly and more adversely than our more geographically diverse competitors, which could have a material adverse effect on our business, financial condition, results of operations and prospects. From time to time, our Bank may provide financing to Nashville-based clients who have companies or properties located outside the Nashville MSA. In such cases, we face similar local market risk in those communities.

 

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Our business strategy includes the continuation of our growth plans, and our business, financial condition, results of operations and prospects could be negatively affected if we fail to grow or fail to manage our growth effectively.

We intend to continue pursuing our growth strategy for our business through organic growth of our loan portfolio. Our prospects must be considered in light of the risks, expenses and difficulties that can be encountered by financial service companies in rapid growth stages, which include the risks associated with the following:

 

·

maintaining loan quality;

 

·

maintaining adequate management personnel and information systems to oversee such growth;

 

·

maintaining adequate control and compliance functions;

 

·

obtaining regulatory approvals with respect to acquisitions; and

 

·

securing capital and liquidity needed to support anticipated growth.

We may not be able to expand our presence in our existing market. Our ability to grow successfully will depend on a variety of factors, including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. Failure to manage our growth effectively could adversely affect our ability to successfully implement our business strategy, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Additionally, as we continue to invest in our growth, we will experience business risk associated with expansion. Our expansion may occur via new bankers, new lines of business, new products, new geographic areas, or many other ways. Each method of expansion includes its own set of business risks which could potentially have a material adverse effect on our business, financial condition, results of operations and prospects.

Our recent results may not be indicative of our future results, and may not provide guidance to assess the risk of an investment in our common stock.

Our business has grown rapidly. Although rapid business growth can reflect favorable business conditions, financial institutions that grow rapidly can experience significant difficulties as a result of rapid growth. Failure to build infrastructure sufficient to support rapid growth and suffering loan losses in excess of reserves for such losses, as well as other risks associated with rapidly growing financial institutions, could materially impact our operations.

We may not be able to sustain our historical rate of growth and may not even be able to expand our business at all. In addition, our recent growth may distort some of our historical financial ratios and statistics. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. As a small commercial bank, we have different lending risks than larger banks. We provide services to our local communities; thus, our ability to diversify our economic risks is limited by our own local market and economy. We lend primarily to small to medium-sized businesses, which may expose us to greater lending risks than those faced by banks lending to larger, better-capitalized businesses with longer operating histories. We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through our loan approval and review procedures. Our use of historical and objective information in determining and managing credit exposure may not be accurate in assessing our risk. Our failure to sustain our historical rate of growth or adequately manage the factors that have contributed to our growth could have a material adverse effect on our business, financial condition, results of operations and prospects.

Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability.

The federal bank regulatory agencies have indicated their view that banks with high concentrations of loans secured by commercial real estate are subject to increased risk and should hold higher capital than regulatory minimums to maintain an appropriate cushion against loss that is commensurate with the perceived risk. In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in CRE loans. The guidance identifies institutions potentially exposed to CRE concentration risk as having construction, land development and other land loans representing more than 100% of the institution’s total capital and total CRE loans representing more than 300% of the institution’s total capital. Because a significant portion of our loan portfolio is dependent on commercial real estate, a change in the regulatory capital requirements applicable to us as a result of these policies could limit our ability to leverage our capital, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our lending limit may restrict our growth and prevent us from effectively implementing our business strategy.

We are limited in the amount we can loan in the aggregate to a single borrower or related borrowers by the amount of our capital. Avenue Bank is a Tennessee chartered bank and therefore all branches, regardless of location, fall under the legal lending

 

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limits of the state of Tennessee. Tennessee’s legal lending limit is a safety and soundness measure intended to prevent one person or a relatively small and economically related group of persons from borrowing an unduly large amount of a bank’s funds. It is also intended to safeguard a bank’s depositors by diversifying the risk of loan losses among a relatively large number of creditworthy borrowers engaged in various types of businesses. Under Tennessee law, total loans and extensions of credit to a borrower may not exceed 15% of our Bank’s capital surplus and undivided profits. However, such loans may be in excess of that percentage, but not above 25%, if each loan in excess of 15% is first submitted to and approved in advance in writing by the board of directors and a record is kept of such written approval and reported to the board of directors quarterly. We have also established an informal, internal house limit on loans to one borrower equal to 80% of our 15% legal lending limit. Loans in excess of the house limit are noted as a policy exception and require acknowledgment by our Bank’s full board of directors. Based upon our current capital levels, the amount we may lend is significantly less than that of many of our larger competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy may not always be available. If we are unable to compete effectively for loans from our target customers, we may not be able to effectively implement our business strategy, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Competition from financial institutions and other financial service providers may adversely affect our profitability.

The banking business is highly competitive, and we experience competition in our market from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other community banks and super-regional and national financial institutions that operate offices in our service area. These competitors often have far greater resources than we do and are able to conduct more intensive and broader based promotional efforts to reach both commercial and individual customers.

We compete with these other financial institutions both in attracting deposits and in making loans. In addition, we must attract our customer base from other existing financial institutions and from new residents. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to successfully compete with an array of financial institutions in our service area.

Our ability to compete successfully will depend on a number of factors, including, among other things:

 

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our ability to recruit and retain experienced and talented bankers at competitive compensation levels;

 

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our ability to build and maintain long-term customer relationships while ensuring high ethical standards and safe and sound banking practices;

 

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the scope, relevance and pricing of products and services that we offer;

 

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customer satisfaction with our products and services;

 

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industry and general economic trends; and

 

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our ability to keep pace with technological advances and to invest in new technology.

Increased competition could require us to increase the rates that we pay on deposits or lower the rates that we offer on loans, which could reduce our profitability. We derive a majority of our business from our primary market area, the Nashville MSA. Our failure to compete effectively in our market could restrain our growth or cause us to lose market share, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our continued pace of growth may require us to raise additional capital in the future to fund such growth, and the unavailability of additional capital on terms acceptable to us could adversely affect our growth and/or our business, financial condition, results of operations and prospects.

We believe that we will have sufficient capital to meet our capital needs for our immediate growth plans. However, we will continue to need capital to support our longer-term growth plans. If capital is not available on favorable terms when we need it, we will have to either issue common stock or other securities on less than desirable terms or reduce our rate of growth until market conditions become more favorable. Either of such events could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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Our growth and expansion strategy may involve strategic acquisitions, and we may not be able to overcome risks associated with such transactions.

Although we plan to continue to grow our business organically, we will continue to explore opportunities to acquire other financial institutions and businesses that we believe would complement our existing business. Our investment or acquisition activities could be material to our business and involve a number of risks, including the following:

 

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incurring time and expense associated with identifying and evaluating potential investments or acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business;

 

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the lack of history among our management team in working together on acquisitions and related integration activities;

 

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the time, expense and difficulty of integrating the operations and personnel of the combined businesses;

 

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an inability to realize expected synergies or returns on investment;

 

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potential disruption of our ongoing banking business; and

 

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a loss of key employees or key customers following our investment or acquisition.

We may not be successful in overcoming these risks or any other problems encountered in connection with pending or potential investments or acquisitions. Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy and enhance shareholder value, which, in turn, could have a material adverse effect on our business, financial condition, results of operations and prospects.

Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and our funding sources may be insufficient to fund our future growth.

Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain adequate funding. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. In particular, approximately 87% of our Bank’s deposits as of December 31, 2015 were checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, 72% of the assets of our Bank were loans at December 31, 2015, which cannot be called or sold in the same time frame. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could negatively impact our access to liquidity sources include a decrease of our business activity as a result of a downturn in the markets in which our loans are concentrated, adverse regulatory action against us, or our inability to attract and retain deposits. Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Any substantial, unexpected or prolonged change in the level or cost of liquidity could have a material adverse effect on our ability to meet deposit withdrawals and other customer needs, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Additionally, when mortgage loans are sold, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to purchasers, guarantors and insurers, including government-sponsored entities, about the mortgage loans and the manner in which they were originated. Whole loan sale agreements may require us to repurchase or substitute mortgage loans, or indemnify buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower on a mortgage loan. If repurchase and indemnity demands increase and such demands are valid claims and are in excess of our provision for potential losses, our liquidity, results of operations and financial condition may be adversely affected.

We rely on customer deposits, advances from the Federal Home Loan Bank of Cincinnati (FHLB), nationally marketed CDs, brokered CDs and lines of credit at other financial institutions to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if our financial condition, the financial condition of the FHLB or market conditions were to change.

FHLB borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations. Furthermore, our own actions could result in a loss of adequate funding. For example, our availability at the FHLB could be reduced if we are deemed to have poor documentation or processes. Accordingly, we may seek additional higher-cost debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on favorable terms. If additional financing sources are unavailable or are not available on reasonable terms, our growth and future prospects could be adversely affected.

Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more

 

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expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our profitability would be adversely affected.

The fair value of our investment securities can fluctuate due to factors outside of our control.

As of December 31, 2015, the fair value of our investment securities portfolio was approximately $221.5 million. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments (OTTI) and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could materially and adversely affect our business, results of operations, financial condition and prospects. The process for determining whether impairment of a security is OTTI usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Our failure to assess any currency impairments or losses with respect to our securities could have a material adverse effect on our business, financial condition, results of operations and prospects.

Deterioration in the fiscal position of the U.S. federal government and downgrades in the U.S. Department of the Treasury (Treasury) and federal agency securities could adversely affect us and our banking operations.

The long-term outlook for the fiscal position of the U.S. federal government is uncertain, as illustrated by the 2011 downgrade by certain rating agencies of the credit rating of the U.S. government and federal agencies. However, in addition to causing economic and financial market disruptions, any future downgrade, failure to raise the U.S. statutory debt limit, or deterioration in the fiscal outlook of the U.S. federal government, could, among other things, have a material adverse affect on the market value of the U.S. and other government and governmental agency securities that we hold, the availability of those securities as collateral for borrowing, and our ability to access capital markets on favorable terms. In particular, it could increase interest rates and disrupt payment systems, money markets, and long-term or short-term fixed income markets, adversely affecting the cost and availability of funding, which could negatively affect our profitability. Also, the adverse consequences of any downgrade could extend to those to whom we extend credit and could adversely affect their ability to repay their loans. Any of these developments could have a material adverse effect on our business, financial condition, results of operations and prospects.

We are subject to losses due to fraudulent and negligent acts on the part of loan applicants, our borrowers, other vendors, and our employees.

When we originate loans, we rely heavily upon information supplied by third parties, including the information contained in the loan application, property appraisal, title information and employment and income documentation. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected. Whether a misrepresentation is made by the loan applicant, the borrower, another third party or one of our employees, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a misrepresentation, and the persons and entities involved are often difficult to locate and it is often difficult to collect any monetary losses that we have suffered from them. We have controls and processes designed to help us identify misrepresented information in our loan origination operations. We cannot assure, however, that we have detected or will detect all misrepresented information in our loan originations.

If we fail to design, implement and maintain effective internal control over financial reporting or remediate any future material weakness in our internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles (U.S. GAAP). Effective internal control over financial reporting is necessary for us to provide reliable reports and prevent fraud.

We believe that a control system, no matter how well designed and managed, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. 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 a company have been detected. We may not be able to identify all significant deficiencies and/or material weaknesses in our internal control in the future, and our failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business, financial condition, results of operations and prospects.

We may bear costs associated with the proliferation of computer theft and cybercrime.

We necessarily collect, use and hold sensitive data concerning individuals and businesses with whom we have a banking relationship. Threats to data security, including unauthorized access and cyber-attacks, rapidly emerge and change, exposing us to additional costs for protection or remediation and competing time constraints to secure our data in accordance with customer

 

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expectations and statutory and regulatory requirements. It is difficult and near impossible to defend against every risk being posed by changing technologies as well as criminals intent on committing cyber-crime. Increasing sophistication of cyber-criminals and terrorists make keeping up with new threats difficult and could result in a breach of our data security. Patching and other measures to protect existing systems and servers could be inadequate, especially on systems that are being retired. Controls employed by our information technology department and third-party vendors could prove inadequate. We could also experience a breach by intentional or negligent conduct on the part of our employees or other internal sources, software bugs or other technical malfunctions, or other causes. As a result of any of these threats, our customer accounts may become vulnerable to account takeover schemes or cyber-fraud. Our systems and those of our third-party vendors may become vulnerable to damage or disruption due to circumstances beyond our or their control, such as from catastrophic events, power anomalies or outages, natural disasters, network failures, and viruses and malware.

A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations as well as to data loss, litigation, damages, fines and penalties, customer notification requirements, significant increases in compliance costs, and reputational damage, any of which could individually or in the aggregate have a material adverse effect on our business, results of operations, financial condition and prospects.

Our risk management framework may not be effective in mitigating risks and/or losses to us.

Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances or that it will adequately mitigate any risk or loss to us. If our framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.

If third parties infringe upon our intellectual property or if we were to infringe upon the intellectual property of third parties, we may expend significant resources enforcing or defending our rights or suffer competitive injury.

We rely on a combination of patent, copyright, trademark, trade secret laws and confidentiality provisions to establish and protect our proprietary rights. If we fail to successfully maintain, protect and enforce our intellectual property rights, our competitive position could suffer. Similarly, if we were to infringe on the intellectual property rights of others, our competitive position could suffer. Third parties may challenge, invalidate, circumvent, infringe or misappropriate our intellectual property, or such intellectual property may not be sufficient to permit us to take advantage of current market trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, discontinuance of certain product or service offerings or other competitive harm. We may also be required to spend significant resources to monitor and police our intellectual property rights. Others, including our competitors may independently develop similar technology, duplicate our products or services or design around our intellectual property, and in such cases we could not assert our intellectual property rights against such parties. Further, our contractual arrangements may not effectively prevent disclosure of our confidential information or provide an adequate remedy in the event of unauthorized disclosure of our confidential or proprietary information. We may have to litigate to enforce or determine the scope and enforceability of our intellectual property rights, trade secrets and know-how, which could be time-consuming and expensive, could cause a diversion of resources and may not prove successful. The loss of intellectual property protection or the inability to obtain rights with respect to third-party intellectual property could harm our business and ability to compete. In addition, because of the rapid pace of technological change in our industry, aspects of our business and our products and services rely on technologies developed or licensed by third parties, and we may not be able to obtain or continue to obtain licenses and technologies from these third parties on reasonable terms or at all.

We depend on our information technology and telecommunications systems and third-party servicers, and any systems failures or interruptions could adversely affect our operations and financial condition.

Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We outsource many of our major systems, such as data processing, loan servicing and deposit processing systems. For example, one vendor provides our entire core banking system through a service bureau arrangement. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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We encounter technological change continually and have fewer resources than many of our competitors to invest in technological improvements.

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our success will depend in part on our ability to address our customers’ needs by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we have. We may not be able to implement new technology-driven products and services effectively or be successful in marketing these products and services to our customers. As these technologies are improved in the future, we may, in order to remain competitive, be required to make significant capital expenditures, which may increase our overall expenses and have a material adverse effect on our net income.

We may be adversely affected by the soundness of other financial institutions.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties, and through transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. These losses or defaults could have a material adverse effect on our business, financial condition, results of operations and prospects.

Current market volatility and industry developments may adversely affect our business and financial results.

The volatility in the capital and credit markets, along with the housing declines over the past years, has resulted in significant pressure on the financial services industry. If volatility in market conditions continues or worsens, we may have further increases in loan losses, deterioration of capital or limitations on our access to funding or capital, if needed, which could have a material adverse effect on our business, financial condition, results of operations and prospect.

Further, if other, particularly larger, financial institutions continue to fail to be adequately capitalized or funded, it may negatively impact our business and financial results. We routinely interact with numerous financial institutions in the ordinary course of business and are therefore exposed to operational and credit risk to those institutions. Failures of such institutions may adversely impact our operations and have a material adverse effect on our business, financial condition, results of operations and prospects.

We are subject to environmental liability risks associated with our lending activities.

In the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. As a result, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could have a material adverse effect on our business, financial condition, results of operations and prospects.

We are subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line-items and affect our profitability.

The nature of our business makes us sensitive to changes to the large body of accounting rules in the U.S. From time to time, the governing body that oversees changes to accounting rules may release new guidance for the treatment of certain line items on financial statements. Any such changes may potentially affect our financial statements and could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP and with general practices within the financial services industry. The preparation of financial of statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, disclosure of contingent assets and liabilities and the reported amount of related revenues and expenses. Certain accounting policies inherently are based to a greater extent on estimates, assumptions and judgments of management and, as such, have a greater possibility of producing results that could be materially different than originally reported. They require management to make subjective or complex judgments, estimates or assumptions, and changes in those estimates or assumptions that could have a significant impact on our consolidated financial statements. These critical accounting policies include the allowance for loan losses, investment securities impairment and goodwill. Because of the uncertainty of estimates involved in these matters, we may be required to significantly increase the allowance for loan losses or sustain loan losses that are significantly higher than the reserve provided,

 

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significantly increase our accrued tax liability or otherwise incur charges that could have a material adverse effect on our business, financial condition, results of operations and prospects.

By engaging in derivative transactions, we are exposed to additional credit and market risk.

We use interest rate swaps to help manage our interest rate risk from recorded financial assets and liabilities when they can be demonstrated to effectively hedge a designated asset or liability and the asset or liability exposes us to interest rate risk or risks inherent in customer related derivatives. We use other derivative financial instruments to help manage other economic risks, such as liquidity and credit risk, including exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts principally related to our fixed rate loan assets. We also have derivatives that result from a service we provide to certain qualifying customers approved through our credit process, and therefore, are not used to manage interest rate risk in our assets or liabilities. Hedging interest rate risk is a complex process, requiring sophisticated models and routine monitoring, and is not a perfect science. As a result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the derivative instruments that are linked to the hedged assets and liabilities. By engaging in derivative transactions, we are exposed to credit and market risk. If the counterparty fails to perform, credit risk exists to the extent of the fair value gain in the derivative. Market risk exists to the extent that interest rates change in ways that are significantly different from what we expected when we entered into the derivative transaction. The existence of credit and market risk associated with our derivative instruments could adversely affect our net interest income and, therefore, could have a material adverse effect on our business, financial condition, results of operations and prospects.

We are or may become involved from time to time in suits, legal proceedings, information-gathering requests, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.

Many aspects of our business involve substantial risk of legal liability. From time to time, we are, or may become, the subject of lawsuits and related legal proceedings, governmental and self-regulatory agency information-gathering requests, reviews, investigations and proceedings and other forms of regulatory inquiry, including by bank regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgments, settlements, fines, injunctions, restrictions on the way in which we conduct our business, or reputational harm.

Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, amounts accrued may not represent the ultimate loss to us from the legal proceedings in question. Thus, our ultimate losses may be higher, and possibly significantly so, than the amounts accrued for legal loss contingencies, which could adversely affect our financial condition and results of operations.

Risks Related to Our Industry

We are subject to extensive regulation that could limit or restrict our activities and business and impose financial requirements, such as minimum capital requirements, which limitations, restrictions, or requirements could have a material adverse effect on our profitability.

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies including the Federal Reserve, the FDIC, and the TDFI. Regulatory compliance is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, transactions with affiliates, treatment of our customers, and interest rates paid on deposits. We are also subject to financial requirements prescribed by our regulators such as minimum capitalization guidelines, which require us to maintain adequate capital to support our growth. Violations of various laws, even if unintentional, may result in significant fines or other penalties, including restrictions on branching or bank acquisitions. Recently, banks generally have faced increased regulatory sanctions and scrutiny particularly with respect to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, or USA Patriot Act, and other statutes relating to anti-money laundering compliance and customer privacy. The recent recession had major adverse effects on the banking and financial industry, during which time many institutions saw a significant amount of their market capitalization erode as they charged off loans and wrote down the value of other assets. As described above, recent legislation has substantially changed, and increased, federal regulation of financial institutions, and there may be significant future legislation (and regulations under existing legislation) that could have a further material effect on banks and bank holding companies like us.

In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III regulatory capital reforms, or Basel III, and issued rules effecting certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act. Basel III is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and

 

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saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $500 million). Basel III not only increases most of the required minimum regulatory capital ratios, they introduce a new common equity Tier 1 capital ratio and the concept of a capital conservation buffer. Basel III also expands the current definition of capital by establishing additional criteria that capital instruments must meet to be considered additional Tier 1 capital (that is, Tier 1 capital in addition to common equity) and Tier 2 capital. A number of instruments that now generally qualify as Tier 1 capital will not qualify or their qualifications will change when Basel III is fully implemented. However, Basel III permits banking organizations with less than $15 billion in assets to retain, through a one-time election, the existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. Basel III has maintained the general structure of the current prompt corrective action thresholds while incorporating the increased requirements, including the common equity Tier 1 capital ratio. In order to be a “well-capitalized” depository institution under the new regime, an institution must maintain a common equity Tier 1 capital ratio of 6.5% or more; a Tier 1 capital ratio of 8% or more; a total capital ratio of 10% or more; and a leverage ratio of 5% or more. Institutions must also maintain a capital conservation buffer consisting of common equity Tier 1 capital. Generally, financial institutions became subject to Basel III on January 1, 2015 with a phase-in period through 2019 for many of the changes.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

Federal and state regulators periodically examine our business and may require us to remediate adverse examination findings or may take enforcement action against us.

The Federal Reserve, the FDIC and the TDFI periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, the Federal Reserve, the FDIC, or the TDFI were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, they may take a number of different remedial actions as they deem appropriate. These actions include the power to require us to remediate any such adverse examination findings.

In addition, these agencies have the power to take enforcement action against us to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation of law or regulation or unsafe or unsound practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to direct the sale of subsidiaries or other assets, to limit dividends and distributions, to restrict our growth, to assess civil monetary penalties against us or our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. Any regulatory enforcement action against us could have a material adverse effect on our business, results of operations, financial condition and prospects.

We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.

The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations prohibit discriminatory lending practices by financial institutions. The U.S. Department of Justice, federal banking agencies, and other federal agencies are responsible for enforcing these laws and regulations. A challenge to an institution’s compliance with fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations and prospects.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

The Bank Secrecy Act, the USA Patriot Act and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and to file reports such as suspicious activity reports and currency transaction reports. We are required to comply with these and other anti-money laundering requirements. The federal banking agencies and Financial Crimes Enforcement Network are authorized to impose significant civil money penalties for violations of those requirements and have recently engaged in coordinated enforcement efforts against banks and other financial services providers with the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service, or IRS. We are also subject to increased scrutiny of compliance with the rules enforced by the OFAC. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

31


 

Financial reform legislation tightened capital standards, created a new Consumer Financial Protection Bureau and resulted in new regulations that are likely to increase our costs of operations.

On July 21, 2010, the Dodd-Frank Act was signed into law. As final rules and regulations implementing the Dodd-Frank Act have been adopted, this law has significantly changed the current bank regulatory framework and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act will depend on the rules and regulations that implement it.

Among many other changes, the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits effective one year after the date of its enactment, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor. The Dodd-Frank Act requires publicly traded companies to give shareholders a non-binding vote on executive compensation and golden parachute payments. In addition, the Dodd-Frank Act authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials and directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks.

The Dodd-Frank Act created a new Consumer Financial Protection Bureau, or the Bureau, with broad powers to supervise and enforce consumer financial protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau has examination and enforcement authority with respect to enumerated consumer financial protection laws over all banks with more than $10.0 billion in assets. Institutions with less than $10.0 billion in assets will continue to be examined for compliance with consumer financial protection laws by their primary bank regulator.

As noted above, many aspects of the Dodd-Frank Act are subject to rulemaking and take effect over several years, making it difficult to anticipate the overall financial impact on us. However, compliance with the Dodd-Frank Act and its implementing regulations will result in additional operating and compliance costs that could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our FDIC deposit insurance premiums and assessments may increase.

The deposits of our Bank are insured by the FDIC up to legal limits and, accordingly, subject it to the payment of FDIC deposit insurance assessments based on the bank’s average consolidated total assets less its average tangible equity. The Bank’s regular assessments are determined by its risk classification, which is based on its regulatory capital levels and the level of supervisory concern that it poses. High levels of bank failures since the beginning of the financial crisis and increases in the statutory deposit insurance limits have increased resolution costs to the FDIC and put significant pressure on the Deposit Insurance Fund. In order to maintain a strong funding position and restore the reserve ratios of the Deposit Insurance Fund, the FDIC increased deposit insurance assessment rates and charged a special assessment to all FDIC-insured financial institutions. Further increases in assessment rates or special assessments may occur in the future, especially if there are significant additional financial institution failures. Any future special assessments, increases in assessment rates or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

Our Bank may become subject to further reporting requirements under FDIC regulations.

We became subject to further reporting requirements under the rules of the FDIC for the fiscal year in which our Bank’s total assets first exceeded $1.0 billion, including a requirement for management to prepare a report that contains an assessment by management of our Bank’s effectiveness of its internal control structure and procedures for financial reporting as of the end of such fiscal year. In addition, we will be required to obtain an independent public accountant’s attestation report concerning our internal control structure over financial reporting. The rules for management to assess the Bank’s internal controls over financial reporting are complex, and require significant documentation, testing and possible remediation. The effort to comply with regulatory requirements relating to internal controls will likely cause us to incur increased expenses and will cause a diversion of management’s time and other internal resources. If our Bank cannot favorably assess the effectiveness of our internal controls over financial reporting, or if our independent registered public accounting firm is unable to provide an unqualified attestation report on our Bank’s internal controls, the price of our common stock as well as investor confidence could be adversely affected and we may be subject to additional regulatory scrutiny.

 

32


 

The federal banking agencies have proposed new liquidity standards that could result in our having to lengthen the term of our funding, restructure our business lines by forcing us to seek new sources of liquidity for them, and/or increase our holdings of liquid assets.

As part of the Basel III capital process, the Basel Committee on Banking Supervision has finalized a new liquidity standard, a liquidity coverage ratio, which requires a banking organization to hold sufficient “high quality liquid assets” to meet liquidity needs for a 30 calendar day liquidity stress scenario. A net stable funding ratio, which imposes a similar requirement over a one-year period, is under consideration. The U.S. banking regulators have proposed a liquidity coverage ratio for systemically important banks. Although the proposal would not apply directly to us, the substance of the proposal may inform the regulators’ assessment of our liquidity. We could be required to reduce our holdings of illiquid assets, which may adversely affect our results and financial condition.

Risks Related to Our Common Stock

The market price of our common stock may be subject to substantial fluctuations, which may make it difficult for you to sell your shares at the volume, prices and times desired.

The market price of our common stock may be highly volatile, which may make it difficult for you to resell your shares at the volume, prices and times desired. There are many factors that may impact the market price and trading volume of our common stock, including, without limitation:

 

·

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

 

·

changes in economic or business conditions;

 

·

the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;

 

·

publication of research reports about us, our competitors, or the financial services industry generally, or changes in, or failure to meet, securities analysts’ estimates of our financial and operating performance, or lack of research reports by industry analysts or ceasing of coverage;

 

·

operating and stock price performance of companies that investors deem comparable to us;

 

·

future issuances of our common stock or other securities;

 

·

additions to or departures of key personnel;

 

·

proposed or adopted changes in laws, regulations or policies affecting us;

 

·

perceptions in the marketplace regarding our competitors and/or us;

 

·

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

 

·

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and

 

·

other news, announcements or disclosures (whether by us or others) related to us, our competitors, our core market or the financial services industry.

The stock market and, in particular, the market for financial institution stocks, have experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our common stock, which could make it difficult to sell your shares at the volume, prices and times desired.

An active, liquid market for our common stock may not develop or be sustained, which may impair the ability of our shareholders to sell their shares.

Before listing of our common stock on the NASDAQ Global Select Market on February 10, 2015, there was no established public market for our common stock. Even though our common stock is now listed on the NASDAQ Global Select Market under the symbol “AVNU”, there is limited trading volume and an active, liquid trading market for our common stock may not develop or be sustained. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace and independent decisions of willing buyers and sellers of our common stock, over which we have no control. Without an active, liquid trading market for our common stock, shareholders may not be able to sell their shares at the volume, prices and times desired. Moreover, the lack of an established market could materially and adversely affect the value of our common stock.

 

33


 

The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common stock in the future.

Shares of our common stock are subject to dilution and the market price of our common stock could decline due to the number of outstanding shares of our common stock eligible for future sale, including shares that will be available for sale following the expiration of lock-up periods.

Actual or anticipated issuances or sales of additional amounts of our common stock in the future could cause the market price of our common stock to decline significantly and make it more difficult for us to sell equity or equity-related securities in the future at a time and on terms that we deem appropriate. The issuance of any shares of our common stock in the future also would, and equity-related securities could, dilute the percentage ownership interest held by shareholders prior to such issuance.

Securities analysts may not continue coverage on our common stock, which could adversely affect the market for our common stock.

The trading market for our common stock depends in part on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts, and they may not cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are covered by securities analysts, and our common stock is the subject of an unfavorable report, the price of our common stock may decline. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of our common stock to decline.

Our directors and executive officers own a significant portion of our common stock and can exert influence over our business and corporate affairs.

Our directors and executive officers, as a group, beneficially owned approximately 21.16% of our outstanding common stock as of March 25, 2015. As a result of their ownership, our directors and executive officers will have the ability, by voting their shares in concert, to influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.

There are substantial regulatory limitations on changes of control of bank holding companies.

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

We have the ability to incur debt and pledge our assets, including our stock in our Bank, to secure that debt.

We have the ability to incur debt and pledge our assets to secure that debt. Absent special and unusual circumstances, a holder of indebtedness for borrowed money has rights that are superior to those of holders of our common stock. For example, interest must be paid to the lender before dividends can be paid to our shareholders, and loans must be paid off before any assets can be distributed to our shareholders if we were to liquidate. Furthermore, we would have to make principal and interest payments on our indebtedness, which could reduce our profitability or result in net losses on a consolidated basis even if our Bank were profitable.

The rights of our common shareholders are subordinate to the rights of the holders of any debt securities that we may issue and may be subordinate to the holders of any other class of preferred stock that we may issue in the future.

Our board of directors has the authority to issue in the aggregate up to ten million shares of preferred stock, and to determine the terms of each issue of preferred stock, without shareholder approval. Accordingly, you should assume that any shares of preferred stock that we may issue in the future will also be senior to our common stock.

On December 29, 2014, we issued our fixed rate/ floating rate subordinated notes (Subordinated Notes) in an aggregate principal amount of $20.0 million. The terms of our Subordinated Notes prohibit us from declaring or paying any dividends or distributions on our capital stock or redeeming, purchasing, acquiring or making a principal payment on our Subordinated Notes, at any time when payment of interest on our Subordinated Notes has not been timely made and while any such accrued and unpaid interest remains unpaid.

Because our decision to issue debt or equity securities or incur other borrowings in the future will depend on market conditions and other factors beyond our control, the amount, timing, nature or success of our future capital raising efforts is uncertain. Because our ability to pay dividends on our common stock in the future will depend on our and our Bank’s financial condition as well as factors outside of our control, our common shareholders bear the risk that no dividends will be paid on our common stock in future periods or that, if paid, such dividends will be reduced or eliminated, which may negatively impact the market price of our common stock.

 

34


 

We do not intend to pay dividends in the foreseeable future and we and our Bank are subject to capital and other legal and regulatory requirements which restrict our ability to pay dividends.

Our board of directors intends to retain all of our earnings to promote growth and build capital. Accordingly, we do not expect to pay dividends in the foreseeable future. In addition, we are subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies as well as our participation in the Small Business Lending Fund (SBLF). Finally, because our Bank is our only material asset, our ability to pay dividends to our shareholders depends on our receipt of dividends from the Bank, which is also subject to restrictions on dividends as a result of banking laws, regulations and policies.

Tennessee law limits the ability of others to acquire the bank, which may restrict your ability to fully realize the value of your common stock.

In many cases, shareholders receive a premium for their shares when one company purchases another. Tennessee law makes it difficult for anyone to purchase our Bank or us without approval of our board of directors. Thus, your ability to realize the potential benefits of any sale by us may be limited, even if such sale would represent a greater value for shareholders than our continued independent operation.

Our charter, as amended, authorizes the issuance of preferred stock which could adversely affect holders of our common stock and discourage a takeover of us by a third party.

Our charter, as amended, or our charter, authorizes our board of directors to issue up to ten million shares of preferred stock without any further action on the part of our shareholders.

Our board of directors has the power, without shareholder approval, to set the terms of any series of preferred stock that may be issued, including voting rights, dividend rights, and preferences over our common stock with respect to dividends or in the event of a dissolution, liquidation or winding up and other terms. In the event that we issue preferred stock in the future that has preference over our common stock with respect to payment of dividends or upon our liquidation, dissolution or winding up, or if we issue preferred stock with voting rights that dilute the voting power of our common stock, the rights of the holders of our common stock or the market price of our common stock could be adversely affected. In addition, the ability of our board of directors to issue shares of preferred stock without any action on the part of the shareholders may impede a takeover of us and prevent a transaction favorable to our shareholders.

An investment in our common stock is not an insured deposit and is subject to risk of loss.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, the Deposit Insurance Fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and is subject to the same market forces that affect the price of common stock in any company. As a result, an investor may lose some or all of such investor’s investment in our common stock.

The laws that regulate our operations are designed for the protection of depositors and the public, not our shareholders.

The federal and state laws and regulations applicable to our operations give regulatory authorities extensive discretion in connection with their supervisory and enforcement responsibilities, and generally have been promulgated to protect depositors and the Deposit Insurance Fund and not for the purpose of protecting shareholders. These laws and regulations can materially affect our future business. Laws and regulations now affecting us may be changed at any time, and the interpretation of such laws and regulations by bank regulatory authorities is also subject to change.

Future changes in laws and regulations or changes in their interpretation may also adversely affect our business. Legislative and regulatory changes may increase our cost of doing business or otherwise adversely affect us and create competitive advantages for non-bank competitors.

Our corporate governance documents, and certain corporate and banking laws applicable to us, could make a takeover more difficult.

Certain provisions of our charter and bylaws, as amended, and corporate and federal banking laws, could make it more difficult for a third party to acquire control of our organization, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions, and the corporate and banking laws and regulations applicable to us:

 

·

provide that special meetings of shareholders may be called at any time by the Chairman of our board of directors, by the President or by order of our board of directors;

 

·

enable our board of directors to issue preferred stock up to the authorized amount, with such preferences, limitations and relative rights, including voting rights, as may be determined from time to time by the board;

 

·

enable our board of directors to increase the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at the meeting;

 

35


 

 

·

enable our board of directors to amend our bylaws without shareholder approval; and  

 

·

do not provide for cumulative voting rights (therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose).

These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including under circumstances in which our shareholders might otherwise receive a premium over the market price of our shares.

We are an “emerging growth company,” and the reduced regulatory and reporting requirements applicable to emerging growth companies may make our common stock less attractive to investors.

We are an “emerging growth company,” as described in the JOBS Act. For as long as we continue to be an emerging growth company we may take advantage of reduced regulatory and reporting requirements that are otherwise generally applicable to public companies. These include, without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation, and exemptions from the requirements of holding non-binding advisory votes on executive compensation and golden parachute payments. The JOBS Act also permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we have irrevocably “opted out” of this provision, and we will comply with new or revised accounting standards to the same extent that compliance is required for non-emerging growth companies.

We may take advantage of these provisions for up to five years, unless we earlier cease to be an emerging growth company, which would occur if our annual gross revenues exceed $1.0 billion, if we issue more than $1.0 billion in non-convertible debt in a three-year period, or if the market value of our common stock held by non-affiliates exceeds $700.0 million as of any June 30 before that time, in which case we would no longer be an emerging growth company as of the following December 31. Investors may find our common stock less attractive if we rely on the exemptions, which may result in a less active trading market and increased volatility in our stock price.

Fulfilling our public company financial reporting and other regulatory obligations is expensive and time consuming, and it may strain our resources.

We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, and the related rules and regulations promulgated by the SEC. These laws and regulations increase the scope, complexity and cost of corporate governance, reporting and disclosure practices over those of non-public or non-reporting companies. Despite our conducting business in a highly regulated environment, these laws and regulations have different requirements for compliance than we experienced prior to becoming a reporting company. Our expenses related to services rendered by our accountants, legal counsel and consultants have increased in order to ensure compliance with these laws and regulations that we became subject to as a reporting company and may increase further as we grow in size. These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to us may impact the profitability of our business activities and may change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose us to additional costs, including increased compliance costs, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

ITEM 2.

PROPERTIES

Our main office is located at 111 10th Avenue South, Suite 400, Nashville, Tennessee 37203. We lease our main office and also lease office space for our four branches. We believe that we have the necessary infrastructure in place to support our projected growth in our primary markets and do not anticipate establishing additional offices in new markets in the foreseeable future.

ITEM 3.

LEGAL PROCEEDINGS

From time to time, we are a party to various legal proceedings incident to our business. Except as described below, as of the date hereof, there are no material pending legal proceedings to which we or any of our subsidiaries is a party or of which any of our or our subsidiaries’ properties are subject.

ITEM 4.

MINE SAFETY DISCLOSURE

Not applicable.

 

 

 

36


 

PART II

ITEM 5.

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

Market Information and Holders of Record

Avenue Financial Holdings, Inc.’s common stock is traded on the Nasdaq Global Select Market under the symbol “AVNU” and has traded on that market since February 10, 2015. Prior to that time, there was no established public trading market for our stock.  The following table shows the high and low sales price information for the Company’s common stock for each full quarter in 2015 as reported on the Nasdaq Global Select Market.  

 

 

Year Ended December 31, 2015

 

 

 

High

 

 

Low

 

First quarter

 

$

-

 

 

 

-

 

Second quarter

 

 

13.44

 

 

 

11.48

 

Third quarter

 

 

13.47

 

 

 

12.05

 

Fourth quarter

 

 

15.00

 

 

 

12.73

 

 

As of March 25, 2016, the Company had approximately 847 total stockholders, including 165 stockholders of record and 682 beneficial owners whose shares are held in “street” name by securities broker-dealers or other nominees.

Dividend Policy

We have never paid cash dividends to holders of our common stock. Although we may pay cash dividends in the future, we intend to retain a large majority of any earnings to fund our growth for the foreseeable future.

We are a bank holding company and accordingly, any dividends paid by us are subject to various federal and state regulatory limitations and also may be subject to the ability of our subsidiary Bank to make distributions or pay dividends to us. Our ability to pay dividends is limited by minimum capital and other requirements prescribed by law and regulation. Banking regulators have authority to impose additional limits on dividends and distributions by us and our subsidiaries. Certain restrictive covenants in future debt instruments, if any, may also limit our ability to pay dividends or the ability of our subsidiary depository institutions to make distributions or pay dividends to us. Any determination to pay cash dividends in the future will be at the unilateral discretion of our board of directors and will depend on a variety of considerations, including, without limitation, our historical and projected financial condition, liquidity and results of operations, capital levels, tax considerations, statutory and regulatory prohibitions and other limitations, general economic conditions and other factors deemed relevant by our board of directors. See “Supervision and Regulation.”

 

37


 

ITEM 6.

SELECTED FINANCIAL DATA  

You should read the following selected historical consolidated financial data in conjunction with our consolidated financial statements and related notes and the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.

 

 

 

At or For the Year Ended December 31,

 

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

 

(Dollars in Thousands, Except Per Share and Employee Data)

 

SELECTED INCOME STATEMENT DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

38,321

 

 

 

33,024

 

 

 

27,061

 

 

 

22,888

 

 

 

21,927

 

Interest expense

 

 

5,642

 

 

 

4,067

 

 

 

3,865

 

 

 

5,196

 

 

 

5,788

 

Net interest income

 

 

32,679

 

 

 

28,957

 

 

 

23,196

 

 

 

17,692

 

 

 

16,139

 

Provision for loan losses

 

 

2,029

 

 

 

1,643

 

 

 

1,593

 

 

 

1,623

 

 

 

1,102

 

Net interest income after provision for loan losses

 

 

30,650

 

 

 

27,314

 

 

 

21,603

 

 

 

16,069

 

 

 

15,037

 

Non-interest income

 

 

6,579

 

 

 

4,665

 

 

 

5,055

 

 

 

5,793

 

 

 

2,984

 

Non-interest expense

 

 

27,143

 

 

 

23,862

 

 

 

20,309

 

 

 

18,199

 

 

 

15,701

 

Income tax expense (benefit)

 

 

3,132

 

 

 

2,525

 

 

 

2,400

 

 

 

988

 

 

 

(11,519

)

Net income

 

 

6,954

 

 

 

5,592

 

 

 

3,949

 

 

 

2,675

 

 

 

13,839

 

Dividends on preferred shares

 

 

(32

)

 

 

(190

)

 

 

(190

)

 

 

(358

)

 

 

(396

)

Accretion of net preferred stock discount

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(234

)

Net income available to common stockholders

 

$

6,922

 

 

 

5,402

 

 

 

3,759

 

 

 

2,317

 

 

 

13,209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PER COMMON SHARE DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.70

 

 

 

0.64

 

 

 

0.45

 

 

 

0.27

 

 

 

1.56

 

Diluted earnings per share

 

 

0.69

 

 

 

0.63

 

 

 

0.45

 

 

 

0.27

 

 

 

1.56

 

Book value per common share

 

 

9.16

 

 

 

8.37

 

 

 

7.36

 

 

 

7.78

 

 

 

7.37

 

Tangible book value per common share (1)

 

 

8.87

 

 

 

8.03

 

 

 

7.02

 

 

 

7.43

 

 

 

7.02

 

Basic weighted average common shares

 

 

9,891,993

 

 

 

8,485,780

 

 

 

8,424,598

 

 

 

8,443,393

 

 

 

8,444,063

 

Diluted weighted average common shares

 

 

10,026,947

 

 

 

8,539,121

 

 

 

8,424,598

 

 

 

8,443,393

 

 

 

8,444,063

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED BALANCE SHEET DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,165,454

 

 

 

1,001,721

 

 

 

893,144

 

 

 

726,484

 

 

 

629,947

 

Total loans, net of deferred fees

 

 

845,821

 

 

 

693,908

 

 

 

573,430

 

 

 

455,980

 

 

 

395,812

 

Allowance for loan losses

 

 

(10,061

)

 

 

(8,518

)

 

 

(7,204

)

 

 

(6,695

)

 

 

(6,550

)

Securities available for sale

 

 

209,574

 

 

 

220,462

 

 

 

257,797

 

 

 

194,090

 

 

 

166,961

 

Goodwill and other intangible assets

 

 

2,966

 

 

 

2,966

 

 

 

2,966

 

 

 

2,966

 

 

 

2,966

 

Deposits

 

 

969,603

 

 

 

803,172

 

 

 

705,794

 

 

 

590,840

 

 

 

482,402

 

Advances from FHLB/FRB

 

 

68,000

 

 

 

70,300

 

 

 

79,250

 

 

 

39,000

 

 

 

44,000

 

Preferred stock

 

 

-

 

 

 

18,950

 

 

 

18,950

 

 

 

18,950

 

 

 

18,950

 

Tangible common stockholders’ equity (1)

 

 

91,448

 

 

 

69,312

 

 

 

60,135

 

 

 

62,846

 

 

 

59,254

 

Total stockholders’ equity

 

 

94,414

 

 

 

91,228

 

 

 

82,051

 

 

 

84,762

 

 

 

81,170

 

Average total assets

 

 

1,078,765

 

 

 

946,086

 

 

 

802,578

 

 

 

670,272

 

 

 

587,200

 

Average common stockholders’ equity

 

 

89,146

 

 

 

68,751

 

 

 

65,189

 

 

 

64,431

 

 

 

49,084

 

Full time employees

 

 

145

 

 

 

134

 

 

 

120

 

 

 

109

 

 

 

94

 

 

 

 

38


 

 

 

At or For the Year Ended December 31,

 

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

SELECTED PERFORMANCE RATIOS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets (2)

 

 

0.64

%

 

 

0.57

 

 

 

0.47

 

 

 

0.35

 

 

 

2.25

 

Return on average common stockholders’ equity (2)

 

 

7.76

 

 

 

7.86

 

 

 

5.77

 

 

 

3.59

 

 

 

26.91

 

Net interest margin (fully taxable equivalent)

 

 

3.26

 

 

 

3.30

 

 

 

3.17

 

 

 

2.97

 

 

 

3.02

 

Efficiency ratio (1) (3)

 

 

69.60

 

 

 

71.00

 

 

 

73.24

 

 

 

81.22

 

 

 

83.12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SELECTED ASSET QUALITY RATIOS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonaccruing loans

 

$

550

 

 

 

695

 

 

 

591

 

 

 

1,880

 

 

 

2,624

 

Past due loans over 90 days and still accruing interest

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

Net loans charge-offs

 

 

486

 

 

 

329

 

 

 

1,084

 

 

 

1,478

 

 

203

 

Nonaccruing loans to total loans

 

 

0.07

%

 

 

0.10

 

 

 

0.10

 

 

 

0.41

 

 

 

0.66

 

Nonaccruing loans and loans past due 90 days and still

   accruing to total loans

 

 

0.07

 

 

 

0.10

 

 

 

0.10

 

 

 

0.41

 

 

 

0.66

 

Non-performing assets to total assets (4)

 

 

0.09

 

 

 

0.41

 

 

 

0.45

 

 

 

0.66

 

 

 

1.06

 

Non-performing assets to loans and OREO

 

 

0.13

 

 

 

0.58

 

 

 

0.70

 

 

 

1.05

 

 

 

1.67

 

Allowance for loan losses to total loans

 

 

1.19

 

 

 

1.23

 

 

 

1.26

 

 

 

1.47

 

 

 

1.65

 

Allowance for loan losses to nonaccruing loans

 

 

1,829.27

 

 

 

1,224.87

 

 

 

1,219.43

 

 

 

356.12

 

 

 

249.58

 

Net loan charge-offs to average loans

 

 

0.06

 

 

 

0.05

 

 

 

0.22

 

 

 

0.36

 

 

 

0.05

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CAPITAL RATIOS (Consolidated)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 Leverage Ratio

 

 

8.17

%

 

 

9.14

 

 

 

9.04

 

 

 

10.87

 

 

 

11.70

 

Tier 1 Common Capital Ratio

 

 

9.28

 

 

 

10.44

 

 

 

8.57

 

 

 

10.08

 

 

 

10.87

 

Tier 1 Risk-Based Capital Ratio

 

 

9.28

 

 

 

10.53

 

 

 

11.35

 

 

 

13.52

 

 

 

14.95

 

Total Risk-Based Capital Ratio

 

 

12.25

 

 

 

13.91

 

 

 

12.40

 

 

 

14.73

 

 

 

16.20

 

Tangible common stockholders' equity to tangible assets (1)

 

 

7.87

 

 

 

6.94

 

 

 

6.76

 

 

 

8.69

 

 

 

9.45

 

 

(1)

These measures are not measures recognized under U.S. generally accepted accounting principles (U.S. GAAP), and are therefore considered to be non-U.S. GAAP financial measures. See below for a reconciliation of these measures to their most comparable U.S. GAAP measures.

(2)

Return on average assets is defined as net income available to common stockholders divided by average total assets. Return on average common stockholders’ equity is defined as net income available to common stockholders divided by average common stockholders’ equity.

(3)

Efficiency ratio is defined as total non-interest expense divided by our operating revenue, which is equal to the sum of net interest income and total non-interest income, (excluding securities sale gains/(losses)) and is not an U.S. GAAP measure.

(4)

Non-performing assets are deemed to be nonaccruing loans and OREO.

U.S. GAAP Reconciliation and Management Explanation of Non-U.S. GAAP Financial Measures

The information set forth above contains certain financial information determined by methods other than in accordance with U.S. GAAP. These non-U.S. GAAP financial measures are “tangible book value per common share,” “tangible common stockholders’ equity,” “efficiency ratio,” and “tangible common stockholders’ equity to tangible assets.” Although we believe these non-U.S. GAAP financial measures provide a greater understanding of our business, these measures are not necessarily comparable to similar measures that may be presented by other companies.

“Tangible book value per common share” is defined as tangible common stockholders’ equity divided by total common shares outstanding. We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in book value per common share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing book value while not increasing our tangible book value.

“Tangible common stockholders’ equity” is defined as common stockholders’ equity reduced by goodwill. We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in common stockholders’ equity exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing both common stockholders’ equity and assets while not increasing our tangible common stockholders’ equity or tangible assets.

 

39


 

“Efficiency ratio” is defined as non-interest expenses divided by our operating revenue, which is equal to the sum of net interest income plus non-interest income excluding gains and losses on sales of loans and securities. In our judgment, the adjustments made to operating revenue allow investors and analysts to better assess our operating expenses in relation to our core operating revenue by removing the volatility that is associated with certain non-recurring items and other discrete items that are unrelated to our core business.

“Tangible common stockholders’ equity to tangible assets” is defined as the ratio of common stockholders’ equity reduced by goodwill divided by total assets reduced by goodwill. We believe that this measure is important to many investors in the marketplace who are interested in relative changes from period to period in common stockholders’ equity and total assets, each exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing both common stockholders’ equity and assets while not increasing our tangible common equity or tangible assets.

The information provided below reconciles each non-U.S. GAAP measure to its most comparable U.S. GAAP measure.

 

 

 

At or For the Year Ended December 31,

 

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

 

(Dollars in Thousands Except, Per Share Data)

 

NON-GAAP FINANCIAL MEASURES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tangible Common Stockholders' Equity and Tangible Common Stockholders' Equity/Tangible Assets