COMMUNITY FIRST INC - FORM 10-Q

COMMUNITY FIRST INC - FORM 10-Q - November 12, 2014

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Attached files

COMMUNITY FIRST INC Reports

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EXCEL - IDEA: XBRL DOCUMENT - COMMUNITY FIRST INC	Financial_Report.xls
EX-32.2 - EX-32.2 - COMMUNITY FIRST INC	d797984dex322.htm
EX-31.1 - EX-31.1 - COMMUNITY FIRST INC	d797984dex311.htm
EX-32.1 - EX-32.1 - COMMUNITY FIRST INC	d797984dex321.htm
EX-31.2 - EX-31.2 - COMMUNITY FIRST INC	d797984dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended: September 30, 2014

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

FOR THE TRANSITION PERIOD FROM TO

Commission File Number 000-49966

COMMUNITY FIRST, INC.

(Exact Name of Registrant as Specified in its Charter)


Tennessee		04-3687717
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

501 South James M. Campbell Blvd. Columbia, Tennessee		38401
(Address of Principal Executive Offices)		(Zip Code)

(931) 380-2265

(Registrant’s Telephone Number, Including Area Code)

None

(Former Name, Address and Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 has 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. Common stock outstanding (no par value): 3,274,946 shares of common stock, no par value per share, as of November 12, 2014.

COMMUNITY FIRST, INC.

TABLE OF CONTENTS


PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Consolidated Balance Sheets September 30, 2014 (Unaudited) and December 31, 2013	3

	Consolidated Statements of Operations and Comprehensive Income Nine months and three months ended September 30, 2014 and 2013 (Unaudited)	5

	Consolidated Statement of Changes in Shareholders’ Equity Nine months ended September 30, 2014 (Unaudited)	7

	Consolidated Statements of Cash Flows Nine months ended September 30, 2014 and 2013 (Unaudited)	8

	Notes to Consolidated Financial Statements (Unaudited)	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	51

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	78

Item 4.	Controls and Procedures	79

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	80

Item 1A.	Risk Factors	80

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	80

Item 3.	Defaults Upon Senior Securities	80

Item 4.	Mine Safety Disclosures	80

Item 5.	Other Information	80

Item 6.	Exhibits	81

SIGNATURES		82

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Community First, Inc.

Consolidated Balance Sheets

September 30, 2014 (Unaudited) and December 31, 2013

(amounts in thousands, except share and per share data)


	September 30, 2014			December 31, 2013
*Assets*
Cash and due from financial institutions	$	31,753		$	49,036
Time deposits in other financial institutions		19,950			6,500
Securities available for sale, at fair value		87,566			81,926
Loans		263,267			273,707
Allowance for loan losses		(6,105	)		(8,039	)

*Net loans*		257,162			265,668

Restricted equity securities, at cost		1,727			1,727
Premises and equipment, net		11,962			10,215
Accrued interest receivable		1,077			1,225
Core deposit and customer relationship intangibles, net		1,111			1,215
Other real estate owned, net		14,172			18,314
Bank owned life insurance		9,797			9,603
Other assets		758			3,014

*Total Assets*	$	437,035		$	448,443


*Liabilities and Shareholders’ Equity*
Deposits:
Noninterest-bearing	$	60,972		$	53,980
Interest-bearing		331,843			353,552

*Total Deposits*		392,815			407,532

Subordinated debentures		23,000			23,000
Accrued interest payable		4,827			4,287
Other liabilities		6,382			5,008

*Total Liabilities*		427,024			439,827

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Community First, Inc.

Consolidated Balance Sheets

September 30, 2014 (Unaudited) and December 31, 2013

(Continued)

(amounts in thousands, except share and per share data)


	September 30, 2014			December 31, 2013
Shareholders’ Equity
Senior Preferred shares, no par value; 9% cumulative. Authorized 2,500,000 shares; 17,806 issued and outstanding with liquidation value of $21,445 at September 30, 2014 and $20,368 at December 31, 2013.		17,806			17,806
Warrant Preferred shares, no par value; 9% cumulative. 890 issued and outstanding with liquidation value of $1,191 at September 30, 2014 and $1,120 at December 31, 2013.		890			890
Net discount on Preferred shares		—			(33	)

Total Preferred shares		18,696			18,663
Common stock, no par value. Authorized 10,000,000 shares; 3,274,888 shares issued and outstanding at September 30, 2014 and 3,274,777 shares issued and outstanding at December 31, 2013		28,591			28,590
Accumulated deficit		(35,116	)		(35,760	)
Accumulated other comprehensive loss, net		(2,160	)		(2,877	)

*Total Shareholders’ Equity*		10,011			8,616

*Total Liabilities and Shareholders’ Equity*	$	437,035		$	448,443

See accompanying notes to unaudited consolidated financial statements.

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Community First, Inc.

Consolidated Statements of Operations and Comprehensive Income (Loss)

Nine Months and Three Months Ended September 30, 2014 and 2013

(Unaudited)

(amounts in thousands, except share and per share data)


	Nine Months Ended September 30					Three Months Ended September 30,
	2014			2013		2014		2013
Interest income
Loans, including fees	$	10,313		$	12,079	$	3,406	$	3,930
Taxable securities		1,398			875		499		304
Tax-exempt securities		62			110		15		32
Federal funds sold and other		227			211		77		60

*Total interest income*		12,000			13,275		3,997		4,326
Interest expense
Deposits		1,668			2,501		523		753
FHLB advances and federal funds purchased		—			108		—		—
Subordinated debentures and other		592			689		202		202

*Total interest expense*		2,260			3,298		725		955

*Net interest income*		9,740			9,977		3,272		3,371
(Reversal of) provision for loan losses		(800	)		300		—		—

*Net interest income after provision for loan losses*		10,540			9,677		3,272		3,371
Noninterest income
Service charges on deposit accounts		1,290			1,276		436		444
Gain on sale of loans		59			75		37		26
Gain on sale of securities available for sale		213			182		173		—
Other		488			558		172		192

*Total noninterest income*		2,050			2,091		818		662
Noninterest expense
Salaries and employee benefits		4,980			4,889		1,682		1,632
Regulatory and compliance		797			877		265		279
Occupancy		606			732		234		241
Furniture and equipment		236			305		82		101
Data processing fees		860			794		292		272
Advertising and public relations		143			68		41		18
Operational expense		307			315		101		113
Other real estate owned expense		827			768		449		399
Other		2,010			2,137		712		688

*Total noninterest expense*		10,766			10,885		3,858		3,743

*Income before income tax expense*		1,824			883		232		290

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Community First, Inc.

Consolidated Statements of Operations and Comprehensive Income (Loss)

Nine Months and Three Months Ended September 30, 2014 and 2013

(Unaudited, Continued)

(amounts in thousands, except share and per share data)


	Nine Months Ended September 30						Three Months Ended September 30,
	2014			2013			2014			2013
Income tax expense		—			—			—			—

*Net income*		1,824			883			232			290
Preferred stock dividends declared		(1,147	)		(726	)		(424	)		(245	)
Accretion of preferred stock discount		(33	)		(148	)		—			(50	)

Net income (loss) available (allocated) to common shareholders	$	644		$	9		$	(192	)	$	(5	)

Income (loss) per share available (allocated) to common shareholders
Basic	$	0.20		$	0.00		$	(0.06	)	$	0.00
Diluted		0.20			0.00			(0.06	)		0.00
Weighted average common shares outstanding
Basic		3,274,844			3,274,551			3,274,876			3,274,716
Diluted		3,274,844			3,274,551			3,274,876			3,274,716

Comprehensive Income (Loss)
Net income	$	1,824		$	883		$	232		$	290
Reclassification adjustment for realized gains included in net income, net of $0 income taxes in 2014 and 2013		(213	)		(182	)		(173	)		—
Net change in unrealized gains (losses) on securities, net of income taxes of $0 in 2014 and 2013		930			(2,057	)		(253	)		(112	)

Comprehensive income (loss)	$	2,541		$	(1,356	)	$	(194	)	$	178

See accompanying notes to unaudited consolidated financial statements.

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Community First, Inc.

Consolidated Statement of Changes in Shareholders’ Equity

Nine Months Ended September 30, 2014

(Unaudited)

(amounts in thousands, except share and per share data)


	Common Shares		Preferred Stock		Common Stock		Accumulated Deficit			Accumulated Other Comprehensive Loss, Net			Total Shareholders’ Equity
Balance at January 1, 2014		3,274,777	$	18,663	$	28,590	$	(35,760	)	$	(2,877	)	$	8,616
Accretion of discount on preferred stock		—		33		—		(33	)		—			—
Sale of shares of common stock		111		—		1		—			—			1
Cash dividends declared on preferred stock		—		—		—		(1,147	)		—			(1,147	)
Net income		—		—		—		1,824			—			1,824
Reclassification adjustment for realized gains included in net income, net of $0 income tax		—		—		—		—			(213	)		(213	)
Change in unrealized loss on securities available for sale, net of $0 income tax		—		—		—		—			930			930

Balance at September 30, 2014		3,274,888	$	18,696	$	28,591	$	(35,116	)	$	(2,160	)	$	10,011

See accompanying notes to unaudited consolidated financial statements.

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Community First, Inc.

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2014 and 2013

(Unaudited)

(amounts in thousands, except share and per share data )


	Nine Months Ended September 30,
	2014			2013
Cash flows from operating activities
Net income	$	1,824		$	883
Adjustments to reconcile net income to net cash from operating activities
Depreciation		410			478
Amortization on securities, net		357			276
Core deposit intangible amortization		104			103
(Reversal of) provision for loan losses		(800	)		300
Loans originated for sale		(2,226	)		(4,168	)
Proceeds from sale of loans		2,285			5,085
Gain on sale of loans		(59	)		(75	)
Decrease in accrued interest receivable		148			285
Increase in accrued interest payable		540			676
Increase in surrender value of bank owned life insurance		(194	)		(205	)
Gain on sale of securities		(213	)		(182	)
Net write down of other real estate owned		751			797
Other, net		2,483			797

Net cash from operating activities		5,410			5,050

Cash flows from investing activities
Available for sale securities
Purchases:
Mortgage-backed securities		(33,217	)		(6,154	)
Other		(5,133	)		(18,284	)
Sales:
Mortgage-backed securities		5,068			3,087
Other		19,519			588
Maturities, prepayments, and calls:
Mortgage-backed securities		6,636			6,295
Other		2,060			14,555
Net decrease in loans		8,892			13,395
Proceeds from sales of other real estate owned		3,321			3,914
Increase in time deposits in other financial institutions		(13,450	)		—
Additions to premises and equipment		(1,673	)		(1,990	)

Net cash (used in) from investing activities		(7,977	)		15,406

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Community First, Inc.

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2014 and 2013

(Unaudited, Continued)

(amounts in thousands, except share and per share data )


	Nine Months Ended September 30,
	2014			2013
Cash flows from financing activities
Net decrease in deposits		(14,717	)		(39,695	)
Payments on Federal Home Loan Bank advances		—			(13,000	)
Payments on repurchase agreements		—			(7,000	)
Proceeds from issuance of common stock		1			2

Net cash used in financing activities		(14,716	)		(59,693	)

Net decrease in cash and cash equivalents		(17,283	)		(39,237	)
Cash and cash equivalents at beginning of period		49,036			94,877

Cash and cash equivalents at end of period	$	31,753		$	55,640


Supplemental disclosures of cash flow information
Cash paid during year for:
Interest	$	1,720		$	2,622
Income taxes paid		13			8
Supplemental noncash disclosures
Transfers from loans to repossessed assets		414			202
Preferred stock dividends declared but not paid		1,147			726
Subordinated debenture interest accrued but not paid		592			595

See accompanying notes to unaudited consolidated financial statements.

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

(amounts in thousands, except share and per share data)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

The consolidated financial statements include Community First, Inc. and its wholly-owned subsidiary, Community First Bank & Trust. Community First, Inc., together with the Bank, is referred to herein as the “Company.” The sole subsidiary of Community First Bank & Trust is Community First Properties, Inc., which was originally established as a Real Estate Investment Trust (“REIT”) but which terminated its REIT election in the first quarter of 2012. Community First Bank & Trust together with its subsidiary is referred to herein as the “Bank.” Intercompany transactions and balances are eliminated in consolidation.

The Bank conducts substantially all of its banking activities in Maury, Williamson and Hickman Counties, in Tennessee. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flows from operations of businesses. The significant loan concentrations that exceed 10% of total loans are as follows: commercial real estate loans, 1-4 family residential loans, and construction loans. The customers’ ability to repay their loans is dependent on the real estate and general economic conditions in the Company’s market areas. Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

The unaudited consolidated financial statements as of September 30, 2014 and for the nine-month and three-month periods ended September 30, 2014 and 2013 have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (the “SEC”) and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the information. They do not include all the information and footnotes required by GAAP for complete financial statements. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the 2013 consolidated audited financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014 (File No. 000-49966) (the “2013 Form 10-K”).

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

Critical Accounting Policies:

The consolidated financial statements in this report are prepared in conformity with GAAP and with general practices in the banking industry. As such, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. A summary of our significant accounting policies is described in our 2013 Form 10-K. The significant accounting policies and estimates which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Allowance for Loan Losses: Credit risk is inherent in the business of extending loans to borrowers. This credit risk is addressed through a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

A loan is identified as impaired when, based on current information and events, it is probable that the scheduled payments of principal or interest will not be collected when due according to the contractual terms of the loan agreement. However, some loans are termed impaired because of doubt regarding collectability of interest and principal according to the contractual terms, even though such loans are both fully secured by collateral and current in their interest and principal payments. Additionally, loans are considered troubled debt restructurings and classified as impaired if their terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans over $150 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component of the allowance covers loans collectively evaluated for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following loan portfolio segments have been identified with a discussion of the risk characteristics of these portfolio segments:

Real Estate Construction loans consist of loans made for both residential and commercial construction and land development. Residential real estate construction loans are loans secured by real estate to build 1-4 family dwellings. These are loans made to borrowers obtaining loans in their personal name for the personal construction of their own dwellings or loans to builders for the purpose of constructing homes for resale. These loans to builders can be for speculative homes for which there is no specific homeowner for which the home is being built, as well as loans to builders that have a pre-sale contract to another individual.

Commercial Construction loans are loans extended to borrowers secured by and to build commercial structures such as churches, retail strip centers, industrial warehouses or office buildings. Land development loans are granted to commercial borrowers to finance the improvement of real estate by adding infrastructure so that ensuing construction can take place. Construction and land development loans are generally short term in maturity to match the expected completion of a particular project. These loan types are generally more vulnerable to changes in economic conditions in that they project there will be a demand for the product. They require monitoring to ensure the project is progressing in a timely manner within the expected budgeted amount. This monitoring is accomplished via periodic physical inspections by an outside third party.

1-4 Family Residential loans consist of both open end and closed end loans secured by first or junior liens on 1-4 family improved residential dwellings. Open end loans are Home Equity Lines of Credit that allow the borrower to use equity in the real estate to borrow and repay as the need arises. First and junior lien residential real estate loans are closed end loans with a specific maturity that generally does not exceed 7 years. Economic conditions can affect the borrower’s ability to repay the loans, and the value of the real estate securing the loans can change over the life of the loan.

Commercial Real Estate loans consist of loans secured by farmland or by improved commercial property. Farmland includes all land known to be used or usable for agricultural purposes, such as crop and livestock production, grazing, or pasture land. Improved commercial property can be owner occupied or non-owner occupied property secured by commercial structures such as churches, retail strip centers, hotels, industrial warehouses or office buildings. The repayment of these loans tends to depend upon the operation and management of a business or lease income from a business, and therefore adverse economic conditions can affect the ability to repay.

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

Other Real Estate Secured loans consist of loans secured by five or more multi-family dwelling units. These loans are typically exemplified by apartment buildings or complexes. The ability to manage and rent units affects the income that usually provides repayment for this type of loan.

Commercial, Financial, and Agricultural loans consist of loans extended for the operation of a business or a farm. They are not secured by real estate. Commercial loans are used to provide working capital, acquire inventory, finance the carrying of receivables, purchase equipment or vehicles, or purchase other capital assets. Agricultural loans are typically for purposes such as planting crops, acquiring livestock, or purchasing farm equipment. The repayment of these loans comes from the cash flow of a business or farm and is generated by sales of inventory or providing of services. The collateral tends to depreciate over time and is difficult to monitor. Frequent statements are required from the borrower pertaining to inventory levels or receivables aging.

Consumer loans consist largely of loans extended to individuals for purposes such as to purchase a vehicle or other consumer goods. These loans are not secured by real estate but are frequently collateralized by the consumer items being acquired with the loan proceeds. This type of collateral tends to depreciate, and therefore the term of the loan is tailored to fit the expected value of the collateral as it depreciates, along with specific underwriting policies and guidelines.

Tax Exempt loans consist of loans that are extended to entities such as municipalities. These loans tend to be dependent on the ability of the borrowing entity to continue to collect taxes to repay the indebtedness.

Other loans consist of those loans which are not elsewhere classified in these categories and are not secured by real estate.

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS

As a result of improvements in the Bank’s financial condition and results of operations and the Bank’s compliance with the terms thereof, the written agreement that the Bank had entered into with the Tennessee Department of Financial Institutions (the “Department”) on March 14, 2013 was terminated effective October 29, 2014. In addition, the Federal Deposit Insurance Corporation (“FDIC”) has notified the Bank that it intends to terminate the consent order that was entered into with the Bank on September 20, 2011 (the “Consent Order”).

In connection with the termination of the written agreement the Bank had entered into with the Department and the anticipated termination of the Consent Order, the Bank reached an understanding with the FDIC and the Department in the form of a single informal agreement with both agencies. The informal agreement significantly reduces the restrictions that were placed on the Bank under the Consent Order and the written agreement with the Department. The informal agreement requires that the Bank, among other things:

•

Maintain the following minimum regulatory capital ratios: Leverage Capital 8.0%; Tier I Risk Based Capital 10.00%; and Total Risk Based Capital 12.00%.

•

Receive prior written consent of each of the FDIC and the Department before the Bank declares or pays any cash dividends.

•

Develop a written profit plan to improve the Bank’s earnings.

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

Although the Company reported net income in 2012, 2013 and the first nine months of 2014, the Company reported losses for each year from 2008 to 2011. The losses incurred by the Company were primarily the result of the economic recession that began in 2008 and the continued impacts of that recession and the resulting sluggish economic conditions. The Bank is a community bank that focuses heavily on commercial and residential development lending. As a result of the collapse of the housing market, many developments stalled, resulting in developers no longer being able to meet their payment obligations to the Bank. Also, during this time, market values for existing real estate properties decreased, which jeopardized the collateral securing the loans made by the Bank. The losses incurred by the Bank and the Company contributed to both the Bank and the Company becoming subject to additional regulatory scrutiny and increased supervisory actions by regulators.

Banks and bank holding companies with total consolidated assets in excess of $500 million are subject to regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate regulatory actions that could have a direct material effect on the financial statements.

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

Prompt corrective action regulations classify banks into one of five capital categories depending on how well they meet their minimum capital requirements. Although these terms are not used to represent the overall financial condition of a bank, the classifications are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. If adequately capitalized or worse, or subject to a written agreement, consent order, or cease and desist order requiring higher minimum capital levels as the Bank was as of September 30, 2014, regulatory approval is required for the Bank to accept, renew or rollover brokered deposits. If a bank is classified as undercapitalized or worse, its capital distributions are restricted, as is asset growth and expansion, and capital restoration plans are required. At September 30, 2014, the Bank’s capital ratios were above those levels necessary to be considered “well capitalized” under the regulatory framework for prompt corrective action and all ratios were above those levels required by the Consent Order and the written agreement that the Bank had entered into with the Department. The Company’s capital ratios are below what is required to be considered “adequately capitalized” under the regulatory framework. Two of the three capital ratios were considered “adequate”; however, the Tier 1 to Average Assets ratio was below the requirements to be considered “adequate”, which prohibits the Company from being “adequately capitalized”.

On April 19, 2012, the Company entered into a written agreement (the “Written Agreement”) with the Federal Reserve Bank of Atlanta (the “FRB”). Under the terms of the Written Agreement, the Company agreed to, among other things, take the following actions:

•

Take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with the Consent Order;

•

Submit within 60 days of April 19, 2012 a written plan to maintain sufficient capital at the Company on a consolidated basis, and within 10 days of approval of the plan by the FRB, adopt the approved capital plan;

•

Submit within 60 days of April 19, 2012 a written statement of the Company’s planned sources and uses of cash for debt service, operating expenses, and other purposes for 2012;

•

Provide notice in compliance with applicable federal law and regulations, of any changes in directors or senior executive officer of the Company;

•

Comply with applicable federal law and regulations restricting indemnification and severance payments; and

•

Provide within 45 days after the end of each calendar quarter, a written progress report detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement.

- 15 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

In addition, under the terms of the Written Agreement, the Company has agreed to, among other things:

•

Refrain from declaring or paying any dividends without prior approval of the FRB;

•

Not directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without prior approval;

•

Not (along with the Company’s non-bank subsidiary) make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior approval;

•

Not (along with the Company’s non-bank subsidiary) directly or indirectly incur, increase, or guarantee any debt without prior approval; and

•

Not directly or indirectly purchase or redeem any shares of its stock without prior approval.

As of September 30, 2014, all of the plans required to be submitted to the FRB have been submitted and approved. Management believes that the Company is in compliance with the requirements of the Written Agreement as of September 30, 2014. The Written Agreement remains in effect.

The Company has the right to defer the payment of interest on its subordinated debentures at any time, for a period not to exceed 20 consecutive quarters. During the period in which it is deferring the payment of interest on its subordinated debentures, the Company may not pay any dividends on its common or preferred stock, and the Company’s subsidiaries may not pay dividends on the subsidiaries’ common or preferred stock owned by entities other than the Company and its subsidiaries. Accordingly, the Company was required to suspend dividend payments on the Preferred Stock beginning in the second quarter of 2011.

- 16 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

Consequently, at September 30, 2014, the Company had $4,314 of interest accrued on its subordinated debentures for which payment is being deferred. In addition, the Company had accumulated $3,939 in deferred dividends on the shares of Preferred Stock it had sold to the United States Department of the Treasury (the “U.S. Treasury”) under the TARP Capital Purchase Program (the “CPP”). Under the terms of the CPP, failure to pay dividends for six dividend periods triggers the right of the holders of the Preferred Stock to elect two directors to an institution’s board. Since the Company has deferred payment of dividends on its Preferred Stock for more than six quarters, the holders of the Preferred Stock voting together as a single class now have the right to elect up to two directors to the Company’s board of directors. On April 14, 2014, the U.S. Treasury sold all of the shares of Preferred Stock it owned in a modified Dutch auction to multiple qualified investors, including certain members of the Company’s board of directors and senior officers.

The sale of the Preferred Stock had no effect on the terms of the outstanding securities, including the Company’s obligation to satisfy accrued and unpaid dividends or the holders’ right to elect up to two directors to the Company’s board of directors. However, the Company is no longer subject to various executive compensation and corporate governance requirements to which participants in the CPP were subject while the U.S. Treasury held the Preferred Stock.

Similarly, the sole subsidiary of the Bank, Community First Properties, Inc., also suspended the payment of dividends on its preferred stock beginning with the dividend payment due on December 31, 2011. At September 30, 2014, Community First Properties, Inc. had $47 of preferred stock dividends accrued for which payment is being deferred.

On September 20, 2011, the Bank consented to the issuance of the Consent Order. The Consent Order, which the Company has been informed is being terminated in connection with the Bank’s entering into an informal agreement with the FDIC, required the Bank to attain and achieve regulatory capital ratios higher than those required by regulatory standards, improve, among other things, its processes for identifying and classifying problem loans, and improve its overall profitability. The Consent Order required the Bank to formulate written plans detailing how the Bank would achieve such requirements. The Bank prepared and submitted all of the plans required by the Consent Order to the FDIC and the FDIC approved those plans as written. In addition, the terms of the Consent Order required the Bank to provide quarterly progress reports to the FDIC. For more information regarding the Consent Order, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” On March 14, 2013, the Bank entered into a written agreement with the Department, the terms of which were substantially the same as those of the Consent Order, including required minimum levels of capital that the Bank must maintain. As described above, the written agreement with the Department was terminated subsequent to the end of the third quarter of 2014, and the FDIC has informed the Bank that the Consent Order is being terminated in connection with the Bank’s entering into an informal agreement with the FDIC.

- 17 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

As a result of entering into the Consent Order, the Bank also became subject to additional limitations on its operations including a prohibition on accepting, rolling over, or renewing brokered deposits, which could adversely affect the Bank’s liquidity and/or operating results. The existence of the Consent Order also limited the Bank from paying deposit rates above national rate caps published weekly by the FDIC unless the Bank is determined to be operating in a high-rate market area. On December 1, 2011, the Bank received notification from the FDIC that it is operating in a high-rate environment, which allowed the Bank to pay rates higher than the national rate caps, but continued to limit the Bank to rates that did not exceed the prevailing rate in the Bank’s market by more than 75 basis points. The Bank was also limited, as a result of its condition, in its ability to pay more than de minimis severance payments to its employees and must receive the consent of the FDIC and the Department to appoint new officers or directors. Following termination of the Consent Order, the Bank will no longer be subject to limitations on its operations related to brokered deposits or its ability to pay interest above national rate caps. Moreover, the Bank will no longer be subject to limitations on its ability to pay severance or appoint officers or directors.

The Consent Order included time frames to implement the foregoing and on-going compliance requirements for the Bank, such as quarterly progress reports that the Bank must submit to its regulators. In accordance with the terms of the Consent Order, management prepared and submitted a capital plan with the objective of attaining the capital ratios required by the Consent Order. At September 30, 2014, each of the Bank’s regulatory capital ratios exceeded the regulatory capital ratios proscribed by the Consent Order and the written agreement with the Department.

The Company’s principal source of funds for dividend and/or interest payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid by the Bank in any calendar year is limited to the current year’s net income, combined with the retained net income of the preceding two years, subject to the capital requirements described above. Although the Bank was profitable in each of 2012 and 2013, and the first nine months of 2014, the Bank was prohibited under the terms of the Consent Order with the FDIC and the written agreement with the Department from paying dividends to the Company without prior approval from the FDIC and the Department. These restrictions remain in place until the Consent Order is formally terminated, and thereafter will continue to be applicable to the Bank as a result of the informal agreement that the Bank entered into in connection with termination of the Consent Order and written agreement with the Department. The Company is also restricted in the types and amounts of dividends it can pay pursuant to the terms of the Preferred Stock and by the terms of the Written Agreement, which prohibits the Company from paying interest or dividends (including interest on the Company’s subordinated debentures and dividends on the Company’s Preferred Stock) without the FRB’s prior approval.

- 18 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

Banks and bank holding companies with total consolidated assets in excess of $500 million are subject to various regulatory capital requirements administered by state and federal banking agencies. The Company’s and the Bank’s capital amounts and ratios at September 30, 2014 and December 31, 2013, were as follows:


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Applicable Regulatory Provisions⁽¹⁾					Required by terms of Consent Order with FDIC
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2014
Total Capital to risk weighted assets
Community First Bank & Trust	$	43,389		15.84	%	$	21,920		8.00	%	$	27,400		10.00	%	$	32,880		12.00	%
Consolidated		26,319		9.60	%		21,944		8.00	%		27,429		10.00	%		N/A		N/A

Tier 1 Capital to risk weighted assets
Community First Bank & Trust	$	39,931		14.57	%	$	10,960		4.00	%	$	16,440		6.00	%	$	27,400		10.00	%
Consolidated		15,238		5.56	%		10,972		4.00	%		16,458		6.00	%		N/A		N/A

Tier 1 Capital to average assets
Community First Bank & Trust	$	39,931		9.06	%	$	17,622		4.00	%	$	22,027		5.00	%	$	37,447		8.50	%
Consolidated		15,238		3.44	%		17,717		4.00	%		N/A		N/A			N/A		N/A

December 31, 2013
Total Capital to risk weighted assets
Community First Bank & Trust	$	41,250		14.70	%	$	22,445		8.00	%	$	28,056		10.00	%	$	33,667		12.00	%
Consolidated		24,905		8.87	%		22,474		8.00	%		28,092		10.00	%		N/A		N/A

Tier 1 Capital to risk weighted assets
Community First Bank & Trust	$	37,687		13.43	%	$	11,222		4.00	%	$	16,833		6.00	%	$	28,056		10.00	%
Consolidated		14,225		5.06	%		11,237		4.00	%		16,855		6.00	%		N/A		N/A

Tier 1 Capital to average assets
Community First Bank & Trust	$	37,687		8.41	%	$	17,917		4.00	%	$	22,396		5.00	%	$	38,073		8.50	%
Consolidated		14,225		3.16	%		18,008		4.00	%		N/A		N/A			N/A		N/A

(1)	Because the Company’s total assets were less than $500 million at September 30, 2014 and December 31, 2013, the Company was not at those dates subject to capital level requirements at the Company level.

The Bank’s capital ratios at September 30, 2014 were above those levels necessary to be considered “well capitalized” under the regulatory framework for prompt corrective action, but the existence of the Consent Order required regulators to continue to classify the Bank as “adequately capitalized” even though the capital levels would qualify as “well capitalized” if the Consent Order were not in place. Following termination of the Consent Order, the Bank’s capitalization status will be determined by its actual capital levels and ratios.

- 19 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

Because the Company’s total assets were less than $500 million at September 30, 2014, the Company is not required to meet consolidated capital level requirements. Had the Company’s total assets exceeded $500 million at that date, the Company’s capital levels at September 30, 2014 would have been considered below those required to be considered “adequately capitalized” under applicable regulations because only two of the three capital ratios were above the levels necessary to be considered “adequate”. The Company’s Tier 1 to Average Assets ratio was below the requirements to be considered “adequate”, which prohibits the Company from being considered “adequately capitalized”.

Management’s Plans

The Company is currently considering various options to increase capital levels at the Company and the Bank, including strengthening the Bank’s core earnings, the sale of common or preferred stock of the Company or other assets, the issuance or incurrence of debt by the Company, or alternatively the sale of the Company. Any sale of the Company’s common stock would likely be at a price that would result in substantial dilution in ownership for the Company’s existing common shareholders and could result in a change in control of the Company. If a change in control was deemed to have occurred, certain IRS regulations related to the preservation of net operating loss carryforwards could subject the Company to risk of forfeiture of these tax benefits. The loss of these tax benefits would not cause the Company to recognize a direct reduction in cash, but rather would eliminate the tax benefits that the Company would otherwise be able to utilize to offset future year’s profits, if any, to reduce the Company’s tax liabilities. Failure by the Bank or the Company to comply with the terms of the Written Agreement, the Consent Order, until it is formally terminated, or the informal agreement that the Bank has entered into with the FDIC and the Department, as applicable, may result in additional adverse regulatory action.

- 20 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 3 – SECURITIES AVAILABLE FOR SALE

The following table summarizes the amortized cost and fair value of the available for sale securities portfolio at September 30, 2014 and December 31, 2013 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss), net of applicable income taxes:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2014
U.S. Government sponsored entities	$	22,358	$	—	$	(569	)	$	21,789
Mortgage-backed (residential)		63,551		333		(315	)		63,569
State and municipals		2,140		68		—			2,208

Total	$	88,049	$	401	$	(884	)	$	87,566

December 31, 2013
U.S. Government sponsored entities	$	34,604	$	—	$	(1,247	)	$	33,357
Mortgage-backed (residential)		42,294		488		(501	)		42,281
State and municipals		6,228		78		(18	)		6,288

Total	$	83,126	$	566	$	(1,766	)	$	81,926

The proceeds from sales of securities and the associated gains and losses are listed below:


	Nine months ended September 30,					Three months ended September 30,
	2014			2013		2014			2013
Proceeds	$	24,587		$	3,675	$	12,825		$	—
Gross gains		376			182		271			—
Gross losses		(163	)		—		(98	)		—

The amortized cost and fair value of the securities portfolio are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage backed securities are presented separately due to varying maturity dates as a result of prepayments.


	September 30, 2014
	Amortized Cost		Fair Value
Due in one year or less	$	375	$	379
Due after one through five years		10,236		10,071
Due after five through ten years		9,985		9,700
Due after ten years		3,902		3,847
Mortgage backed (residential)		63,551		63,569

Total	$	88,049	$	87,566

- 21 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

At September 30, 2014 and December 31, 2013, respectively, securities totaling $40,812 and $37,182 were pledged to secure public deposits.

At September 30, 2014, the Company did not hold any securities for which the aggregate face amount of investments is greater than 10% of the Company’s shareholders’ equity as of September 30, 2014.

At December 31, 2013, the Company held one security for which the aggregate face amount of investments is greater than 10% of shareholders’ equity as of December 31, 2013 as follows:


Type	Issuer		Face Value		Fair Value		% of Capital
State and municipals		State of Texas	$	1,245	$	1,248		14.45	%

Other than the above investments, the Company did not hold securities of any one issuer, other than U.S. Government sponsored entities, with a face amount greater than 10% of shareholders’ equity as of September 30, 2014 or December 31, 2013.

The following table summarizes securities with unrealized losses at September 30, 2014 and December 31, 2013 aggregated by major security type and length of time in a continuous unrealized loss position:


	Less than 12 Months					12 Months or More					Total
September 30, 2014
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government sponsored entities	$	—	$	—		$	21,289	$	(569	)	$	21,289	$	(569	)
Mortgage-backed (residential)		33,608		(168	)		7,158		(147	)		40,766		(315	)
State and municipals		—		—			—		—			—		—

Total temporarily impaired	$	33,608	$	(168	)	$	28,447	$	(716	)	$	62,055	$	(884	)


	Less than 12 Months					12 Months or More					Total
December 31, 2013
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government sponsored entities	$	32,376	$	(1,228	)	$	481	$	(19	)	$	32,857	$	(1,247	)
Mortgage-backed (residential)		27,902		(501	)		—		—			27,902		(501	)
State and municipals		3,003		(18	)		—		—			3,003		(18	)

Total temporarily impaired	$	63,281	$	(1,747	)	$	481	$	(19	)	$	63,762	$	(1,766	)

- 22 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

Other-Than-Temporary Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Securities classified as available for sale are generally evaluated for OTTI under the provisions of ASC 320-10, Investments—Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in accumulated other comprehensive income becomes the new amortized cost basis of the investment.

As of September 30, 2014, the Company’s securities portfolio consisted of 103 securities, 62 of which were in an unrealized loss position. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company did not have at September 30, 2014 the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company did not consider these securities to be other-than-temporarily impaired at September 30, 2014.

- 23 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

The table below presents a rollforward for the nine-month and three-month periods ended September 30, 2014 and 2013 of the credit losses recognized in earnings:


	Nine months ended September 30,					Three months ended September 30,
	2014		2013			2014		2013
Beginning Balance	$	—	$	6,338		$	—	$	—
Additions for credit losses on securities for which no previous other-than-temporary impairment was recognized		—		—			—		—
Reduction for credit losses on securities for which no recovery has been received and for which no recovery is expected		—		(6,338	)		—		—

Ending Balance	$	—	$	—		$	—	$	—

During the second quarter of 2013, the Company wrote off two securities for which previous other than temporary losses had been recognized. Both of the securities written off were trust preferred securities issued by affiliated trusts of financial institutions that have failed and are no longer in existence. Management does not anticipate that the Company will recover any of the charged off balances in the future.

NOTE 4 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

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

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

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on matrix pricing which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using estimates of current market rates for each type of security.

- 24 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

During times when trading is more liquid, broker quotes are used (if available) to validate the model agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Loans Held for Sale: Generally, the fair value of loans held for sale is based on what secondary markets are currently offering for loans with similar characteristics or based on an agreed upon sales price with third party investors and typically result in a Level 2 classification of the inputs for determining fair value.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Real estate acquired through foreclosure on a loan or by surrender of the real estate in lieu of foreclosure is called “OREO”. OREO is initially recorded at the fair value of the property less estimated costs to sell, which establishes a new cost basis. OREO is subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Valuation adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Valuation adjustments are also required when the listing price to sell an OREO property has had to be reduced below the current carrying value. If there is a decrease in the fair value of the property from the last valuation, the decrease in value is charged to noninterest expense. All income produced from, changes in fair values in, and gains and losses on OREOs is also included in noninterest expense. During the time the property is held, all related operating and maintenance costs are expensed as incurred.

Appraisals for both collateral dependent impaired loans and OREO are performed by certified general appraisers, certified residential appraisers or state licensed appraisers whose qualifications and licenses are annually reviewed and verified by the Bank. Once received, either Bank personnel or an independent review appraiser reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value, and determines whether the appraisal is reasonable. Appraisals for collateral dependent impaired loans and OREO are updated annually. On an annual basis, the Company compares the actual selling costs of collateral that has been liquidated to the selling price to determine what additional adjustment should be made to the appraisal value to arrive at fair value. Beginning in the third quarter of 2010, the Company’s analysis indicated that an additional discount of 15% should be applied to properties with appraisals performed within 12 months.

Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on the anticipated gain from the sale of the underlying loan. Changes in the fair values of these derivatives are included in noninterest income as gain on sale of loans.

- 25 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

Assets and Liabilities Measured on a Recurring Basis


	Carrying Value		Fair Value Measurements at September 30, 2014 using
	Carrying Value		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. government sponsored entities	$	21,789	$	21,789	$	—
Mortgage-backed (residential)		63,569		63,569		—
State and municipals		2,208		2,104		104

Total available for sale securities		87,566		87,462		104


	Carrying Value		Fair Value Measurements at December 31, 2013 using
	Carrying Value		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. government sponsored entities	$	33,357	$	33,357	$	—
Mortgage-backed (residential)		42,281		42,281		—
State and municipals		6,288		6,183		105

Total available for sale securities		81,926		81,821		105

There were no transfers among fair value pricing levels during the nine months ended September 30, 2014 and 2013.

- 26 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine-month and three-month periods ended September 30, 2014 and 2013:


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Corporate Securities
	Nine months ended September 30,					Three months ended September 30,
	2014		2013			2014		2013
Beginning balance	$	—	$	987		$	—	$	987
Securities matured		—		(987	)		—		(987	)
Change in fair value		—		—			—		—

Ending balance	$	—	$	—		$	—	$	—


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	State and County Municipal Securities
	Nine months ended September 30,						Three months ended September 30,
	2014			2013			2014			2013
Beginning balance	$	105		$	108		$	105		$	107
Change in fair value		(1	)		(2	)		(1	)		(1	)

Ending balance	$	104		$	106		$	104		$	106

- 27 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

The following methods and assumptions were used by the Company in generating its fair value disclosures:

U.S. Government Sponsored Entities and Mortgage-Backed Securities:

The Company uses an independent third party to value its U.S. government sponsored entities and mortgage-backed securities, which are obligations that are not backed by the full faith and credit of the United States government and consist of Government Sponsored Entities that either issue the securities or guarantee the collection of principal and interest payments thereon. The third party’s valuation approach uses relevant information generated by recently executed transactions that have occurred in the market place that involve similar assets, as well as using cash flow information when necessary. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing; however, when the securities are added to the portfolio after the third party’s system-wide market value monthly update, the valuations are considered Level 3 pricing.

State and Municipal Securities:

The valuation of the Company’s state and municipal securities is supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. For these securities that are rated by the rating agencies and have recent trades, the Company considers these valuations to be Level 2 pricing. For these securities that are not rated by the rating agencies and for which trading volumes are thin, the valuations are considered Level 3 pricing.

Corporate Securities:

For corporate securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3) as determined by an independent third party. The significant unobservable inputs used in the valuation model include discount rates and yields or current spreads to U.S. Treasury rates.

- 28 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:


	September 30, 2014
	Carrying Value		Fair Value Measurements using other significant unobservable inputs (Level 3)
Assets:
Impaired loans:
Real estate construction	$	727	$	727
1-4 Family residential		1,458		1,458
Commercial real estate		1,414		1,414
Commercial, financial and agricultural		1,043		1,043
Other loans		463		463

Total impaired loans		5,105		5,105
Other real estate owned:
Construction and development		5,006		5,006
1-4 Family residential		710		710
Farmland		357		357
Non-farm, non-residential		4,365		4,365

Total other real estate owned		10,438		10,438

- 29 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)


	December 31, 2013
	Carrying Value		Fair Value Measurements using other significant unobservable inputs (Level 3)
Assets:
Impaired loans:
Real estate construction	$	4,321	$	4,321
1-4 Family residential		6,173		6,173
Commercial real estate		3,382		3,382
Commercial, financial and agricultural		1		1
Other loans		926		926

Total impaired loans		14,803		14,803
Other real estate owned:
Construction and development		6,079		6,079
1-4 Family residential		228		228
Non-farm, non-residential		4,707		4,707

Total other real estate owned		11,014		11,014

Impaired loans, with specific allocations or partial charge-offs based on the fair value of the underlying collateral for collateral dependent loans, had a recorded investment of $5,922 as of September 30, 2014, with a valuation allowance of $817, resulting in no additional provision for loan losses for the nine-month period ended September 30, 2014, compared to an additional provision of $262 in the first nine months of 2013. Impaired loans, with specific allocations or partial charge-offs based on the fair value of the underlying collateral for collateral dependent loans, had a recorded investment of $17,223 at December 31, 2013, with a valuation allowance of $2,420, resulting in an additional provision for loan losses of $45 for the year ended December 31, 2013.

Other real estate owned, measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $10,438, which is made up of the outstanding balance of $12,326, net of a valuation allowance of $1,888 at September 30, 2014, resulting in a write-down of $523 charged to expense in the nine months ended September 30, 2014, compared to a write-down of $829 charged to expense in the first nine months of 2013. Net carrying amount was $11,014 at December 31, 2013, which was made up of the outstanding balance of $13,163, net of a valuation allowance of $2,149.

- 30 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

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


	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average) (1)
Impaired Loans:
Real estate construction	$	727	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (21.0%) (6.98%)
1-4 Family residential		1,458	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (0.0%) (0.0%)
Commercial real estate		1,414	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (20.0%) (4.09%)
Commercial, financial and agricultural		1,043	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (0.0%) (0.0%)
Other loans		463	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (15.0%) (15.0%)
Other real estate owned:
Construction and development		5,006	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (22.0%) (7.17%)
1-4 Family residential		710	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (0.0%) (0.0%)
Farmland		357	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (0.0%) (0.0%)
Non-farm, non-residential		4,365	Sales comparison approach	Adjustment for differences between the comparable sales	(0.0%) – (11.0%) (8.15%)

(1)	The range presented in the table reflects the discounts applied by the independent appraiser in arriving at their conclusion of market value. Management applies an additional 15% discount to the appraiser’s conclusion of market value to arrive at fair value.

- 31 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

Carrying amount and estimated fair values of significant financial instruments at September 30, 2014 and December 31, 2013 were as follows:


	September 30, 2014
	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	31,753	$	31,753	$	31,753	$	—	$	—
Time deposits in other financial institutions		19,950		19,930		—		19,930		—
Securities available for sale		87,566		87,566		—		87,462		104
Loans, net of allowance		257,162		253,065		—		—		253,065
Restricted equity securities		1,727		NA		NA		NA		NA
Accrued interest receivable		1,077		1,077		17		270		790
Financial liabilities
Deposits with stated maturities		210,225		211,303		—		211,303		—
Deposits without stated maturity		182,590		182,590		182,590		—		—
Accrued interest payable		4,827		4,827		1		512		4,314
Subordinated debentures		23,000		11,500		—		—		11,500


	December 31, 2013
	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial assets
Cash and cash equivalents	$	49,036	$	49,036	$	49,036	$	—	$	—
Time deposits in other financial institutions		6,500		6,524		—		6,524		—
Securities available for sale		81,926		81,926		—		81,821		105
Loans, net of allowance		265,668		264,613		—		—		264,613
Restricted equity securities		1,727		NA		NA		NA		NA
Accrued interest receivable		1,225		1,225		5		311		909
Financial liabilities
Deposits with stated maturities		233,777		234,984		—		234,984		—
Deposits without stated maturity		173,755		173,755		173,755		—		—
Accrued interest payable		4,287		4,287		1		564		3,722
Subordinated debentures		23,000		12,500		—		—		12,500

- 32 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 4 – FAIR VALUE (Continued)

Carrying amount is the estimated fair value for cash and cash equivalents, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully resulting in a Level 1 classification. Fair value for accrued interest receivable and payable is based on the contractual terms of the facility, resulting in a Level 1, Level 2 or Level 3 classification based on the classification of the respective facility. The method for determining fair values of securities is discussed above. Restricted equity securities do not have readily determinable fair values due to their restrictions on transferability, therefore no fair value is presented. For fixed rate loans and variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk resulting in a Level 3 classification. For fixed and variable rate deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk resulting in a Level 2 classification. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values resulting in a Level 3 classification. Fair value of loans held for sale is based on market quotes resulting in a Level 2 classification. Fair value of subordinated debentures is based on discounted cash flows using current rates for similar financing resulting in a Level 3 classification. The fair value of off-balance-sheet items is not considered material.

NOTE 5 – LOANS

Loans outstanding by category at September 30, 2014 and December 31, 2013 were as follows:


	September 30, 2014		December 31, 2013
Real estate construction:
Residential construction	$	8,774	$	8,454
Other construction		22,260		21,684
1-4 Family residential:
Revolving, open ended		19,358		22,513
First liens		83,422		86,318
Junior liens		1,969		1,991
Commercial real estate:
Farmland		7,859		7,667
Owner occupied		40,503		41,286
Non-owner occupied		50,458		48,137
Other real estate secured loans		5,796		4,800
Commercial, financial and agricultural:
Agricultural		816		839
Commercial and industrial		15,434		22,346
Consumer		5,522		5,474
Tax exempt		41		51
Other		1,055		2,147

	$	263,267	$	273,707

- 33 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

The following tables present activity in the allowance for loan losses and the outstanding loan balance by portfolio segment and are based on impairment methods as of and for the nine-month and three-month periods ended September 30, 2014 and 2013. The balances for “recorded investment” in the following tables related to credit quality do not include approximately $790, $831 and $909 in accrued interest receivable at September 30, 2014, September 30, 2013 and December 31, 2013, respectively. Accrued interest receivable is a component of the Company’s recorded investment in loans.


	Real Estate Construction			1-4 Family Residential			Commercial Real Estate			Other Real Estate Secured Loans			Commercial, Financial and Agricultural			Consumer			Tax Exempt		Other Loans			Unallocated			Total
Nine months ended September 30, 2014
Activity in the allowance for loan losses:
Beginning Balance	$	1,249		$	3,235		$	1,273		$	33		$	704		$	24		$	—	$	929		$	592		$	8,039
Charge-offs		(103	)		(100	)		—			—			(113	)		—			—		(957	)		—			(1,273	)
Recoveries		43			24			21			—			12			3			—		36			—			139
(Reversal of) provision		(224	)		(602	)		(314	)		(9	)		(121	)		—			—		456			14			(800	)

Total ending allowance balance	$	965		$	2,557		$	980		$	24		$	482		$	27		$	—	$	464		$	606		$	6,105


Nine months ended September 30, 2013
Activity in the allowance for loan losses:
Beginning Balance	$	1,938		$	4,133		$	1,514		$	226		$	994		$	14		$	—	$	368		$	580		$	9,767
Charge-offs		—			(753	)		(577	)		—			(550	)		(5	)		—		(42	)		—			(1,927	)
Recoveries		19			68			29			—			78			7			—		22			—			223
(Reversal of) provision		(493	)		(171	)		575			(145	)		119			7			—		454			(46	)		300

Total ending allowance balance	$	1,464		$	3,277		$	1,541		$	81		$	641		$	23		$	—	$	802		$	534		$	8,363

- 34 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)


	Real Estate Construction			1-4 Family Residential			Commercial Real Estate			Other Real Estate Secured Loans			Commercial, Financial and Agricultural			Consumer			Tax Exempt		Other Loans			Unallocated		Total
Three months ended September 30, 2014
Activity in the allowance for loan losses:
Beginning Balance	$	997		$	2,560		$	1,134		$	14		$	575		$	24		$	—	$	465		$	537	$	6,306
Charge-offs		(103	)		—			—			—			(113	)		—			—		(14	)		—		(230	)
Recoveries		(1	)		15			4			—			3			1			—		7			—		29
(Reversal of) provision		72			(18	)		(158	)		10			17			2			—		6			69		—

Total ending allowance balance	$	965		$	2,557		$	980		$	24		$	482		$	27		$	—	$	464		$	606	$	6,105


Three months ended September 30, 2013
Activity in the allowance for loan losses:
Beginning Balance	$	1,509		$	3,571		$	2,016		$	82		$	624		$	24		$	—	$	703		$	525	$	9,054
Charge-offs		—			(47	)		(575	)		—			(101	)		(1	)		—		(9	)		—		(733	)
Recoveries		16			8			8			—			2			1			—		7			—		42
(Reversal of) provision		(61	)		(255	)		92			(1	)		116			(1	)		—		101			9		—

Total ending allowance balance	$	1,464		$	3,277		$	1,541		$	81		$	641		$	23		$	—	$	802		$	534	$	8,363

- 35 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)


	Real Estate Construction		1-4 Family Residential		Commercial Real Estate		Other Real Estate Secured Loans		Commercial, Financial and Agricultural		Consumer		Tax Exempt		Other Loans		Unallocated		Total
Ending allowance balance attributable to loans at September 30, 2014:
Individually evaluated for impairment	$	67	$	230	$	99	$	—	$	124	$	—	$	—	$	463	$	—	$	983
Collectively evaluated for impairment		898		2,327		881		24		358		27		—		1		606		5,122

Total ending allowance balance	$	965	$	2,557	$	980	$	24	$	482	$	27	$	—	$	464	$	606	$	6,105


Ending allowance balance attributable to loans at December 31, 2013:
Individually evaluated for impairment	$	476	$	592	$	276	$	—	$	176	$	—	$	—	$	926	$	—	$	2,446
Collectively evaluated for impairment		773		2,643		997		33		528		24		—		3		592		5,593

Total ending allowance balance	$	1,249	$	3,235	$	1,273	$	33	$	704	$	24	$	—	$	929	$	592	$	8,039

Loans at September 30, 2014:
Individually evaluated for impairment	$	8,698	$	2,519	$	1,803	$	109	$	1,143	$	8	$	—	$	926			$	15,206
Collectively evaluated for impairment		22,336		102,230		97,017		5,687		15,107		5,514		41		129				248,061

Total loans balance	$	31,034	$	104,749	$	98,820	$	5,796	$	16,250	$	5,522	$	41	$	1,055			$	263,267


Loans at December 31, 2013:
Individually evaluated for impairment	$	11,370	$	7,658	$	4,883	$	119	$	176	$	12	$	—	$	1,853			$	26,071
Collectively evaluated for impairment		18,768		103,164		92,207		4,681		23,009		5,462		51		294				247,636

Total loans balance	$	30,138	$	110,822	$	97,090	$	4,800	$	23,185	$	5,474	$	51	$	2,147			$	273,707

- 36 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans individually evaluated for impairment by class of loans as of and for the nine months ended September 30, 2014:


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Income Recognized		Cash Basis Income Recognized
With no related allowance recorded:
Real estate construction:
Residential construction	$	—	$	—	$	—	$	821	$	—	$	—
Other construction		7,383		7,280		—		5,959		—		—
1-4 Family residential:
Revolving, open ended		35		35		—		38		2		2
First liens		705		705		—		951		6		6
Junior liens		—		—		—		42		—		—
Commercial real estate:
Owner occupied		—		—		—		353		—		—
Non-owner occupied		3,214		1,258		—		1,523		2		2
Other real estate loans		109		109		—		115		—		—
Commercial, financial and agricultural:
Agricultural		1		—		—		—		—		—
Commercial and industrial		87		24		—		34		3		4
Consumer		8		8		—		5		—		—

Total with no related allowance recorded		11,542		9,419		—		9,841		13		14

With an allowance recorded:
Real estate construction:
Residential construction		—		—		—		925		56		56
Other construction		1,419		1,419		67		2,845		1		1
1-4 Family residential:
Revolving, open ended		38		38		33		95		3		3
First Liens		1,739		1,739		196		2,583		63		60
Commercial real estate:
Owner occupied		545		545		99		734		50		47
Non-owner occupied		—		—		—		604		—		—
Commercial, financial and agricultural:
Commercial and industrial		1,119		1,119		100		372		27		32
Consumer		—		—		—		8		—		—
Other loans		6,227		926		463		1,158		—		—

Total with an allocated allowance recorded		11,087		5,786		958		9,324		200		199

Total	$	22,629	$	15,205	$	958	$	19,165	$	213	$	213

- 37 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans individually evaluated for impairment by class of loans as of and for the three months ended September 30, 2014:


	Average Recorded Investment		Income Recognized			Cash Basis Income Recognized
With no related allowance recorded:
Real estate construction:
Residential construction	$	478	$	—		$	—
Other construction		5,356		—			—
1-4 Family residential:
Revolving, open ended		20		2			2
First liens		777		(1	)		(2	)
Junior liens		—		—			—
Commercial real estate:
Owner occupied		—		—			—
Non-owner occupied		1,417		2			2
Other real estate loans		112		—			—
Commercial, financial and agricultural:
Commercial and industrial		68		3			4
Consumer		8		—			—

Total with no related allowance recorded		8,236		6			6

With an allowance recorded:
Real estate construction:
Residential construction		592		(2	)		(2	)
Other construction		3,407		(2	)		(2	)
1-4 Family residential:
Revolving, open ended		53		2			2
First Liens		1,453		32			29
Commercial real estate:
Owner occupied		545		15			12
Non-owner occupied		18		(8	)		(8	)
Commercial, financial and agricultural:
Commercial and industrial		567		27			32
Consumer		5		—			—
Other loans		926		—			—

Total with an allocated allowance recorded		7,566		64			63

Total	$	15,802	$	70		$	69

- 38 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans individually evaluated for impairment by class of loans as of and for the nine months ended September 30, 2013:


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Income Recognized			Cash Basis Income Recognized
With no related allowance recorded:
Real estate construction:
Residential construction	$	—	$	—	$	—	$	633	$	—		$	—
Other construction		6,564		6,564		—		7,507		1			1
1-4 Family residential:
Revolving, open ended		40		40		—		170		1			1
First liens		1,593		1,593		—		1,837		38			42
Junior liens		83		83		—		70		2			2
Commercial real estate:
Owner occupied		1,092		1,092		—		1,095		35			37
Non-owner occupied		—		—		—		1,028		—			—
Other real estate secured loans		120		120		—		123		—			—
Commercial, financial and agricultural:
Agricultural		2		1		—		1		—			—
Commercial and industrial		20		9		—		95		1			1
Consumer		2		2		—		1		—			—

Total with no related allowance recorded		9,516		9,504		—		12,560		78			84

With an allowance recorded:
Real estate construction:
Residential construction		2,779		2,779		170		2,921		—			—
Other construction		2,459		2,459		475		2,899		18			18
1-4 Family residential:
Revolving, open ended		180		180		132		378		2			4
First Liens		5,395		5,395		433		5,022		155			125
Junior Liens		—		—		—		87		—			—
Commercial real estate:
Owner occupied		1,852		1,852		278		1,863		96			101
Non-owner occupied		3,753		1,798		142		1,584		5			6
Other real estate secured loans		—		—		—		—		—			—
Commercial, financial and agricultural:
Agricultural		—		—		—		—		—			—
Commercial and industrial		179		179		179		375		(35	)		—
Consumer		12		12		—		7		1			1
Other loans		6,227		1,853		800		1,853		—			—

Total with an allocated allowance recorded		22,836		16,507		2,609		16,989		242			255

Total	$	32,352	$	26,011	$	2,609	$	29,549	$	320		$	339

- 39 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans individually evaluated for impairment by class of loans as of and for the three months ended September 30, 2013:


	Average Recorded Investment		Income Recognized			Cash Basis Income Recognized
With no related allowance recorded:
Real estate construction:
Residential construction	$	—	$	—		$	—
Other construction		6,913		(14	)		(14	)
1-4 Family residential:
Revolving, open ended		319		—			(6	)
First liens		1,422		23			24
Junior liens		70		—			—
Commercial real estate:
Owner occupied		1,093		12			12
Non-owner occupied		—		—			—
Other real estate secured loans		121		—			—
Commercial, financial and agricultural:
Agricultural		1		—			—
Commercial and industrial		15		—			—
Consumer		2		—			—

Total with no related allowance recorded		9,956		21			16

With an allowance recorded:
Real estate construction:
Residential construction		2,839		—			—
Other construction		3,249		(1	)		(1	)
1-4 Family residential:
Revolving, open ended		180		1			1
First Liens		5,372		64			43
Junior Liens		—		—			—
Commercial real estate:
Owner occupied		1,858		32			32
Non-owner occupied		2,028		(65	)		(64	)
Other real estate secured loans		—		—			—
Commercial, financial and agricultural:
Agricultural		1		—			—
Commercial and industrial		315		(35	)		—
Consumer		14		1			1
Other loans		1,853		—			—

Total with an allocated allowance recorded		17,709		(3	)		12

Total	$	27,665	$	18		$	28

- 40 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans individually evaluated for impairment by class of loans as of and for the year ended December 31, 2013:


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Income Recognized			Cash Basis Income Recognized
With no related allowance recorded:
Real estate construction:
Residential construction	$	—	$	—	$	—	$	633	$	—		$	—
Other construction		6,564		6,564		—		7,507		1			1
1-4 Family residential:
Revolving, open ended		110		110		—		184		4			5
First liens		1,163		1,163		—		1,751		29			33
Junior liens		83		83		—		70		4			3
Commercial real estate:
Farmland		—		—		—		—		—			—
Owner occupied		1,411		1,411		—		1,159		58			64
Non-owner occupied		3,582		1,627		—		1,354		—			—
Other real estate loans		119		119		—		123		—			—
Commercial, financial and agricultural:
Agricultural		1		1		—		93		—			—
Commercial and industrial		—		—		—		1		—			—
Consumer		1		1		—		—		—			—
Other Loans		—		—		—		—		—			—

Total with no related allowance recorded		13,034		11,079		—		12,875		96			106
With an allowance recorded:
Real estate construction:
Residential construction		2,515		2,515		62		2,868		—			—
Other construction		2,291		2,291		414		2,866		15			15
1-4 Family residential:
Revolving, open ended		179		179		132		377		3			5
First Liens		6,122		6,122		460		5,167		272			255
Junior Liens		—		—		—		87		—			—
Commercial real estate:
Farmland		—		—		—		—		—			—
Owner occupied		1,845		1,845		276		1,862		129			126
Non-owner occupied		—		—		—		1,224		—			—
Other real estate loans		—		—		—		1,100		—			—
Commercial, financial and agricultural:
Commercial and industrial		176		176		176		374		(35	)		—
Consumer		11		11		—		7		1			1
Other loans		6,227		1,853		926		1,853		—			—

Total with an allocated allowance recorded		19,366		14,992		2,446		17,785		385			402

Total	$	32,400	$	26,071	$	2,446	$	30,660	$	481		$	508

- 41 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Troubled Debt Restructurings

The Company has $19,049 of loans with allocated specific reserves of $740 to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2014 compared to $24,667 with allocated specific reserves of $2,122 at December 31, 2013. The Company lost $107 and $121 of interest income in the nine months and $95 and $36 of interest income in the three months ended September 30, 2014 and 2013, respectively, that would have been recorded in interest income if the specific loans had not been restructured. The Bank had no commitments to lend additional funds to loans classified as troubled debt restructurings at September 30, 2014 or December 31, 2013.

During the first nine months of 2014, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or granting of amortization terms for balloon notes that are longer than the Bank’s typical practice.

Modifications involving a reduction of the stated interest rate and extension of the maturity date of the loan were for periods ranging from six months to two years.

Loans classified as troubled debt restructurings are included in impaired loans.

- 42 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

The following table presents loans by class modified as troubled debt restructurings that occurred during the first nine months of 2014 and 2013:


	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
September 30, 2014
1-4 Family residential:
Revolving, open ended		1	$	35	$	35
First liens		1		263		263
Commercial real estate:
Owner occupied		2		545		545
Non-owner occupied		1		35		35
Commercial, financial and agricultural
Commercial and industrial		3		38		38

Total		8	$	916	$	916


September 30, 2013
Real estate construction:
Other construction		3	$	1,365	$	1,365
1-4 Family residential:
Revolving, open ended		1		6		6
First liens		8		5,575		5,575
Commercial real estate:
Owner occupied		1		162		162
Commercial, financial and agricultural
Agricultural		1		1		1
Commercial and industrial		2		21		21
Consumer		5		16		16

Total		21	$	7,146	$	7,146

Troubled debt restructurings described above had an outstanding balance of $914 at September 30, 2014. There was no increase for the allowance for loan losses during the first nine months of 2014 on account of these troubled debt restructurings. Troubled debt restructurings still accruing interest totaled $1,636 and $9,014 at September 30, 2014 and December 31, 2013, respectively.

A loan is considered to be in payment default once it is more than 90 days contractually past due under the modified terms.

- 43 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the first nine months of 2014.


	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
September 30, 2014
1-4 Family residential:
First liens		1	$	263	$	263
Commercial real estate:
Owner occupied		1		221		221

Total		2	$	484	$	484

There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the first nine months of 2013.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. This evaluation is performed in accordance with the Company’s internal loan policy. Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

- 44 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still accruing by class of loans as of September 30, 2014 and December 31, 2013:


	September 30, 2014				December 31, 2013
	Nonaccrual		Loans past due over 90 days still accruing		Nonaccrual		Loans past due over 90 days still accruing
Real estate construction:
Residential construction	$	—	$	—	$	2,514	$	—
Other construction		8,736		—		8,833		—
1-4 Family residential:
Revolving, open ended		250		—		230		—
First Liens		1,339		—		868		—
Junior Liens		—		—		—		—
Commercial real estate:
Farmland		—		—		—		—
Owner occupied		324		—		324		—
Non-owner occupied		1,224		—		1,627		—
Other real estate loans		109		—		119		—
Commercial, financial and agricultural:
Agricultural		—		—		—		—
Commercial and industrial		1,129		—		1,784		—
Consumer		19		—		—		—
Other loans		927		—		1,853		—

Total	$	14,057	$	—	$	18,152	$	—

- 45 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans, including nonaccrual loans as of September 30, 2014 and December 31, 2013 by class of loans:


	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
September 30, 2014
Real estate construction:
Residential construction	$	—	$	—	$	—	$	—	$	8,774	$	8,774
Other construction		—		8		54		62		22,198		22,260
1-4 Family residential:
Revolving, open ended		14		78		250		342		19,016		19,358
First Liens		279		554		199		1,032		82,390		83,422
Junior Liens		19		—		—		19		1,950		1,969
Commercial real estate:
Farmland		—		—		—		—		7,859		7,859
Owner occupied		144		—		—		144		40,359		40,503
Non-owner occupied		77		—		—		77		50,381		50,458
Other real estate secured loans		—		—		—		—		5,796		5,796
Commercial, financial and agricultural:
Agricultural		—		—		—		—		816		816
Commercial and industrial		90		176		1,014		1,280		14,154		15,434
Consumer		9		3		19		31		5,491		5,522
Tax exempt		—		—		—		—		41		41
Other loans		—		—		926		926		129		1,055

Total	$	632	$	819	$	2,462	$	3,913	$	259,354	$	263,267


	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
December 31, 2013
Real estate construction:
Residential construction	$	—	$	—	$	—	$	—	$	8,454	$	8,454
Other construction		110		13		—		123		21,561		21,684
1-4 Family residential:
Revolving, open ended		48		33		230		311		22,202		22,513
First Liens		295		358		162		815		85,503		86,318
Junior Liens		83		—		—		83		1,908		1,991
Commercial real estate:
Farmland		216		—		—		216		7,451		7,667
Owner occupied		747		221		324		1,292		39,994		41,286
Non-owner occupied		—		—		—		—		48,137		48,137
Other real estate secured loans		—		119		—		119		4,681		4,800
Commercial, financial and agricultural:
Agricultural		—		—		—		—		839		839
Commercial and industrial		1,058		—		1,784		2,842		19,504		22,346
Consumer		22		26		—		48		5,426		5,474
Tax exempt		—		—		—		—		51		51
Other loans		—		—		1,853		1,853		294		2,147

Total	$	2,579	$	770	$	4,353	$	7,702	$	266,005	$	273,707

- 46 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. The Company assigns an initial credit risk rating on every loan. All loan relationships with aggregate debt greater than $250 are reviewed at least annually or more frequently if performance of the loan or other factors warrants review. Smaller balance loans are reviewed and evaluated based on changes in loan performance, such as becoming past due or upon notifying the Bank of a change in the borrower’s financial status. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch are considered to be of acceptable credit quality, but contain greater credit risk than pass rated loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance.

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Impaired loans are evaluated separately from other loans in the Bank’s portfolio. Credit quality information related to impaired loans was presented above and is excluded from the tables below.

- 47 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 5 – LOANS (Continued)

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of September 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk categories of loans by class of loans are as follows:


	Pass		Watch		Special Mention		Substandard		Doubtful
September 30, 2014
Real estate construction:
Residential construction	$	5,769	$	3,005	$	—	$	—	$	—
Other construction		6,710		6,011		—		840		—
1-4 Family residential:
Revolving, open ended		18,718		32		—		535		—
First Liens		65,240		11,253		—		4,485		—
Junior Liens		1,969		—		—		—		—
Commercial real estate:
Farmland		5,244		908		—		1,707		—
Owner occupied		36,216		3,742		—		—		—
Non-owner occupied		40,796		5,575		—		2,829		—
Other real estate loans		5,687		—		—		—		—
Commercial, financial and agricultural:
Agricultural		748		12		—		56		—
Commercial and industrial		13,258		932		—		101		—
Consumer		5,341		2		—		171		—
Tax exempt		41		—		—		—		—
Other loans		129		—		—		—		—

Total	$	205,866	$	31,472	$	—	$	10,724	$	—


	Pass		Watch		Special Mention		Substandard		Doubtful
December 31, 2013
Real estate construction:
Residential construction	$	5,241	$	698	$	—	$	—	$	—
Other construction		5,525		6,447		—		857		—
1-4 Family residential:
Revolving, open ended		20,837		194		—		1,193		—
First Liens		69,877		3,807		—		5,349		—
Junior Liens		1,660		248		—		—		—
Commercial real estate:
Farmland		4,934		1,141		—		1,592		—
Owner occupied		34,594		1,580		—		1,856		—
Non-owner occupied		39,463		4,107		—		2,940		—
Other real estate loans		2,993		1,688		—		—		—
Commercial, financial and agricultural:
Agricultural		782		56		—		—		—
Commercial and industrial		19,761		2,098		—		311		—
Consumer		5,292		4		1		165		—
Tax exempt		51		—		—		—		—
Other loans		294		—		—		—		—

Total	$	211,304	$	22,068	$	1	$	14,263	$	—

- 48 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 6 – INCOME PER SHARE

In accordance with ASC 260-10, Earnings Per Share, basic income per share available to common shareholders is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted income per share available to common shareholders reflects the potential dilution that could occur if securities, stock options or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company. The factors used in the income per share computation follow:


	Nine months ended September 30,						Three months ended September 30,
	2014			2013			2014			2013
Basic
Net income	$	1,824		$	883		$	232		$	290
Less: Earnings allocated to preferred stock		(1,147	)		(726	)		(424	)		(245	)
Less: Accretion of preferred stock discount		(33	)		(148	)		—			(50	)

Net Income (loss) available (allocated) to common stock	$	644		$	9		$	(192	)	$	(5	)

Weighted average common shares		3,274,844			3,274,551			3,274,876			3,274,716

Basic net income (loss) per common share	$	0.20		$	0.00		$	(0.06	)	$	0.00


Diluted
Net income (loss) available (allocated) to common stock	$	644		$	9		$	(192	)	$	(5	)

Weighted average common shares		3,274,844			3,274,551			3,274,876			3,274,716
Add: Dilutive effects of assumed exercises of stock options		—			—			—			—

Average common shares and dilutive potential common shares outstanding		3,274,844			3,274,551			3,274,876			3,274,716

Diluted net income (loss) per common share	$	0.20		$	0.00		$	(0.06	)	$	0.00

At September 30, 2014 and 2013, respectively, stock options for 55,100 and 60,200 shares of common stock were not considered in computing diluted net income (loss) per share for the nine-month and three-month periods ended September 30, 2014 and 2013 because they were antidilutive.

- 49 -

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

September 30, 2014

(Unaudited)

NOTE 7 – INCOME TAXES

The Company recorded no tax expense during the first nine months of 2014. During 2010, the Company established a valuation allowance against all of its deferred tax assets and has maintained that valuation allowance through the first nine months of 2014. The Company intends to maintain this valuation allowance until it determines it is more likely than not that the asset can be realized through current and future taxable income. Because the Company has recorded a valuation allowance against its deferred tax assets, any deferred tax benefit or expense will be offset by a corresponding increase or decrease, respectively, to the valuation allowance. Until the reversal of the deferred tax valuation allowance, tax benefit or expense from current year operations is expected to be minimal.

- 50 -

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

OVERVIEW

(amounts in thousands, except share and per share data)

The following discussion compares the financial condition of the Company at September 30, 2014 to December 31, 2013, and the results of operations for the nine months and three months ended September 30, 2014 and 2013. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

Certain of the statements made herein, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning and subject to the protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target,” and other similar words and expressions of the future.

These forward-looking statements may not be realized due to a variety of factors, including, without limitation those described under Item 1A, “Risk Factors”, in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014 (File No. 000-49966) (the “2013 Form 10-K”) and in other reports we file with the SEC from time to time, and the following:

•

deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses;

•

greater than anticipated deterioration or lack of sustained growth in the national or local economies including the Nashville-Davidson-Murfreesboro-Franklin MSA;

•

changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions or regulatory developments;

•

the inability to meet the requirements of our regulatory orders and agreements to which we and our Bank subsidiary are subject;

•

failure to maintain capital levels above levels required by banking regulations or commitments or agreements we make with our regulators;

•

the inability to comply with regulatory capital requirements, including those resulting from recently adopted changes to capital calculation methodologies and required capital maintenance levels, and to secure any required regulatory approvals for capital actions;

•

the vulnerability of our network and online banking portals to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches;

•

the continued reduction of our loan balances and, conversely, the inability to ultimately grow our loan portfolio;

- 51 -

OVERVIEW (Continued)

•

governmental monetary and fiscal policies, as well as legislative and regulatory changes, including changes in banking, securities and tax laws and regulations;

•

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities;

•

continuation of the historically low short-term interest rate environment;

•

the ability to retain large, uninsured deposits;

•

rapid fluctuations or unanticipated changes in interest rates;

•

any activity that would cause us to conclude that there was impairment of any asset, including goodwill or any other intangible asset;

•

our recording a further valuation allowance related to our deferred tax asset;

•

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment, and insurance services;

•

changes in state and federal legislation, regulations or policies applicable to banks and other financial service providers, including regulatory or legislative developments arising out of current unsettled conditions in the economy, including implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

•

the failure of assumptions underlying the establishment of reserves for possible loan losses and other estimates;

•

the failure of the FDIC to terminate the Consent Order;

•

further deterioration in the valuation of other real estate owned;

•

changes in accounting policies, rules and practices;

•

the actions of the owners of the preferred securities sold through our participation in the United States Department of the Treasury’s (the “U.S. Treasury”) Capital Purchase Program (the “CPP”);

•

changes in technology or products that may be more difficult, or costly, or less effective, than anticipated;

•

the effects of war or other conflict, acts of terrorism or other catastrophic events that may affect general economic conditions; and

•

other circumstances, many of which may be beyond our control.

All written or oral forward-looking statements that are made by or are attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

- 52 -

FINANCIAL CONDITION

At September 30, 2014, total assets were $437,035 and total liabilities were $427,024. Total assets decreased $11,408 or 2.5% compared to $448,443 at December 31, 2013. Total liabilities decreased $12,803, or 2.9%, compared to $439,827 at December 31, 2013. The decrease in assets was caused by decreases in cash and cash equivalents, net loans and other real estate owned offset in part by increases in time deposits in other financial institutions, securities available for sale and premises and equipment. The decrease in liabilities was caused by a decrease in interest-bearing deposits offset in part by an increase in noninterest-bearing deposits. Total equity increased 16.2%, or $1,395, to $10,011 at September 30, 2014 compared to $8,616 at December 31, 2013. The increase in equity is primarily due to net income and gains in other comprehensive income during the first nine months of 2014 caused by market fluctuations in securities available for sale.

Cash and Cash Equivalents

Cash and cash equivalents were $31,753 at September 30, 2014 compared to $49,036 at December 31, 2013. This decrease is primarily due to the use of cash to invest in time deposits in other financial institutions and securities available for sale. The Bank has continued to maintain high levels of liquid resources during 2014 due to the availability of excess liquidity in the Bank’s market area coupled with reduced loan demand as a result of weak economic conditions.

Time Deposits in Other Financial Institutions

Time deposits in other financial institutions totaled $19,950 at September 30, 2014 compared to $6,500 at December 31, 2013. Management has begun utilizing time deposits in other financial institutions in conjunction with the Bank’s securities portfolio in order to maximize yield and maintain a reasonable total duration for the Bank’s assets outside of the loan portfolio. Original maturities of time deposits in other financial institutions range from three months to 5 years. Most of the CDs with maturities beyond three years are callable with minimal early withdrawal penalties. All of the deposits are in FDIC insured institutions and the amount on deposit with each individual institution does not exceed the FDIC insurance limit of $250. As of September 30, 2014, time deposits in other financial institutions had a weighted average rate of 0.89% and a weighted average remaining life of 1.12 years.

- 53 -

FINANCIAL CONDITION (Continued)

Loans

Total loans (excluding loans held for sale) at September 30, 2014 were $263,267, compared to $273,707 at December 31, 2013, a decrease of $10,440 or 3.8%. The decrease in loans during the first nine months of 2014 is due to regular loan payments outpacing demand for new loans and additional foreclosure activity.

Loans in the portfolio at September 30, 2014 of approximately $52,640, or 20.0%, are at a variable rate of interest, $196,570, or 74.7%, are at a fixed rate, and $14,057, or 5.3%, are nonaccrual. $99,514, or 38.7%, of total loans reprice within one year of September 30, 2014. As market rates dropped during the economic recession, management implemented rate floors for many variable rate loans in an effort to protect the Bank’s net interest margin. As a result, when market rates begin to rise, loans at their floor will not reprice at higher rates until market rates rise above their contractual floor rates. Only the loans noted above that have variable rates not at a floor rate will reprice with the first increase in market rates. The existence of these rate floors may negatively impact our net interest margin when rates begin to rise, at least until rates rise above these floors.

On September 30, 2014, the Company’s loan to deposit ratio (including loans held for sale) was 67.0%, compared to 67.2% at December 31, 2013. Management expects loan demand to modestly improve through the remainder of 2014, which should slow or stop the decline in gross loans, though excessive amounts of paydowns and foreclosure activity could result in some additional decreases in loan balances. Management anticipates that there will not be significant growth in loans until there are indicators of significant improvements in both the local and national economy, leading customers to begin spending more and resulting in increased demand. If the Company’s deposit growth among core deposit customers continues to outpace its loan demand, the Company’s net interest margin may be adversely affected as the funds from these deposits may be invested in securities and other interest earning assets, like time deposits in other financial institutions, that offer lower yields than loans.

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FINANCIAL CONDITION (Continued)

Securities Available for Sale

Set forth below is a table showing the carrying amount and breakdown of the Company’s securities available for sale at September 30, 2014 and December 31, 2013:


	September 30, 2014					December 31, 2013
	Amount		% of Total			Amount		% of Total
U.S. government sponsored entities	$	21,789		24.9	%	$	33,357		40.7	%
Mortgage-backed (residential)		63,569		72.6	%		42,281		51.6	%
State and municipal		2,208		2.5	%		6,288		7.7	%

Total	$	87,566		100.0	%	$	81,926		100.0	%

The Company’s securities portfolio is used to, among other things, provide yield and for pledging purposes to secure public fund deposits. As of September 30, 2014, the carrying value of securities increased $5,640 to $87,566, compared to $81,926 at December 31, 2013. Securities available for sale as a percentage of total assets was 20.0% at September 30, 2014, compared to 18.3% at December 31, 2013. Net unrealized loss on securities available for sale was $482 at September 30, 2014, compared to a net unrealized loss of $1,200 at December 31, 2013. Changes in interest rates in the securities market and some re-positioning of the portfolio caused this fluctuation in the net unrealized loss. Management is continually monitoring the credit quality of the Bank’s investments and believes that the unrealized losses that existed in the Bank’s portfolio at September 30, 2014 were temporary based on the bond ratings and anticipated recovery of bonds held. At September 30, 2014, the Company did not have the intent to sell these securities and it is more likely than not that it will not be required to sell the securities before their anticipated recovery.

During the first nine months of 2014, the Bank sold two different groups of securities in an effort to reduce price volatility in the portfolio. These sales resulted in a net gain of $213. The proceeds were reinvested primarily in new mortgage-backed securities.

Other Real Estate Owned

At September 30, 2014, other real estate owned (“ORE”) totaled $14,172, a decrease of $4,142 from $18,314 at December 31, 2013. This decrease is primarily due to the sale of properties during the first three quarters of 2014. The balance of ORE is comprised of properties acquired through or in lieu of foreclosure on real estate loans, property acquired by the Company for future Bank branch locations that is no longer intended for that purpose and is currently held for sale, and loans made to facilitate the sale of ORE properties that are required to be reported as ORE (“FAS 66 Loans”). The balances recorded for each individual property are based on appraisals that are not more than twelve months old, discounted by an additional 15%. The additional 15% discount was adopted by the Company beginning in the third quarter of 2010 based on an analysis of actual recoveries of ORE balances, including selling costs. Based on that analysis, the Company recorded a valuation allowance of $346 (recognized through ORE expense) in the third quarter of 2010. In addition, the Company began applying the additional 15% discount in its determination of specific reserves for impaired loans that are collateral dependent. As a result, the majority of the financial loss incurred by the Company as a result of the 15% discount has been recognized through loan charge-offs and the provision for loan losses at the time the property is transferred to ORE, with the foreclosed property being transferred into ORE at the discounted value. The Company annually updates its analysis regarding the additional 15% discount. Should such updates indicate that a change in the 15% discount is warranted, the Company would implement the change accordingly and that change would be applied to all properties that are subsequently moved into ORE. Additional write-downs of individual properties typically occur when the results of updated appraisals and further application of the 15% discount on the value reflected in the updated appraisal indicates that the value of the respective property has declined. The Company obtains updated appraisals for ORE properties at least annually. These write-downs are recognized in the quarterly period in which the appraisal is accepted by the Company.

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FINANCIAL CONDITION (Continued)

The Company actively markets the properties within its ORE portfolio utilizing both Bank personnel and third parties (brokers, agents, etc.). All ORE properties are classified into one of four categories: rental properties, non-rental properties, auction properties, and land. Rental properties consist of any property that can be leased or rented in order to produce income for the Company while the Company is pursuing the sale of the property. Non-rental properties consist of improved real estate that the Company’s management has concluded would not be attractive to a renter or that management believes will be most efficiently sold unoccupied. Auction properties are typically properties of lower value that the Company is willing to accept the risk of an auction in order to sell. These properties are typically auctioned off within six to twelve months of the property being transferred into ORE; however, circumstances related to a particular property may warrant holding the property for a longer period. Auction properties are typically auctioned off in absolute auctions with no minimum reserves. Land generally consists of unimproved raw land, though some properties may have some infrastructure work completed for housing development. Properties within the land category of ORE are typically held for longer periods of time than other ORE properties as the marketing of these properties, particularly large parcels, often extends for over six months.

The following table shows a breakdown of the ORE portfolio by category as of the end of the periods indicated:


	September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013
Bank Premises	$	—	0.0	%	$	—	0.0	%	$	484	2.8	%	$	484	2.6	%
Rental		7,114	50.2	%		7,246	45.7	%		7,614	43.2	%		7,616	41.6	%
Non-rental		986	7.0	%		1,135	7.2	%		1,083	6.1	%		1,126	6.2	%
Auction		—	0.0	%		—	0.0	%		15	0.1	%		21	0.1	%
Land		6,072	42.8	%		7,470	47.1	%		8,432	47.8	%		9,067	49.5	%

Total	$	14,172	100.0	%	$	15,851	100.0	%	$	17,628	100.0	%	$	18,314	100.0	%

The Company makes every effort to sell ORE as quickly as feasible while still recovering as much of the original investment as possible. Management also considers the cost associated with holding individual properties in determining how aggressively it markets an individual property. The Company’s ORE that is classified as rental properties generally consists of 1-4 family properties, though some are commercial real estate. Rental income generated by this group has typically exceeded the holding costs of the respective properties. The majority of the rental properties are listed for sale with real estate agents; however, properties in this group are not the primary focus of management’s marketing efforts given the income producing nature of the property. The Company’s ORE that is classified as auction properties are marketed aggressively with dates set for auctions and most auction properties being allowed to sell without a reserve price. The Company’s other ORE properties are being marketed, though there is no definite date as to when they may be expected to be sold.

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FINANCIAL CONDITION (Continued)

The following table provides activity within the ORE portfolio in terms of individual parcels for the nine-month and three-month periods ended on the dates indicated:


	Rental		Non-rental		Auction		Land
Three Months Ended September 30, 2014
Foreclosures		—		—		—		—
Sales		2		1		—		4

Three Months Ended September 30, 2013
Foreclosures		2		1		—		—
Sales		—		—		2		1

Nine Months Ended September 30, 2014
Foreclosures		2		2		—		1
Sales		12		3		3		13
Weighted average age of properties held at period end (months)		28.3		17.0		—		36.4

Nine Months Ended September 30, 2013
Foreclosures		13		2		—		3
Sales		18		3		9		6
Weighted average age of properties held at period end (months)		11.7		5.1		28.1		21.2

The following table sets forth information related to the largest five ORE properties held by the Company as of September 30, 2014:


Property Description	Original loan classification	Original Loan Amount		Charge-off prior to transfer into ORE		Write-down after transfer into ORE		Carrying Balance
Unimproved land	Real estate construction	$	5,000	$	905	$	536	$	2,949
Unimproved land	Real estate construction		3,103		1,896		204		961
Mixed use commercial property	Commercial real estate		3,684		1,536		238		808
Unimproved land	Real estate construction		1,134		402		—		799
Mini storage facility	Commercial real estate		887		—		—		784

The following table sets forth information related to the largest five ORE properties held by the Company as of December 31, 2013:


Property Description	Original loan classification	Original Loan Amount		Charge-off prior to transfer into ORE		Write-down after transfer into ORE		Carrying Balance
Unimproved land	Real estate construction	$	5,000	$	905	$	374	$	3,111
Unimproved land	Real estate construction		3,103		1,896		204		961
Unimproved land	Real estate construction		2,546		196		85		927
Mixed use commercial property	Commercial real estate		3,684		1,536		196		850
Unimproved land	Real estate construction		1,134		402		—		799

- 57 -

FINANCIAL CONDITION (Continued)

Each of the ORE properties identified in the September 30, 2014 table above is listed with a real estate agent and/or listed as available for sale on the Bank’s website. The three properties classified as unimproved land were, at the time the loans were made, intended to be developed. The property carried at $2,949 is commercial property located in an area that remains significantly and negatively impacted by the downturn in the real estate market. Although the Company continues to actively market the property, management anticipates that it could take a significant amount of time to sell the property. The properties carried at $961 and $799 are located in residential areas that were also negatively impacted by the downturn in the economy. Although there are some positive indicators of improvements in the local markets where the properties are located, management believes it will likely require a significant amount of time to sell the properties. The commercial real estate properties are income producing rental properties that are being managed by a third party property manager on behalf of the Company. The Company continues to market these properties, but because of the income producing nature of the properties, it is likely that management will resist selling the properties for less than the current carrying value of the properties.

Deposits

The Company relies on the Bank’s deposit growth, as well as alternative funding sources such as other borrowed money, FHLB advances, and federal funds purchased from correspondent banks, to fund its operations.

The following table sets forth the composition of the deposits at September 30, 2014 and December 31, 2013.


	September 30, 2014					December 31, 2013
	Amount		% of Total			Amount		% of Total
Noninterest-bearing demand accounts	$	60,972		15.5	%	$	53,980		13.2	%
Interest-bearing demand accounts		121,914		31.0	%		120,259		29.5	%
Savings accounts		26,034		6.6	%		24,770		6.1	%
Time deposits greater than $100		83,481		21.3	%		97,294		23.9	%
Other time deposits		100,414		25.6	%		111,229		27.3	%

Total	$	392,815		100.0	%	$	407,532		100.0	%

The following table sets forth all time deposits broken down by remaining maturity at September 30, 2014:


Less than three months	$	41,002
Three months through twelve months		105,381
One year through three years		23,696
More than three years		13,816

Total	$	183,895

Total deposits were $392,815 at September 30, 2014, compared to $407,532 at December 31, 2013, a decrease of $14,717. The decrease was primarily due to decreases in interest-bearing deposits offset in part by increases in noninterest-bearing demand deposits.

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FINANCIAL CONDITION (Continued)

During 2012 and 2013 and through September 30, 2014, the Bank has maintained higher levels of liquid assets due to the availability of excess liquidity in the Bank’s market area coupled with reduced loan demand as a result of weak economic conditions. Management has been utilizing the available cash to pay off national market and broker deposits as they have matured, resulting in significant reductions in cost of funds. Management has been seeking additional core customer deposits during 2014 and anticipates that it will continue to do so in order to improve the Bank’s overall liquidity position as well as net interest income and to continue to reduce the Bank’s reliance on national market and broker deposits.

Shareholders’ Equity

At September 30, 2014, shareholders’ equity totaled $10,011, an increase of $1,395 from $8,616 at December 31, 2013. The increase was primarily due to gains in other comprehensive income combined with net income.

The 17,806 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Senior Preferred Shares”) have a $21,445 liquidation value and had a cumulative dividend rate of 5% per year, until May 15, 2014, and a dividend rate of 9% thereafter. In addition, under the terms of the CPP, the Company issued warrants to U.S. Treasury to purchase additional preferred shares equal to 5% of the investment in Senior Preferred Shares at a discounted exercise price. The U.S. Treasury exercised the warrants immediately upon investment in the Senior Preferred shares, which resulted in issuance of 890 shares of Fixed Rate Perpetual Preferred Shares, Series B (the “Warrant Preferred Shares” and together with the Senior Preferred Shares, the “Preferred Shares”) . The U.S. Treasury’s exercise of the warrants resulted in a net discount on the issuance of the preferred shares of $890. The discount was amortized over a five year period, which ended on February 27, 2014. The Warrant Preferred Shares have a liquidation value of $1,191 and a cumulative dividend rate of 9% per year until redeemed. Dividends on both Senior Preferred Shares and Warrant Preferred Shares are required to be paid quarterly. Total required annual dividends for both Senior Preferred Shares and Warrant Preferred Shares are expected to be as follows: 2014: $1,564; 2015 and thereafter: $1,683 per year. The Company is permitted to redeem all or a portion of the Preferred Shares at any time after consultation with its primary federal regulator, but may not redeem the Warrant Preferred Shares until all of the Senior Preferred Shares have been redeemed. Holders of both the Senior Preferred and Warrant Preferred shares would be entitled to receive accrued but unpaid dividends in conjunction with any such redemption.

On April 14, 2014, the U.S. Treasury, the holder of all the Senior Preferred and Warrant Preferred shares issued by the Company, closed on the sale of the securities in a modified Dutch auction. The clearing price for the Senior Preferred shares was $300.50 per share and the clearing price for the Warrant Preferred shares was $521.75 per share. The sale was to unaffiliated third party investors as well as certain directors and executive officers of the Company.

The Company received none of the proceeds from the sale of the Senior Preferred or Warrant Preferred shares by the U.S. Treasury. The sale of the securities had no effect on the terms of the outstanding securities, including the Company’s obligation to satisfy accrued and unpaid dividends or the holders’ right to elect two members to the board of directors of the Company. Further, the sale of the securities has no effect on the Company’s capital, regulatory capital, financial condition or results of operations. Upon the closing of the sale of the securities, the Company was no longer subject to various executive compensation and corporate governance requirements to which participants in the CPP were subject while the U.S. Treasury held the securities.

- 59 -

FINANCIAL CONDITION (Continued)

At the request of the FRB, the board of directors of the Company, on January 18, 2011, adopted a board resolution agreeing that the Company would not incur additional debt, pay common or preferred dividends, or redeem treasury stock without approval from the FRB. The board resolution was replaced by the Written Agreement that the Company entered into with the FRB on April 19, 2012, the terms of which similarly prohibit the Company from incurring debt, paying dividends or interest or redeeming shares of its capital stock. The Company requested permission to make dividend payments on its Preferred Shares and interest payments on its subordinated debt that were scheduled for the first quarter of 2011. The FRB granted permission to pay the preferred dividends that were due on February 15, 2011, but denied permission to make interest payments on the Company’s subordinated debt. As a result of the FRB’s decision, the Company was required to begin the deferral of interest payments on each of its three issues of subordinated debentures during the first quarter of 2011. The Company has the right to defer the payment of interest on the subordinated debentures at any time, for a period not to exceed 20 consecutive quarters. During the period in which it is deferring the payment of interest on its subordinated debentures, the Company may not pay any dividends on its common or preferred stock, including the Preferred Shares, and the Company’s subsidiaries may not pay dividends on the subsidiaries’ common or preferred stock owned by entities other than the Company and its subsidiaries. Accordingly, the Company was required to suspend dividend payments on the Preferred Shares beginning in the second quarter of 2011. At September 30, 2014, the Company has $4,314 of interest on its subordinated debentures accrued for which payment is being deferred. In addition, the Company has accumulated $3,939 in deferred dividends on the Preferred Shares. The Bank’s subsidiary Community First Properties, Inc. suspended the payment of dividends on its preferred stock beginning with the dividend payment due on December 31, 2011. At September 30, 2014, Community First Properties, Inc. has $47 of preferred stock dividends accrued for which payment is being deferred.

RESULTS OF OPERATIONS

Net Income

The Company had net income of $1,824 for the nine months ended September 30, 2014 compared to net income of $883 for the same period in 2013, an increase in net income of $941. Net income available to common shareholders was $644 for the first nine months of 2014 compared to $9 for the same period in 2013.

The Company had net income of $232 for the three months ended September 30, 2014 compared to net income of $290 for the same period in 2013, a decrease in net income of $58. Net loss allocated to common shareholders was $192 for the three months ended September 30, 2014 compared to $5 for the same period in 2013.

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RESULTS OF OPERATIONS (Continued)

Average Balance Sheets, Net Interest Income

Changes in Interest Income and Interest Expense

The following table shows the average daily balances of each principal category of our assets, liabilities and shareholders’ equity and an analysis of net interest income for the nine month periods ended September 30, 2014 and 2013. The table reflects how changes in the volume of interest earning assets and interest-bearing liabilities and changes in interest rates have affected our interest income, interest expense, and net interest income for the periods indicated. Information is provided in each category with respect to changes attributable to (1) changes in volume (changes in volume multiplied by prior rate); (2) changes in rate (changes in rate multiplied by prior volume); and (3) changes in rate/volume (changes in rate multiplied by change in volume). The changes attributable to the combined impact of volume and rate have all been allocated to the changes due to rate.


	September 30, 2014								September 30, 2013								Change
	Average Balance			Interest Rate			Revenue/ Expense		Average Balance			Interest Rate			Revenue/ Expense		Due to Volume (1)			Due to Rate (2) (3)			Total

Gross loans (a and b)	$	265,490			5.19	%	$	10,313	$	296,175			5.45	%	$	12,079	$	(1,251	)	$	(515	)	$	(1,766	)
Taxable securities available for sale		88,301			2.12	%		1,398		64,681			1.81	%		875		319			204			523
Tax exempt securities available for sale		2,665			.11	%		62		4,436			3.32	%		110		(44	)		(4	)		(48	)
Federal funds sold and other		52,405			0.58	%		227		78,331			0.36	%		211		(70	)		86			16


Total interest earning assets		408,861			3.92	%		12,000		443,623			4.00	%		13,275		(1,046	)		(229	)		(1,275	)

Cash and due from banks		3,599								3,590
Other nonearning assets		42,597								45,856
Allowance for loan losses		(6,912	)							(9,521	)


Total assets	$	448,145							$	483,548


Deposits:
NOW & money market investments	$	127,000			0.42	%	$	397	$	113,014			0.54	%	$	453	$	56		$	(112	)	$	(56	)
Savings		26,101			0.10	%		19		22,114			0.11	%		19		4			(4	)		—
Time deposits $100 and over		89,243			0.94	%		625		116,127			1.11	%		968		(224	)		(119	)		(343	)
Other time deposits		105,748			0.79	%		627		131,029			1.08	%		1,061		(205	)		(229	)		(434	)

Total interest-bearing deposits		348,092			0.64	%		1,668		382,284			0.87	%		2,501		(369	)		(464	)		(833	)

Federal Home Loan Bank advances		—			0.00	%		—		5,842			2.47	%		108		(108	)		—			(108	)
Subordinated debentures		23,000			3.44	%		592		23,000			3.46	%		595		—			(3	)		(3	)
Repurchase agreement		—			0.00	%		—		3,769			3.33	%		94		(94	)		—			(94	)
Federal funds purchased and other		—			0.00	%		—		15			0.00	%		0		—			—			—

Total other borrowings		23,000			3.44	%		592		32,626			3.27	%		797		(202	)		(3	)		(205	)
Total interest-bearing liabilities		371,092			0.81	%		2,260		414,910			1.06	%		3,298		(571	)		(467	)		(1,038	)
Noninterest-bearing liabilities		67,287								59,007

Total liabilities		438,379								473,917
Shareholders’ equity		9,766								9,631

Total liabilities and shareholders’ equity	$	448,145							$	483,548


Net interest income							$	9,740							$	9,977	$	(474	)	$	237		$	(237	)


Net interest margin					3.19	%							3.01	%

(a)	Interest income includes fees on loans of $360 and $417 in 2014 and 2013, respectively.

(b)	Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest income.

(1)	Changes in volume multiplied by prior rate.

(2)	Changes in rate multiplied by prior volume.

(3)	Changes in rate multiplied by change in volume.

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RESULTS OF OPERATIONS (Continued)

Net Interest Income

Net interest income for the first nine months of 2014 was $9,740, a decrease of $237, or 2.4% compared to $9,977 for the same period in 2013. The decrease in net interest income is primarily due to decreases in the average balance of earning assets offset in part by decreases in the average balance of time deposits, FHLB advances and the repurchase agreement in addition to decreases in the average rate paid on time deposits.

Despite the decrease in absolute dollars of net interest income, the Bank’s net interest margin improved from 3.01% at September 30, 2013 to 3.19% at September 30, 2014. This improvement is primarily due to a decrease in the average rate paid on interest-bearing liabilities. Beginning in 2013 and continuing through the first nine months of 2014, the Bank had several high-priced interest-bearing liabilities mature, and these funding sources did not have to be replaced due to the Bank’s excess liquidity. The Bank also decreased the rate paid on interest-bearing core deposits. The improvement in net interest margin is further due to the Bank’s efforts to mitigate the effect of weakened loan demand on interest income by investing excess liquidity in available for sale securities and time deposits in other financial institutions.

Total interest income for the first nine months of 2014 was $12,000 a decrease of $1,275 from $13,275 for the same period in 2013. The decrease is primarily due to a decline in loan interest income as a result of the decrease in loan balances. The average balance of loans during the first nine months of 2014 was $265,490, a decrease of $30,685 from $296,175 during the same period in 2013. The decrease in the average balance of loans is due to continued weak loan demand. The decrease in net interest income is further due to a decrease in the average rate earned on loans in the first nine months of 2014 compared to the same period in 2013.

Interest income on taxable securities increased $523 to $1,398 in the first nine months of 2014 compared to $875 in the first nine months of 2013. The increase is primarily due to an increase in the average balance of taxable securities combined with an increase in the average rate earned on taxable securities.

The average balance of federal funds sold and other during the first nine months of 2014 was $52,405, a decrease of $25,926 from $78,331 during the same period in 2013. This decrease is due to excess liquidity being invested in available for sale securities. The average rate earned on federal funds sold and other in the first nine months of 2014 was 0.58% compared to 0.36% for the same period in 2013. The increase in rate is due to the Company’s utilization of excess cash by investing in time deposits in other financial institutions.

Total interest expense was $2,260 in the first nine months of 2014, a decrease of $1,038 from $3,298 in the first nine months of 2013. The decrease in interest expense is largely due to a reduction in the average rate paid on deposits and the average balance of deposits in the first nine months of 2014 compared to the same period in 2013. The decrease is further due to the maturity of FHLB advances and the repurchase agreement in 2013 as well as the shift in deposits from interest-bearing time deposits to noninterest bearing deposits.

Total interest expense on deposits was $1,668 in the first nine months of 2014, a reduction of $833 from $2,501 in the first nine months of 2013. The average rate paid on deposits was 0.64% in the first nine months of 2014 compared to 0.87% for the same period in 2013. The most significant decreases in average rates were on time deposits. The reduction in average rate paid on deposits was the result of continued decreases in market rates in the Bank’s market area as well as some shift in the Bank’s deposit mix from time deposits into NOW and money market accounts. Management believes this shift in deposit mix is due to the current rate environment.

- 62 -

RESULTS OF OPERATIONS (Continued)

Net interest income for the three months ended September 30, 2014 was $3,272, a decrease of $99, or 2.9% compared to $3,371 for the same period in 2013. The decrease in net interest income is primarily due to decreases in the average balance of earning assets offset in part by decreases in the average balance of time deposits in addition to decreases in the average rate paid on time deposits, similar to factors noted above for the first nine months of 2014.

Total interest income for the three months ended September 30, 2014 was $3,997 a decrease of $329 from $4,326 for the same period in 2013. The decrease is primarily due to a decline in loan interest income as a result of the decrease in loan balances, similar to factors noted above for the first nine months of 2014.

Total interest expense was $725 for the three months ended September 30, 2014, a decrease of $230 from $955 for the same period in 2013. The decrease in interest expense is largely due to a reduction in the average rate paid on deposits and the average balance of deposits when compared to the three months ended September 30, 2013.

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RESULTS OF OPERATIONS (Continued)

Provisions for Loan Losses

In the first nine months of 2014, the Bank reversed $800 of the allowance for loan loss as a result of improvements in asset quality and reductions in gross loans. In the first nine months of 2013, the Bank recorded provision for loan loss of $300. The ratio of allowance for loan losses to gross loans was 2.32% at September 30, 2014 compared to 2.94% at December 31, 2013.

Management’s determination of the appropriate level of the provision for loan losses and the adequacy of the allowance for loan losses is based, in part, on an evaluation of specific loans, as well as the consideration of historical loss, which management believes is representative of probable incurred loan losses. Other factors considered by management include the composition of the loan portfolio, economic conditions, results of regulatory examinations, reviews of updated real estate appraisals, and the creditworthiness of the Bank’s borrowers and other qualitative factors.

Nonperforming loans decreased from $27,166 at December 31, 2013 to $15,693 at September 30, 2014. The decrease in nonperforming loans is due to improved credit standing for problem loan relationships, foreclosure activity and some decreases in troubled debt restructurings (“TDRs”). Management has been focused on reducing the Bank’s overall level of problem assets. Elimination of those problem assets often requires foreclosure of problem loans, resulting in charge-offs and the balance of the loan moving to ORE. Once the Bank has control of the collateral, it is then able to undertake efforts to liquidate the assets. The ratio of the allowance to nonperforming loans was 30.85% at September 30, 2014, compared to 29.59% at December 31, 2013. The portion of the allowance attributable to impaired loans was $983 at September 30, 2014, a decrease from $2,446 at December 31, 2013. Total impaired loans totaled $15,206 at September 30, 2014 compared to $26,071 at December 31, 2013.

The portion of the allowance attributable to historical and environmental factors has decreased since December 31, 2013. Management’s evaluation of the allowance for loan losses, in addition to specific loan allocations, is based on volume of non-impaired loans and changes in credit quality and environmental factors. The balance of non-impaired loans decreased during the first nine months of 2014 due to the reduction in gross loans.

Problem loans that are not impaired are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. The Company uses the following definitions for risk ratings:

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RESULTS OF OPERATIONS (Continued)

Impaired loans are evaluated separately from other loans in the Bank’s portfolio. Credit quality information related to impaired loans was presented above and is excluded from the tables below.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of September 30, 2014 and December 31, 2013, based on the most recent analysis performed, the risk category of loans by segment of loans is as follows:


	Pass		Watch		Special Mention		Substandard		Doubtful
September 30, 2014
Real estate construction	$	12,479	$	9,016	$	—	$	840	$	—
1-4 Family residential		85,927		11,285		—		5,020		—
Commercial real estate		82,256		10,225		—		4,536		—
Other real estate loans		5,687		—		—		—		—
Commercial, financial and agricultural		14,006		944		—		157		—
Consumer		5,341		2		—		171		—
Tax exempt		41		—		—		—		—
Other loans		129		—		—		—		—

Total	$	205,866	$	31,472	$	—	$	10,724	$	—


	Pass		Watch		Special Mention		Substandard		Doubtful
December 31, 2013
Real estate construction	$	10,766	$	7,145	$	—	$	857	$	—
1-4 Family residential		92,374		4,249		—		6,542		—
Commercial real estate		78,991		6,828		—		6,388		—
Other real estate loans		2,993		1,688		—		—		—
Commercial, financial and agricultural		20,543		2,154		—		311		—
Consumer		5,292		4		1		165		—
Tax exempt		51		—		—		—		—
Other loans		294		—		—		—		—

Total	$	211,304	$	22,068	$	1	$	14,263	$	—

- 65 -

RESULTS OF OPERATIONS (Continued)

The table below illustrates changes in the AFLL ratio (the ratio, expressed as a percentage, of the allowance for loan losses to total gross loans) over the past five quarters and the changes in related risk metrics over the same periods:


Quarter Ended	September 30, 2014			June 30, 2014			March 31, 2014			December 31, 2013			September 30, 2013
AFLL Ratio		2.32	%		2.39	%		2.51	%		2.94	%		2.94	%
ASC 450 allowance ratio (1)		2.06	%		2.15	%		2.20	%		2.26	%		2.22	%

Specifically impaired loans (ASC 310 component)	$	983		$	981		$	1,234		$	2,446		$	2,609
Historical and environmental (ASC 450-10 component)		5,122			5,325			5,379			5,593			5,754

Total allowance for loan loss	$	6,105		$	6,306		$	6,613		$	8,039		$	8,363


Nonperforming loans to gross loans (2)		7.52	%		7.92	%		7.55	%		9.93	%		9.85	%
Impaired loans to gross loans		5.78	%		6.20	%		7.21	%		9.53	%		9.14	%
Allowance to nonperforming loans ratio		30.85	%		30.15	%		33.27	%		29.59	%		29.83	%
Quarter-to-date net charge-offs to average gross loans (3)		0.08	%		0.00	%		0.33	%		0.02	%		0.23	%

(1)	Historical and environmental component as a percentage of non-impaired loans.

(2)	Nonaccrual loans and loans past due 90 or more days still accruing interest, and troubled debt restructurings still accruing interest as a percentage of gross loans.

(3)	Annualized.

Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following table presents information regarding loans included as nonaccrual and troubled debt restructurings and the gross income that would have been recorded in the nine-month and three-month periods ended September 30, 2014 and 2013 if the loans had been current:


	Nine months ended				Three months ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Nonaccrual interest	$	999	$	3,665	$	324	$	201
Troubled debt restructurings interest		104		121		92		36

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RESULTS OF OPERATIONS (Continued)

Noninterest Income

Total noninterest income for the first nine months of 2014 was $2,050, a decrease of $41, or 2.0% from $2,091 for the same period in 2013. The decrease is due to a decrease in other service charges, commissions and fees and gain on sale of loans, offset by an increase in the gain on sale of securities available for sale.

Other service charges, commissions and fees for the first nine months of 2014 was $14 compared to $68 for the same period in 2013. The decrease in other service charges, commissions and fees is a result of a decrease in income from an equity investment in a development partnership and a decrease in check printer income due to a change in service provider.

The gain on sale of loans for the first nine months of 2014 was $59, a decrease of $16, or 21.3%, from $75 for the same period in 2013. This decrease is due to a decline in demand for mortgage loans.

Gain on sale of securities available for sale for the first nine months of 2014 was $213, a decrease of $31, or 17.0%, from $182 for the same period in 2013. This is due to the Company selling more securities during the first nine months of 2014 than in the same period in 2013.

Total noninterest income for the three months ended September 30, 2014 was $818, an increase of $156, or 23.6%, from $662 for the same period in 2012. The increase is due to an increase in the gain on sale of securities available for sale, similar to factors noted above for the nine month period ended September 30, 2014.

The table below shows noninterest income for the nine-month and three-month periods ended September 30, 2014 and 2013.


	Nine Months Ended September 30,				Three Months Ended September 30,
	2014		2013		2014		2013
Service charge on deposit accounts	$	1,290	$	1,276	$	436	$	444
Gain on sale of loans		59		75		37		26
Gain on sale of securities available for sale		213		182		173		—
Other:
Investment service income		107		111		33		67
Safe deposit box rental		22		21		7		7
Credit life insurance commissions		5		4		3		2
Bank Owned Life Insurance income		194		205		66		67
ATM income		99		96		33		32
Other customer fees		34		41		14		12
Other equity investment income		13		12		5		3
Other service charges, commissions and fees		14		68		11		2

Total noninterest income	$	2,050	$	2,091	$	818	$	662

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RESULTS OF OPERATIONS (Continued)

Noninterest Expense

Noninterest expense for the first nine months of 2014 was $10,766, a decrease of $119, or 1.1% from $10,885 for the same period in 2013. The decrease is primarily due to decreases in occupancy expense, legal fees, regulatory and compliance expense, furniture and equipment expense and audit and accounting fees. The decrease was offset in part by slight increases in salaries and employee benefits, advertising and public relations expense, data processing expense and other real estate expense.

Occupancy expense totaled $606 in the first nine months of 2014, a decrease of $126, or 17.2%, from $732 for the same period in 2013. The decrease is primarily due to a one-time adjustment of deferred rent expense related to a long-term lease on property utilized for one of the Bank’s branch locations. During the first quarter of 2014, the Bank purchased the property from the lessor, terminating the lease. In addition, this purchase eliminated the regular monthly lease payment, which created ongoing savings.

Legal fees totaled $51 in the first nine months of 2014, a decrease of $102, or 66.7%, from $153 for the same period in 2013. The decrease is primarily due to the Company being involved in fewer activities requiring legal consultation in 2014 compared to 2013.

Regulatory and compliance expense totaled $797 in the first nine months of 2014, a decrease of $80, or 9.1%, from $877 for the same period in 2013. The decrease is primarily due to a reduction in the Bank’s FDIC insurance expense premium as higher equity levels at the Bank have resulted in lower assessments.

Furniture and equipment expense totaled $236 in the first nine months of 2014, a decrease of $69, or 22.6%, from $305 for the same period in 2013. The decrease is primarily due to a large amount of our furniture, fixtures and equipment reaching full depreciation during 2013.

Audit and accounting fees totaled $248 in the first nine months of 2014, a decrease of $59, or 19.2%, from $307 for the same period in 2013. The decrease is primarily due to a reduction in the use of outsourced internal audit services.

Salaries and employee benefits totaled $4,980 in the first nine months of 2014, an increase of $91, or 1.9%, from $4,889 for the same period in 2013. This increase is due to cost of living salary adjustments and an increase in the Bank’s portion of employee medical insurance costs.

Advertising and public relations expense totaled $143 in the first nine months of 2014, an increase of $75, or 110.3%, from $68 for the same period in 2013. This increase is primarily due to increased support of the community through donations and some additional marketing efforts during 2014.

Data processing expense totaled $860 in the first nine months of 2014, an increase of $66, or 8.3%, from $794 for the same period in 2013. This increase is primarily due to an expanded relationship with our payroll processor, ADP, which began in late 2013. Through this expanded relationship, ADP now provides electronic human resources and benefits administration services in addition to payroll processing services.

Other real estate expense totaled $827 for the first nine months of 2014, an increase of $59, or 7.7%, from $768 for the same period in 2013. This is primarily due to the increase of valuation losses based on reappraisals.

Noninterest expense for the three months ended September 30, 2014 was $3,858, an increase of $115, or 3.1% from $3,743 for the same period in 2013. The increase is primarily due to increases in salaries and employee benefits and other real estate expense, similar to the factors noted above for the nine-month period ended September 30, 2014.

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RESULTS OF OPERATIONS (Continued)

The table below shows noninterest expense for the nine-month and three-month periods ended September 30, 2014 and 2013:


	Nine Months Ended September 30,				Three Months Ended September 30,
	2014		2013		2014		2013
Salaries and employee benefits	$	4,980	$	4,889	$	1,682	$	1,632
Regulatory and compliance		797		877		265		279
Occupancy		606		732		234		241
Furniture and equipment		236		305		82		101
Data processing fees		860		794		292		272
Advertising and public relations		143		68		41		18
Operational expense		307		315		101		113
Other real estate expense		827		768		449		399
Other:
Loan expense		31		43		7		28
Legal		51		153		26		38
Audit and accounting fees		248		307		92		83
Postage and freight		220		186		75		61
Director expense		187		168		63		57
ATM expense		489		459		163		160
Amortization of intangible asset		103		103		34		34
Insurance expense		294		292		98		97
Printing		55		58		19		17
Other employee expenses		72		60		21		23
Dues & memberships		35		33		11		9
Miscellaneous charge-off		—		5		—		5
Miscellaneous taxes and fees		30		49		9		17
Federal Reserve and other bank charges		28		33		7		10
Loss on other investment		5		—		5		—
Other		162		188		82		49

Total noninterest expense	$	10,766	$	10,885	$	3,858	$	3,743

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RESULTS OF OPERATIONS (Continued)

Income Taxes

During 2010, the Company established a valuation allowance against all of its deferred tax assets and has maintained that valuation allowance through the first nine months of 2014.

Deferred income taxes, including net operating losses, arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arose, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we begin with historical results and changes in accounting policies and incorporate assumptions including the amount of future pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.

As of September 30, 2014, we have federal and state income tax net operating loss (NOL) carryforwards of $24,553 and $5,2598, which will expire at various dates from 2020 through 2032. Such NOL carryforwards expire as follows:


	Federal		State
2020-2024	$	—	$	18,583
2025-2029		—		34,015
2030-2032		24,553		—

- 70 -

LIQUIDITY AND CAPITAL RESOURCES

Liquidity refers to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal needs and provide for operating expenses. As summarized in the Consolidated Statements of Cash Flows, the Bank’s main source of cash flow is from receiving deposits from its customers and, to a lesser extent, repayment of loan principal and interest income on loans and investments, FHLB advances, the possible sale or pledge of investment securities, and federal funds purchased.

The Bank’s primary uses of cash are lending to its borrowers and investing in securities and short-term interest-earning assets. During 2013, regular loan repayments outpaced loan demand, resulting in a decrease in gross loans and contributing to the increase in cash and cash equivalents. During the first nine months of 2014, this trend continued and management began utilizing some of the available liquidity to invest in securities available for sale and time deposits in other financial institutions. Although management expects loan demand to modestly improve through the remainder of 2014, which should slow or stop the decline in gross loans, management anticipates that there will not be significant growth in loans until there are indicators of significant improvements in both the local and national economy, leading customers to begin spending more and resulting in increased demand. In addition, management’s efforts to reduce nonperforming loans could result in additional decreases in gross loans.

On September 20, 2011, the Bank consented to the issuance of the Consent Order by the FDIC. Under the terms of the Consent Order, the Bank agreed to, among other things, take the following actions:

• Establish, within 30 days after September 20, 2011, a board committee to oversee the Bank’s compliance with the Consent Order;

• Make, within 30 days after September 20, 2011, provisions to its allowance for loan and lease losses (the “ALLL”) in an amount equal to those loans required to be charged off by the Consent Order, and thereafter maintain a reasonable ALLL and quarterly have its board of directors review the adequacy of the ALLL;

• Review, within 30 days after September 20, 2011, the Bank’s Consolidated Reports on Condition and Income filed with the FDIC after December 31, 2010, and amend such reports if necessary to accurately reflect the Bank’s financial condition as of such dates;

• Use, within 30 days after September 20, 2011, Financial Accounting Standards Board Accounting Standards Codification Numbers 450 and 310 for determining the Bank’s ALLL reserve adequacy;

• Retain, within 60 days after September 20, 2011, a bank consultant to develop, within 90 days after September 20, 2011, a written analysis and assessment of the Bank’s management and staffing needs for the purpose of providing qualified management;

• Formulate and submit to the FDIC and the Department, within 60 days after September 20, 2011, a written policy covering expense reimbursement to the Bank’s directors, officers and employees, and while the Consent Order is in effect have the Board conduct monthly reviews of all expenses submitted for customer entertainment, business development and/or any other expense submitted by the Bank’s officers and directors;

• Prepare and submit, within 120 days after September 20, 2011, to its supervisory authorities a budget and profit plan for calendar year 2012;

• On or before December 31, 2011, achieve, and thereafter, maintain the Bank’s Tier 1 leverage capital ratio, Tier 1 risk-based capital ratio and Total risk-based capital ratios equal to or greater than 8.5%, 10.0% and 12.0%, respectively;

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LIQUIDITY AND CAPITAL RESOURCES (Continued)

• If the Bank’s capital ratios fall below the minimum levels set out in the previous bullet as of the date of any of the Bank’s Reports on Condition and Income, submit within 30 days of receiving a request to do so, to the FDIC and the Department a capital plan to increase the Bank’s capital to levels above these minimum levels; then initiate action within 30 days after the FDIC and the Department respond to the plan;

• Refrain from paying cash dividends to the Company without the prior written consent of the FDIC and the Department;

• Increase, within 30 days after September 20, 2011, the participation of the Bank’s board of directors in the affairs of the Bank by assuming full responsibility for the approval of the Bank’s policies and objectives and for the supervision of management, including all Bank activities;

• Develop, within 120 days after September 20, 2011, a strategic plan that addresses issues including plans for sustaining adequate liquidity, strategies for pricing policies and asset/liability management, goals for reducing problem loans, plans for attracting and retaining qualified individuals to fill vacancies in the lending and accounting functions, financial goals and formulation of a mission statement;

• Not extend, directly or indirectly, any additional credit to or for the benefit of any borrower whose extension of credit is classified “Doubtful” and/or “Substandard” by the FDIC or the Department unless the Bank’s board of directors has signed a detailed written statement giving reasons why the failure to extend such credit would be detrimental to the Bank;

• Take, within 30 days after September 20, 2011, specific actions to eliminate all assets classified as “Loss” as of March 14, 2011, and, within 60 days of September 20, 2011 submit a written plan to reduce the level of assets classified “Doubtful” or “Substandard” with a balance in excess of $1,000,000, in each case as of March 14, 2011;

• Refrain from extending any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified in a certain specified manner and is uncollected;

• Take, within 120 days after September 20, 2011, specified actions to reduce concentrations of construction and development loans in the Bank’s portfolio to not more than 100% of the Bank’s Tier 1 capital and commercial real estate loans (other than owner-occupied commercial real estate loans) to not more than 300% of the Bank’s Tier 1 capital;

• Take, within 60 days after September 20, 2011, specified action for the reduction and collection of delinquent loans;

• Eliminate, within 30 days after September 20, 2011, and/or correct all applicable violations of law and regulation as discussed in the Bank’s most recent exam report and implement procedures to ensure future compliance with all applicable laws and regulations;

• Refrain from entering into any new line of business without the prior written consent of the FDIC while the Consent Order is in effect;

• Establish, within 30 days after September 20, 2011, a loan review committee (at least two-thirds of the members of which shall be independent directors) to periodically review the Bank’s loan portfolio and identify and categorize problem credits;

• Review, within 90 days after September 20, 2011, and annually thereafter, the Bank’s loan policy and procedures for effectiveness; and

- 72 -

LIQUIDITY AND CAPITAL RESOURCES (Continued)

• Furnish, within 30 days following the end of each calendar quarter, quarterly progress reports to the banking regulators.

On March 14, 2013, the Bank entered into a written agreement with the Tennessee Department of Financial Institutions (the “Department”), the terms of which are substantially the same as those of the Consent Order, including as to required minimum levels of capital the Bank must maintain.

As of September 30, 2014, we believe that we were in compliance with all provisions of the Consent Order that were required to be completed by September 30, 2014, including the minimum capital ratios required by the Consent Order. All plans required by the Consent Order have been prepared and submitted to the FDIC and have been accepted by the FDIC.

As a result of entering into the Consent Order, the Bank was subject to additional limitations on its operations including accepting, rolling over, or renewing brokered deposits, which could adversely affect the Bank’s liquidity and/or operating results. The Bank was also limited, as a result of its condition, in its ability to pay more than de minimis severance payments to its employees and was required to receive the consent of the FDIC and the Department to appoint new officers or directors. By virtue of entering into the Consent Order, the Bank was also limited from paying deposit rates above national rate caps published weekly by the FDIC, unless the Bank was determined to be operating in a high-rate market area. On December 1, 2011, the Bank received notification from the FDIC that it was operating in a high-rate environment, which allowed the Bank to pay rates higher than the national rate caps, but continued to limit the Bank to rates that do not exceed the prevailing rate in the Bank’s market by more than 75 basis points.

As a result of improvements in the Bank’s financial condition and results of operations and the Bank’s compliance with the terms thereof, the written agreement that the Bank had entered into with the Department was terminated effective October 29, 2014. In addition, the FDIC has notified the Bank that it intends to terminate the Consent Order.

•

Maintain the following minimum regulatory capital ratios: Leverage Capital 8.0%; Tier I Risk Based Capital 10.00%; and Total Risk Based Capital 12.00%.

•

Receive prior written consent of each of the FDIC and the Department before the Bank declares or pays any cash dividends.

•

Develop a written profit plan to improve the Bank’s earnings.

On April 19, 2012, the Company entered into the Written Agreement with the FRB. The Written Agreement replaces the board resolution adopted by the Board of Directors on January 18, 2011. Under the terms of the Written Agreement, the Company has agreed to, among other things, take the following actions:

•

- 73 -

LIQUIDITY AND CAPITAL RESOURCES (Continued)

•

Submit within 60 days of April 19, 2012 a written statement of the Company’s planned sources and uses of cash for debt service, operating expenses, and other purposes for 2012;

•

Provide notice in compliance with applicable federal law and regulations, of any changes in directors or senior executive officer of the Company;

•

Comply with applicable federal law and regulations restricting indemnification and severance payments; and

•

In addition, under the terms of the Written Agreement, the Company has agreed to, among other things, the following actions:

•

Refrain from declaring or paying any dividends without prior approval;

•

Not directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without prior approval;

•

Not (along with the Company’s non-bank subsidiary) make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior approval;

•

Not (along with the Company’s non-bank subsidiary) directly or indirectly incur, increase, or guarantee any debt without prior approval; and

•

Not directly or indirectly purchase or redeem any shares of its stock without prior approval.

As of September 30, 2014 all of the plans required to be submitted to the FRB have been submitted and approved. Management believes that the Company is in compliance with the requirements of the Written Agreement as of September 30, 2014.

The Company’s principal source of liquidity for dividend payments is dividends received from the Bank. Although the Bank was profitable in each of 2012 and 2013, and the first nine months of 2014, the Bank was prohibited under the terms of the Consent Order with the FDIC and the written agreement with the Department, and is currently prohibited under the terms of the informal agreement entered into by the Bank (and, until it is formally terminated by the FDIC, the Consent Order), from paying dividends to the Company without prior approval from the FDIC and the Department.

- 74 -

LIQUIDITY AND CAPITAL RESOURCES (Continued)

At the request of the FRB, the board of directors of the Company, on January 18, 2011, adopted a board resolution agreeing that the Company will not incur additional debt, pay common or preferred dividends, or redeem treasury stock without approval from the FRB. The terms of the Written Agreement, which replaced the board resolution, among other things, similarly prohibit the Company from incurring debt, paying dividends or interest or redeeming shares of its capital stock without the approval of the FRB. The Company requested permission to make dividend payments on the Preferred Shares and interest payments on its subordinated debt that were scheduled for the first quarter of 2011. The FRB granted permission to pay the preferred dividends that were due on February 15, 2011, but denied permission to make interest payments on the Company’s subordinated debt. As a result of the FRB’s decision, the Company was required to begin the deferral of interest payments on each of its three issuances of subordinated debentures during the first quarter of 2011. The Company has the right to defer the payment of interest on the subordinated debentures at any time, for a period not to exceed 20 consecutive quarters. During the period in which it is deferring the payment of interest on its subordinated debentures, the Company may not pay any dividends on its common stock or preferred stock, including the Preferred Shares, and the Company’s subsidiary may not pay dividends on the subsidiary’s common or preferred stock owned by entities other than the Company and its subsidiaries. Accordingly, the Company was required to suspend dividend payments on the Preferred Shares beginning in the second quarter of 2011. At September 30, 2014, the Company has $4,314 of interest accrued on its subordinated debt for which payment is being deferred. In addition, the Company has accumulated $3,939 in deferred dividends on the Preferred Shares as of September 30, 2014. The Company’s subsidiary Community First Properties, Inc. suspended payment of its dividends on its preferred stock beginning with the dividend payment due December 31, 2011. At September 30, 2014, Community First Properties, Inc. has $47 of preferred stock dividends accrued for which payment is being deferred. Since the Company has deferred payment of dividends on the Preferred Shares for more than six quarters, the holders of the Preferred Shares now have the right to elect up to two directors to the Company’s board of directors. On April 14, 2014, the U.S. Treasury sold all of the shares of Preferred Stock it owned in a modified Dutch auction. The Company received none of the proceeds from the sale by the U.S. Treasury of the Preferred Shares.

Although the Bank was profitable in each of 2012 and 2013, and the first nine months of 2014, the Bank is prohibited under the terms of the informal agreement with the FDIC and the Department (and, until it is terminated, the Consent Order) from paying dividends to the Company without prior approval from the FDIC and the Department. The Company is also restricted in the types and amounts of dividends it can pay by the terms of the Preferred Shares and by the terms of the Written Agreement, which prohibits the Company from paying interest or dividends (including interest on the Company’s subordinated debentures and dividends on the Company’s Preferred Shares) without the FRB’s prior approval. The Company is currently considering the options available to it to increase capital levels at the Bank and the Company, including strengthening the Bank’s core earnings, the sale of common or preferred stock of the Company, the issuance or incurrence by the Company of debt, or alternatively the sale of the Company. Any sale of the Company’s common stock would likely be at a price that would result in substantial dilution in ownership for the Company’s existing common shareholders and could result in a change in control of the Company. This change in control would likely qualify as a change in control under the IRS’s regulations related to the preservation of net operating loss carryforwards causing the Company to likely forfeit this benefit. The loss of this benefit would not cause the Company to recognize a cash charge, but rather would eliminate the benefit that the Company would otherwise be able to utilize to offset future year’s profits, if any, to reduce the Company’s tax liability.

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LIQUIDITY AND CAPITAL RESOURCES (Continued)

In late 2010, the Basel Committee on Banking Supervision issued “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”), a new capital framework for banks and bank holding companies. Basel III will impose a stricter definition of capital, with more focus on common equity for those banks to which it is applicable. In July 2013, the federal bank regulatory agencies, including the Federal Reserve and the FDIC, adopted final rules that would revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to make them consistent with the agreements that were reached by the Basel Committee on Banking Supervision in Basel III and certain provisions of the Dodd-Frank Act. The final rules apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (“banking organizations”). Among other things, the rules establish a new common equity Tier 1 minimum capital requirement of 4.5% and a minimum Tier 1 capital requirement of 6% (up from the currently required 4%) and assign higher risk weightings (150%) to exposures that are more than 90 days past due or are on nonaccrual status. The rules, which become effective as to the Bank on January 1, 2015, limit a banking organization’s capital distributions and certain discretionary bonus payments as well as a banking organization’s ability to repurchase its own shares if the banking organization does not hold a “capital conservation buffer” consisting of an additional 2.5% of Tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. As a result, when fully phased in, the capital requirements, inclusive of the capital conservation buffer, would be a Tier 1 leverage ratio of 4%, a Tier 1 common risk-based equity capital ratio of 7%, a Tier 1 equity risk-based capital ratio of 8.5% and a total risk-based capital ratio of 10.5%. Under the new rules, Tier 1 capital will generally consist of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments and non-cumulative preferred stock, subject to certain eligibility standards, less specified intangible assets and other regulatory deductions. The Company’s Preferred Shares and trust preferred securities will continue to be considered Tier 1 capital under grandfathering provisions included in the new rules. The new rules also introduce a new regulatory capital ratio, common equity Tier 1 capital, which will generally consist of common stock (plus related surplus) and retained earnings plus limited amounts of minority interest in the form of common stock, less specified intangible assets and other regulatory deductions. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt out of a requirement to include unrealized gains and losses in Accumulated Other Comprehensive Income. Because the Company’s total consolidated assets are below $500 million, these new capital rules will not be applicable to the Company on a consolidated basis. The Bank, though, will be subject to these rules once they become effective. Should the Company’s total consolidated assets increase to more than $500 million, the Company would then be subject to these new rules.

At September 30, 2014, the Company had unfunded loan commitments outstanding of $20,785 and unfunded letters of credit of $1,464. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If the Company needed to fund these outstanding commitments, it has the ability to liquidate federal funds sold or securities available for sale or on a short-term basis to borrow and purchase federal funds from other financial institutions. Additionally, the Company could sell participations in these or other loans to correspondent banks.

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LIQUIDITY AND CAPITAL RESOURCES (Continued)

At September 30, 2014 and December 31, 2013, the Bank’s and the Company’s risk-based capital ratios and the minimums to be considered “well-capitalized” under prompt corrective action guidelines and the ratios required by the Consent Order were as follows:


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Applicable Regulatory Provisions					Required by terms of Consent Order with FDIC
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2014
Total Capital to risk weighted assets
Community First Bank & Trust	$	43,389		15.84	%	$	21,920		8.00	%	$	27,400		10.00	%	$	32,880		12.00	%
Consolidated		26,319		9.60	%		21,944		8.00	%		27,429		10.00	%		N/A		N/A

Tier 1 Capital to risk weighted assets
Community First Bank & Trust	$	39,931		14.57	%	$	10,960		4.00	%	$	16,440		6.00	%	$	27,400		10.00	%
Consolidated		15,238		5.56	%		10,972		4.00	%		16,458		6.00	%		N/A		N/A

Tier 1 Capital to average assets
Community First Bank & Trust	$	39,931		9.06	%	$	17,622		4.00	%	$	22,027		5.00	%	$	37,447		8.50	%
Consolidated		15,238		3.44	%		17,717		4.00	%		N/A		N/A			N/A		N/A


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions					Required by terms of Consent Order with FDIC
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2013
Total Capital to risk weighted assets
Community First Bank & Trust	$	41,250		14.70	%	$	22,445		8.00	%	$	28,056		10.00	%	$	33,667		12.00	%
Consolidated		24,905		8.87	%		22,474		8.00	%		28,092		10.00	%		N/A		N/A

Tier 1 Capital to risk weighted assets
Community First Bank & Trust	$	37,687		13.43	%	$	11,222		4.00	%	$	16,833		6.00	%	$	28,056		10.00	%
Consolidated		14,225		5.06	%		11,237		4.00	%		16,855		6.00	%		N/A		N/A

Tier 1 Capital to average assets
Community First Bank & Trust	$	37,687		8.41	%	$	17,917		4.00	%	$	22,396		5.00	%	$	38,073		8.50	%
Consolidated		14,225		3.16	%		18,008		4.00	%		N/A		N/A			N/A		N/A

As of September 30, 2014, the Bank was considered “well-capitalized”; however, the Bank was considered “adequately capitalized” due to the existence of the Consent Order. Following the termination of the Consent Order, the Bank’s capitalization status will be determined by its actual capital levels and ratios. The Company’s capital ratios are below what is required to be considered “adequately capitalized”. Two of the three capital ratios were considered “adequate”; however, the Tier 1 Capital to average assets ratio was below the requirements to be considered “adequate”, which prohibits the Company from being considered “adequately capitalized”.

Management continually monitors the Bank’s sources and uses of cash in order to plan for future liquidity needs. The Bank’s most potentially volatile funding liabilities are national market time deposits. The Bank has reduced its reliance on these funding sources during the first nine months of 2014 and it continues to do so as part of management’s efforts to utilize the Bank’s excess liquidity. National market CDs totaled $9,116 at September 30, 2014 compared to $18,429 at December 31, 2013.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Management uses a gap simulation model that takes cash flows into consideration. These include mortgage-backed securities, loan prepayments, and expected calls on securities. Non-maturing balances such as money markets, savings, and negotiable order of withdrawal (“NOW”) accounts have no contractual or stated maturities. A challenge in the rate risk analysis is to determine the impact of the non-maturing balances on the net interest margin as the interest rates change. Because these balances do not “mature” it is difficult to know how they will reprice as rates change. It is possible to glean some understanding by reviewing our pricing history on these categories relative to interest rates. Using the interest rate history from the Asset Liability Management software database spanning up to 20 quarters of data, we can derive the relationship between interest rates changes and the offering rates themselves. The analysis uses the T-Bill rate as an indicator of rate changes. The gap analysis uses beta factors to spread balances to reflect repricing speed. In the gap analysis the model considers deposit rate movements to determine what percentage of interest-bearing deposits that is actually repriceable within a year. Our cumulative one-year gap position at September 30, 2014, was 0.66% of total assets. Our policy states that our one-year cumulative gap should not exceed 15% of total assets.

At September 30, 2014, $150,383 of $435,863 of interest earning assets will reprice or mature within one year. Loans maturing or repricing within one year totaled $101,037, or 39.3% of total loans, including loans held for sale at September 30, 2014. As of September 30, 2014, we had $153,628 in time deposits maturing or repricing within one year.

Gap analysis only shows the dollar volume of assets and liabilities that mature or reprice. It does not provide information on how frequently they will reprice. To more accurately capture the Company’s interest rate risk, we measure the actual effects the repricing opportunities have on earnings through income simulation models such as rate shocks of economic value of equity and rate shock interest income simulations.

To truly evaluate the impact of rate change on income, we believe the rate shock simulation of interest income is the best technique because variables are changed for the various rate conditions. The interest income change in each category of earning assets and liabilities is calculated as rates move up and down. In addition, the prepayment speeds and repricing speeds are changed. Rate shock is a method for stress testing the net interest margin over the next four quarters under several rate change levels. These levels span four 100 basis point increments up and down from the current interest rate. Our policy guideline is that the maximum percentage change in net interest income cannot exceed plus or minus 15% on a 200 basis point interest rate change.

Although interest rates are currently very low, the Company believes a -200 basis point rate shock is an effective and realistic test since interest rates on many of the Company’s loans still have the ability to decline 200 basis points. For those loans that have floors above the -200 basis point rate shock, the interest rate would be at the floor rate. All deposit account rates would likely fall to their floors under the -200 basis point rate shock as well. This simulation analysis assumes that NOW and savings accounts have a lower correlation to changes in market interest rates than do loans, securities, and time deposits.


September 30, 2014	+200 bps			+100 bps			-100 bps			-200 bps
Basis Point Change	+200 bps			+100 bps			-100 bps			-200 bps
Increase (decrease) in net interest income		(8.38	%)		(3.06	%)		(0.64	%)		(6.67	%)


December 31, 2013	+200 bps			+100 bps			-100 bps			-200 bps
Basis Point Change	+200 bps			+100 bps			-100 bps			-200 bps
Increase (decrease) in net interest income		(2.19	)%		(1.14	%)		0.27	%		(7.56	%)

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)

Our Economic Value of Equity simulation measures our long-term interest rate risk. The economic value is the difference between the market value of the assets and the liabilities and, technically, it is our liquidation.

The technique is to apply rate changes and compute the value. The slope of the change between shock levels is a measure of the volatility of value risk. The slope is called duration. The greater the slope, the greater the impact or rate change on our long-term performance. Our policy guideline is that the maximum percentage change on economic value of equity cannot exceed plus or minus 10% on 100bp change and 20% on 200bp change. The following illustrates our equity at risk in the economic value of equity model.


September 30, 2014	+200 bps			+100 bps			-100 bps			-200 bps
Basis Point Change	+200 bps			+100 bps			-100 bps			-200 bps
Increase (decrease) in equity at risk		(13.98	%)		(6.17	%)		3.03	%		0.09	%


December 31, 2013	+200 bps			+100 bps			-100 bps			-200 bps
Basis Point Change	+200 bps			+100 bps			-100 bps			-200 bps
Increase (decrease) in equity at risk		(10.75	%)		(5.14	%)		3.88	%		1.63	%

One of management’s objectives in managing our balance sheet for interest rate sensitivity is to reduce volatility in the net interest margin by matching, as closely as possible, the timing of the repricing of its interest rate sensitive assets with interest rate sensitive liabilities.

ITEM 4. CONTROLS AND PROCEDURES

The Company, with the participation of its management, including the Company’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Report. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

There were no changes in the Company’s internal control over financial reporting that occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 1A. RISK FACTORS

There have been no material changes in our “Risk Factors” as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

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

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Because the Company is currently deferring the payment of interest on its outstanding subordinated debentures, the Company is not currently permitted to pay dividends on its outstanding shares of Senior Preferred or Warrant Preferred stock originally issued to the U.S. Treasury pursuant to the CPP. The Company has not paid these dividends since the dividend payment on February 15, 2011. The total aggregate amount of dividends due but unpaid on the Senior Preferred Shares and Warrant Preferred Shares as of the date of this report is $3,939.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS


Exhibit Number		Description

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				Community First, Inc. (Registrant)

November 12, 2014				/s/ Louis E. Holloway
(Date)				Louis E. Holloway, President and Chief Executive Officer

November 12, 2014				/s/ Jon Thompson
(Date)				Jon Thompson, Chief Financial Officer

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