CAPSTAR FINANCIAL HOLDINGS, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

The following is a discussion of our financial condition at September 30, 2022
and December 31, 2021 and our results of operations for the three and nine
months ended September 30, 2022 and 2021. The purpose of this discussion is to
focus on information about our financial condition and results of operations
which is not otherwise apparent from the consolidated financial statements. The
following discussion and analysis should be read along with our consolidated
financial statements and the related notes included elsewhere in this Report and
our 2021 10-K. Annualized results for interim periods may not be indicative of
results for the full year or future periods.

The following discussion and analysis pertains to our historical results on a
consolidated basis. However, because we conduct all of our material business
operations through our wholly-owned subsidiary, CapStar Bank, the following
discussion and analysis relates to activities primarily conducted at the
subsidiary level.

All dollar amounts in the tables in this section are in thousands of dollars,
except share or per share data or when otherwise specifically noted.

Overview

The third quarter of 2022 resulted in $0.37 diluted net income per share of
common stock, a decrease of 37.3% compared to the third quarter of 2021.
Annualized return on average assets was 1.01% for the third quarter of 2022
compared to 1.64% for the same period in 2021.


For the nine months ended September 30, 2022, diluted net income per share of
common stock was $1.30, a decrease of 20.2% compared to the same period in 2021.
Annualized return on average assets was 1.22% for the nine months ended
September 30, 2022 compared to 1.56% for the same period in 2021.

At September 30, 2022, loans held for investment increased to $2.29 billion, as
compared to $1.97 billion at December 31, 2021. Included within the increase for
the third quarter was $25.6 million of Tri-Net loans transferred from loans held
for sale to loans held for investment. Total deposits decreased to $2.63 billion
at September 30, 2022 from $2.68 billion at December 31, 2021.

As of September 30, 2022, the outstanding balance of loans originated under the
SBA's Paycheck Protection Program ("PPP") totaled approximately $0.7 million and
was included in commercial and industrial loans.

As the global COVID pandemic and its variants continue, we will continue to
assess the impact on our market. While it is uncertain losses will materialize
in the future, we continue to proactively work with our clients and evaluate the
potential impact of the pandemic on them and us. Furthermore, we currently do
not anticipate a significant adverse liquidity impact related to the COVID-19
pandemic. See further discussion regarding the Company's management of liquidity
risk in the subsequent section titled 'Liquidity'. Despite the uncertainty the
Company is well positioned to continue delivering on its strategic initiatives
in a responsible manner by prioritizing things such as business continuity,
liquidity management and maintaining an adequate allowance for loan losses.

Our primary revenue sources are net interest income and fees from various
financial services provided to customers. Net interest income is the difference
between interest income earned on loans, investment securities and other
interest earning assets less interest expense on deposit accounts and other
interest bearing liabilities. Loan volume and interest rates earned on those
loans are critical to overall profitability. Similarly, deposit volume is
crucial to funding loans and rates paid on deposits directly impact
profitability. Business volumes are influenced by competition, new business
acquisition efforts and economic factors including market interest rates,
business spending and consumer confidence.

Net interest income increased $2.6 million, or 11.3%, for the three months ended
September 30, 2022, compared to the same period in 2021 and increased $3.0
million, or 4.3% for the nine months ended September 30, 2022 compared to the
same period in 2021. Net interest margin increased to 3.50% for the three months
ended September 30, 2022, compared with 3.12% for the same period of 2021 and
increased to 3.29% for the nine months ended September 30, 2022 compared to
3.17% for the comparable period of 2021. The increases primarily resulted from
continued increases in interest rates and the positive mix shift in average
earning assets.

The three months ended September 30, 2022 yielded a $0.9 million provision
compared to no provision being recorded for the comparable period of 2021. The
increase in provision was primarily attributable to strong loan growth and an
increase in qualitative factors.

Total noninterest income for the third quarter of 2022 decreased $8.4 million,
or 71.9%, compared with the same period in 2021, and comprised 11% of total
revenues, defined as net interest income plus noninterest income. For the nine
months ended September 30, 2022, total noninterest income decreased $13.3
million, or 42.2%, compared to the same period in 2021, and comprised 20% of
total revenues for the nine months ended September 30, 2022. Decreases across
comparable periods were primarily attributable to declines in mortgage and
Tri-Net division revenues as the recent rapid rise in interest rates has
decreased demand.

Total noninterest expense for the three months ended September 30, 2022
decreased $0.4 million, or 2.4%, compared to the same period in 2021, and
decreased $2.1 million, or 3.9%, for the nine months ended September 30, 2022
when compared to 2021. The decreases were primarily driven by lower incentive
expense included within salaries and employee benefits offset by $2.2 million in
operational losses. Our efficiency ratio for the three months ended September
30, 2022 was 62.21% compared to 53.06% for the same period in 2021. For the nine
months ended September 30, 2022 our efficiency ratio was 59.01% compared to
55.01% for the same period in 2021.

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Common equity tier 1 capital to risk weighted assets, summarized in Note 11 of
the consolidated financial statements, is a useful measure in evaluating the
quality and adequacy of capital. Our consolidated ratio of common equity tier 1
capital to risk weighted assets was 12.70% as of September 30, 2022, compared
with 14.11% at December 31, 2021.


The following sections provide more details on subjects presented in this
overview.


(a)
Results of Operations

The following is a summary of our results of operations:

                                                     2022 - 2021                                   2022 - 2021
                         Three Months Ended            Percent           Nine Months Ended           Percent
                            September 30,             Increase             September 30,             Increase
                          2022          2021         (Decrease)          2022          2021         (Decrease)
Interest income        $   30,454     $ 24,690                23.3 %   $  79,728     $ 73,800                8.0 %
Interest expense            4,901        1,726               184.0 %       8,595        5,622               52.9 %
Net interest income        25,553       22,964                11.3 %      71,133       68,178                4.3 %
Provision for loan
losses                        867            -               100.0 %         926         (415 )           -323.1 %
Net interest income
after provision for
loan losses                24,686       22,964                 7.5 %      70,207       68,593                2.4 %
Noninterest income          3,272       11,651               -71.9 %      18,237       31,548              -42.2 %
Noninterest expense        17,931       18,366                -2.4 %      52,740       54,859               -3.9 %
Net income before
income taxes               10,027       16,249               -38.3 %      35,704       45,282              -21.2 %
Income tax expense          1,988        3,147               -36.8 %       7,018        9,075              -22.7 %
Net income             $    8,039     $ 13,102               -38.6 %   $  28,686     $ 36,207              -20.8 %

Basic net income per
share of common
stock                  $     0.37     $   0.59               -37.3 %   $    1.30     $   1.64              -20.7 %
Diluted net income
per share of common
stock                  $     0.37     $   0.59               -37.3 %   $    1.30     $   1.63              -20.2 %



Annualized return on average assets and annualized return on average
shareholders' equity were 1.01% and 8.76%, respectively, for the third quarter
of 2022, compared with 1.64% and 14.13%, respectively, for the same period in
2021.

Annualized return on average assets and annualized return on average
shareholders' equity were 1.22% and 10.41%, respectively, for the nine months
ended September 30, 2022, compared with 1.56% and 13.51%, respectively, for the
same period in 2021.

Net Interest Income

The largest component of our net income is net interest income - the difference
between the income earned on interest-earning assets and the interest paid on
deposits and borrowed funds used to support our assets. Net interest income
divided by total average interest-earning assets represents our net interest
margin. The major factors that affect net interest income and net interest
margin are changes in volumes, the yield on interest-earning assets and the cost
of interest-bearing liabilities. Our margin can also be affected by economic
conditions, the competitive environment, loan demand and deposit flow. Our
ability to respond to changes in these factors by using effective
asset-liability management techniques is critical to maintaining the stability
of the net interest margin and our net interest income.

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The following tables set forth the amount of our average balances, interest
income or interest expense for each category of interest-earning assets and
interest-bearing liabilities and the average interest rate for interest-earning
assets and interest-bearing liabilities, net interest spread and net interest
margin for the three and nine month periods ended September 30, 2022 and 2021:

                                                    For the Three Months Ended September 30,
                                               2022                                           2021
                              Average         Interest       Average         Average         Interest       Average
                            Outstanding       Income/         Yield/       Outstanding       Income/         Yield/
                              Balance         Expense          Rate          Balance         Expense          Rate
Interest-Earning Assets
Loans (1)                   $  2,241,355     $   26,128           4.62 %   $  1,884,935     $   20,942           4.41 %
Loans held for sale               94,811          1,207           5.05 %        173,402          1,408           3.22 %
Securities:
Taxable investment
securities (2)                   396,358          2,181           2.20 %        455,583          1,816           1.59 %
Investment securities
exempt from
  federal income tax (3)          54,575            314           2.92 %         60,294            344           2.90 %
Total securities                 450,933          2,495           2.29 %        515,877          2,160           1.75 %
Cash balances in other
banks                            120,624            617           2.03 %        337,011            171           0.20 %
Funds sold                           755              7           3.65 %         19,909              9           0.18 %
Total interest-earning
assets                         2,908,478         30,454           4.17 %      2,931,134         24,690           3.35 %
Noninterest-earning
assets                           238,363                                        240,048
Total assets                $  3,146,841                                   $  3,171,182
Interest-Bearing
Liabilities
Interest-bearing
deposits:
Interest-bearing
transaction accounts        $    821,545          1,205           0.58 %   $    984,874            390           0.16 %
Savings and money market
deposits                         709,591          1,603           0.90 %        589,101            288           0.19 %
Time deposits                    462,036          1,332           1.14 %        406,329            654           0.64 %
Total interest-bearing
deposits                       1,993,172          4,140           0.82 %      1,980,304          1,332           0.27 %
Borrowings and repurchase
agreements                        88,584            761           3.41 %         29,495            394           5.30 %
Total interest-bearing
liabilities                    2,081,756          4,901           0.93 %      2,009,799          1,726           0.34 %
Noninterest-bearing
deposits                         666,096                                        751,862
Total funding sources          2,747,852                                      2,761,661
Noninterest-bearing
liabilities                       34,851                                         41,714
Shareholders' equity             364,138                                        367,807
Total liabilities and
shareholders' equity        $  3,146,841                                   $  3,171,182
Net interest spread (4)                                           3.23 %                                         3.01 %
Net interest
income/margin (5)                            $   25,553           3.50 %   
                $   22,964           3.12 %



Footnotes appear below second table

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                                                                     For 

the Nine Months Ended September 30,

                                                           2022                                                   2021
                                        Average             Interest          Average          Average             Interest          Average
                                      Outstanding            Income/          Yield/         Outstanding            Income/          Yield/
                                        Balance              Expense           Rate            Balance              Expense           Rate
Interest-Earning Assets
Loans (1)                                  $2,131,159             $68,481         4.30%           $1,917,536             $63,077         4.40%
Loans held for sale                            99,749               2,995         4.01%              162,092               3,859         3.18%

Securities:

Taxable investment securities
(2)                                           413,229               6,187         2.00%              444,643               5,373         1.61%
Investment securities exempt
from
  federal income tax (3)                       55,798                 958         2.90%               62,265               1,074         2.91%
Total securities                              469,027               7,145         2.10%              506,908               6,447         1.77%
Cash balances in other banks                  189,681               1,076         0.76%              290,454                 405         0.19%
Funds sold                                      9,547                  31         0.43%               12,866                  12         0.12%
Total interest-earning assets               2,899,163              79,728         3.69%            2,889,856              73,800         3.43%
Noninterest-earning assets                    243,822                                                220,041
Total assets                               $3,142,985                                             $3,109,897
Interest-Bearing Liabilities
Interest-bearing deposits:
Interest-bearing transaction
accounts                                     $895,097               2,279         0.34%             $952,393               1,216         0.17%
Savings and money market
deposits                                      680,331               2,401         0.47%              587,252                 896         0.20%
Time deposits                                 393,594               2,271         0.77%              429,454               2,317         0.72%
Total interest-bearing deposits             1,969,022               6,951         0.47%            1,969,099               4,429         0.30%
Borrowings and repurchase
agreements                                     63,099               1,644         3.49%               30,931               1,193         5.16%
Total interest-bearing
liabilities                                 2,032,121               8,595         0.57%            2,000,030               5,622         0.38%
Noninterest-bearing deposits                  707,084                                                717,122
Total funding sources                       2,739,205                                              2,717,152
Noninterest-bearing liabilities                35,396                                                 33,569
Shareholders' equity                          368,384                                                359,176
Total liabilities and
shareholders' equity                       $3,142,985                                             $3,109,897
Net interest spread (4)                                                           3.12%                                                  3.05%
Net interest income/margin (5)                                    $71,133         3.29%                                  $68,178         3.17%


(1) Average loan balances include nonaccrual loans. Interest income on loans
includes amortization of deferred loan fees, net of deferred loan costs.

(2) Taxable investment securities include restricted equity securities.

(3) Yields on tax exempt securities are shown on a tax equivalent basis.

(4) Net interest spread is the average yield on total interest-earning assets
minus the average rate on total interest-bearing liabilities.

(5) Net interest margin is annualized net interest income calculated on a tax
equivalent basis divided by total average interest-earning assets for the
period.




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The net interest margin was 3.50% and 3.12% for the third quarters of 2022 and
2021, respectively. For the nine months ended September 30, 2022 the net
interest margin was 3.29% compared to 3.17% for the comparable period of 2021.
Both quarter and year to date periods in 2022 benefitted from a mix shift in
interest earning assets as excess liquidity was deployed to fund loan growth.
These improvements were partially offset by a $1.9 million and $6.1 million
decline in PPP fees for the three and nine months ended September 30, 2022,
respectively.

For the three months ended September 30, 2022, the average security yields
increased 54 basis points to 2.29 percent when compared to 2021, while for the
nine month period ended September 30, 2022, average security yields increased 33
basis points to 2.10%. Both increases were due to be benefits of increasing
market interest rates.

Average noninterest bearing deposits represented 25.1% and 26.4% of total
average deposits for the three and nine month periods ending September 30, 2022
, respectively, a decline from 27.5% and 26.7% for the three and nine month
periods ending September 30, 2021. Deposit costs increased across all periods
for all interest-bearing deposit categories. Average funding sources for the
three and nine month periods ended September 30, 2022 remained flat at $2.7
billion compared to the similar periods in 2021. A key longer-term strategic
initiative is to create a stronger deposit-led culture with an emphasis on lower
cost relationship-based deposits.

The average rate paid on interest-bearing liabilities was 0.93% for the third
quarter compared to 0.34% for September 30, 2021. For the nine months ended
September 30, 2022 and 2021, the average rate paid on interest-bearing
liabilities was 0.57% and 0.38%, respectively.

Asset/Liability Management and Interest Rate Risk


Managing interest rate risk is fundamental for the financial services industry.
The primary objective of interest rate risk management is to mitigate effects of
interest rate changes on net income. By considering both on and off-balance
sheet financial instruments, management evaluates interest rate sensitivity
while attempting to optimize net interest income within the constraints of
prudent capital adequacy, liquidity needs, market opportunities and customer
requirements.

Interest Rate Simulation Sensitivity Analysis


We use earnings at risk, or EAR, simulations to assess the impact of changing
rates on earnings under a variety of scenarios and time horizons. The simulation
model is designed to reflect the dynamics of interest earning assets, interest
bearing liabilities and off-balance sheet financial instruments. These
simulations utilize both instantaneous and parallel changes in the level of
interest rates, as well as non-parallel changes such as changing slopes and
twists of the yield curve. Static simulation models are based on current
exposures and assume a constant balance sheet with no growth. By estimating the
effects of interest rate increases and decreases, the model can reveal
approximate interest rate risk exposure. The simulation model is used by
management to gauge approximate results given a specific change in interest
rates at a given point in time. The model is therefore a tool to indicate
earnings trends in given interest rate scenarios and does not indicate actual
expected results.

At September 30, 2022, our EAR static simulation results indicated that our
balance sheet is asset sensitive to parallel shifts in interest rates. This
indicates that our assets generally reprice faster than our liabilities, which
results in a favorable impact to net interest income when market interest rates
increase and an unfavorable impact to net interest income when market interest
rates decline. Many assumptions are used to calculate the impact of interest
rate fluctuations on our net interest income, such as asset prepayments,
non-maturity deposit price sensitivity, and key rate drivers. Because of the
inherent use of these estimates and assumptions in the model, our actual results
may, and most likely will, differ from our static EAR results. In addition,
static EAR results do not include actions that our management may undertake to
manage the risks in response to anticipated changes in interest rates or client
behavior. For example, as part of our asset/liability management strategy,
management has the ability to increase asset duration and/or decrease liability
duration in order to reduce asset sensitivity, or to decrease asset duration
and/or increase liability duration in order to increase asset sensitivity.

The following table illustrates the results of our EAR analysis to determine the
extent to which our net interest income over the next 12 months would change if
prevailing interest rates increased or decreased immediately by the specified
amounts.
                   Net
                 interest
                  income
                  change
Increase 200bp    (0.9)%
Increase 100bp      0.3
Decrease 100bp     (3.2)




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Provision for Loan Losses


Our policy is to maintain an allowance for loan losses at a level sufficient to
absorb probable incurred losses in the loan portfolio. The allowance is
increased by a provision for loan losses, which is a charge to earnings, is
decreased by charge offs and increased by loan recoveries. While our policies
and procedures used to estimate the allowance for loan losses, as well as the
resultant provision for loan losses charged to operations, are considered
adequate by management, they are necessarily approximate and imprecise. There
are factors beyond our control, such as conditions in the local and national
economy, local real estate markets, or particular industry or borrower-specific
conditions, which may materially and negatively impact our asset quality and the
adequacy of our allowance for loan losses and, thus, the resulting provision for
loan losses. Provision expense is impacted by macroeconomic factors, the
absolute level of loans, loan growth, the credit quality of the loan portfolio
and the amount of net charge-offs.

The provision for loan losses amounted to $0.9 million for both the three and
nine month periods ended September 30, 2022 compared to no provision for the
three months ended September 30, 2021 and ($0.4) million for the nine month
period of 2021. The current period provision was primarily a result of continued
strong loan growth partially offset by reduction of pandemic reserve. Net
charge-offs for the three and nine months ended September 30, 2022 were $120
thousand and $193 thousand, respectively, compared to $221 thousand and $297
thousand for the three and nine comparable periods of 2021, respectively. The
allowance for loan losses at September 30, 2022 was 0.98% of total loans held
for investment compared to 1.10% as of December 31, 2021.

See "Notes to Consolidated Financial Statements (Unaudited) - Note 3 - Loans and
Allowance for Loan Losses" for additional information on our allowance for loan
losses.

Noninterest Income

In addition to net interest income, we generate recurring noninterest income.
Our banking operations generate revenue from service charges on deposit
accounts, interchange and debit card transaction fees, originating and selling
mortgage, commercial real estate and SBA loans, wealth management and gains
(losses) on sales of securities. In addition to these types of recurring
noninterest income, we own insurance on several key employees and record income
within "Other noninterest income" based upon the increase in the cash surrender
value of these policies.

The following table sets forth the principal components of noninterest income
for the periods indicated.

                                                        2022 - 2021                                     2022 - 2021
                             Three Months Ended           Percent            Nine Months Ended            Percent
                                September 30,             Increase             September 30,             Increase
                              2022          2021         (Decrease)          2022          2021         (Decrease)
Noninterest income:
Deposit service charges    $    1,251     $  1,187                5.4 %    $   3,575     $  3,398                 5.2 %
Interchange and debit
card transaction fees           1,245        1,236                0.7 %        3,803        3,555                 7.0 %
Mortgage banking                  765        4,693              (83.7 )%       4,436       13,318               (66.7 )%
Tri-Net                        (2,059 )      1,939             (206.2 )%          39        4,618               (99.2 )%
Wealth management                 385          481              (20.0 )%       1,284        1,412                (9.1 )%
SBA lending                       560          911              (38.5 )%       1,054        1,781               (40.8 )%
Net gain (loss) on sale
of securities                       7            7                  -              8           20               (60.0 )%
Other noninterest income        1,118        1,197               (6.6 )%       4,038        3,446                17.2 %
Total noninterest income   $    3,272     $ 11,651              (71.9 )%   $  18,237     $ 31,548               (42.2 )%




Deposit service charges were up slightly for the three and nine months ended
September 30, 2022 compared to the same period in 2021. These amounts originate
from our commercial and consumer deposit accounts.

Interchange and debit card transaction fees fluctuate based upon transaction
volumes, which were slightly higher for the three and nine months ended
September 30, 2022 compared to the same period in 2021. This increase is
attributable to an emphasis on electronic banking and continued growth in
deposits and volume of our commercial and consumer deposit accounts.


Mortgage banking income consists of mortgage fee income from the origination and
sale of mortgage loans. These mortgage fees are for loans originated in our
markets that are subsequently sold to third-party investors. Generally, mortgage
origination fees increase in lower interest rate environments and more robust
housing markets and decrease in rising interest rate environments and more
challenging housing markets. Mortgage origination fees will fluctuate from
period to period as the rate environment changes, though the Company benefits
from our strong markets and focus on purchase transactions. The Company's
mortgage division experienced a reduction in demand due to higher market rates
and reduced demand and anticipates a difficult environment at least until the
2023 buying season returns.

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Tri-Net represents a line of business which originates and sells commercial real
estate loans to third-party investors. All of these loan sales transfer
servicing rights to the buyer. Tri-Net revenue for the three and nine month
period ended September 30, 2022 decreased 206.2% and 99.2%, respectively, when
compared to the same periods of 2021. The decreases are attributable to the
adverse impact of rapidly rising interest rates on pricing and investor demand.
As a result of this impact, the Company transferred $131.1 million of Tri-Net
loans from loans held for sale to loans held for investment, comprised of $106.9
and $24.2 million in the second and third quarters, respectively, of 2022. For
the three months ended September 30, 2022, Tri-Net results included a $1.3
million realized loss on sale of loans and a $2.2 million unrealized loss on
loans transferred to held for investment, partially offset by a $1.6 million
gain on its hedge instruments. For the nine months ended September 30, 2022,
Tri-Net results included a $1.3 million realized loss on sale of loans and a
$2.4 million unrealized loss on loans transferred to held for investment,
partially offset by a $1.6 million gain on its hedge instruments. As of
September 30, 2022, the Company retained $2.1 million Tri-Net loans held for
sale, which were under a letter of intent to be sold in the fourth quarter of
2022. Similar to the Company's mortgage division, the Company anticipates
continued near-term challenges in the Tri-Net division in a volatile rate
environment. The Company paused any further commitments to originate such loans
early in the third quarter and will only restart originations when clear
indications of market stabilization and liquidity normalization are observed.

Wealth management income is derived from advisory services offered to specific
customers. The activity for the three and nine month periods ended September 30,
2022 declined slightly compared to the same periods in 2021. Any changes in
activity are mostly driven by transaction volume, which can fluctuate from
period to period.

Noninterest income for SBA lending, which represents gains on sales of
guaranteed portions of SBA loans, declined 38.5% and 40.8% for the three and
nine month periods ended September 30, 2022, respectively, when compared to the
same period in 2021.

Other noninterest income primarily consists of loan related fees, bank-owned
life insurance, and other service-related fees. While flat for the three month
comparable periods, the increase in the nine months ended September 30, 2022
compared to 2021 relates to $0.9 million in death benefit income from bank-owned
life insurance policies.

Noninterest Expense

The following table presents the primary components of noninterest expense for
the periods indicated.

                                            2022 - 2021                          2022 - 2021
                     Three Months Ended       Percent      Nine Months Ended       Percent
                        September 30,        Increase        September 30,        Increase
                      2022         2021     (Decrease)      2022        2021     (Decrease)
Noninterest
expense:
Salaries and
employee benefits      $8,712     $10,980       (20.7)%    $28,191     $31,210        (9.7)%
Data processing
and software            2,861       2,632          8.7%      8,355       8,530        (2.1)%
Occupancy               1,092       1,028          6.2%      3,266       3,193          2.3%
Equipment                 743         760        (2.2)%      2,235       2,640       (15.3)%
Professional
services                  468         469        (0.2)%      1,653       1,634          1.2%
Regulatory fees           269         279        (3.6)%        814         746          9.1%
Acquisition
related expenses            -           -             -          -         323      (100.0)%
Amortization of
intangibles               415         477       (13.0)%      1,291       1,478       (12.7)%
Other operating         3,371       1,741         93.6%      6,935       5,105         35.8%
Total noninterest
expense               $17,931     $18,366        (2.4)%    $52,740    

$54,859 (3.9)%



The decreases in salaries and employee benefits were driven primarily by lower
incentive expense included within salaries and employee benefits related to
lower profitability driven primarily by lower Tri-Net and Mortgage operating
results. Additionally, following two operational loss incidents in the current
quarter, the Company recorded $0.8 million of voluntary executive incentive
reversals. At September 30, 2022, our associate base decreased to 387 compared
to 392 at September 30, 2021.

The increase in other operating expenses was attributable to $2.2 million in the
aforementioned operational loss incidents, which occurred during the quarter and
for which the bank is seeking potential recoveries.

Our efficiency ratio was 62.21% and 59.01% for the three and nine months ended
September 30, 2022, respectively, versus 53.06% and 55.01%, respectively, for
the comparable periods ended September 30, 2021. The efficiency ratio is the
ratio of noninterest expense to the sum of net interest income and noninterest
income and measures the amount of expense that is incurred to generate a dollar
of revenue. Overall, noninterest expense has declined due to the lower incentive
expense as well as the Company's continued focus on expense discipline and
operational improvements.


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Income Tax Provision

The Company’s effective tax rate for the three and nine month periods ended
September 30, 2022 was 19.8% and 19.7%, respectively, compared to 19.4% and
20.0% for the three and nine month periods ended September 30, 2021.


The effective tax rate for the three months ended September 30, 2022 compared
favorably from the statutory tax rate due to our investments in qualified
municipal securities, tax benefits from our real estate investment trust,
company owned life insurance, state tax credits, net of the effect of certain
non-deductible expenses, and the recognition of excess tax benefits related to
stock compensation. The Company anticipates its effective tax rate for 2022 to
be approximately 20.0 percent.

(b) Financial Condition

Balance Sheet


Total assets increased $32.7 million, or 1.1%, from $3.13 billion on December
31, 2021 to $3.17 billion on September 30, 2022. Loans held for investment grew
$327.0 million in the first nine months of 2022.

Total liabilities increased to $2.8 billion at September 30, 2022 when compared
to $2.75 billion at December 31, 2021. Deposits decreased $50.6 million, or
1.9%.


Our growth in cash, loans and deposits continues to be significantly influenced
by inflation, volatility in the interest rate environment, and funding through
the Company's correspondent banking customers.

Loans

The composition of loans at September 30, 2022 and December 31, 2021 and the
percentage of each classification to total loans are summarized as follows:


                                                  September 30, 2022        

December 31, 2021

                                                Amount         Percent         Amount         Percent
Commercial real estate - owner occupied       $   235,519           10.3 %   $   209,261           10.6 %
Commercial real estate - non-owner occupied       832,156           36.3 %       616,023           31.3 %
Consumer real estate                              386,628           16.9 %       326,412           16.6 %
Construction and land development                 198,869            8.7 %       214,310           10.9 %
Commercial and industrial                         499,048           21.8 %       497,615           25.3 %
Consumer                                           52,715            2.3 %        46,811            2.4 %
Other                                              85,334            3.7 %        55,337            2.8 %
Total loans                                   $ 2,290,269          100.0 %   $ 1,965,769          100.0 %




Our principal market for lending is the State of Tennessee and adjacent states
that can be effectively accessed from our banking offices. Our target borrower
profile includes consumers, small to medium sized businesses, professional
firms, real estate investors and developers, and their owners and managers. Our
growth since 2018 has been concentrated in borrowers meeting that profile. Our
primary competition is community, regional, and national banks operating in our
primary markets. In seeking customer banking relationships, we rely on a model
of delivering services through a qualified banker meeting all the banking
service needs of the business and its primary stakeholders.



At September 30, 2022, our loan portfolio composition remained relatively
consistent with the composition at December 31, 2021. Our primary focus has been
on commercial and industrial and commercial real estate lending, which
constituted 68% of our loan portfolio as of September 30, 2022. Although we
expect continued growth with respect to our loan portfolio, we do not expect any
significant changes over the foreseeable future in the composition of our loan
portfolio or in our emphasis on commercial lending. Our loan growth since
inception has been reflective of the target market that we serve. The commercial
real estate category includes owner-occupied and non-owner occupied properties.
The repayment of owner-occupied properties is largely dependent on the
operations of the tenant, while non-owner occupied properties is dependent upon
the operation, refinance, or sale of the underlying real estate.

                                       39

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Non-Performing Loans and Assets


Information summarizing non-performing assets, including non-accrual loans
follows:

                                             September 30, 2022       December 31, 2021
Non-accrual loans                            $             6,734     $             3,258
Troubled debt restructurings                                 344                   1,832
Loans past due over 90 days and still
accruing                                                     991                   1,380

Non-performing loans                                       6,734                   3,258
Other real estate owned                                      165                     266
Non-performing assets                                      6,899                   3,524
Non-performing loans to loans held for
investment                                                  0.29 %                  0.17 %
Non-performing assets to total assets                       0.22 %                  0.12 %






The following table sets forth the major classifications of non-accrual loans:

                                    September 30, 2022       December 31, 2021
Commercial real estate              $             4,974     $                 -
Consumer real estate                                307                   1,086
Construction and land development                     8                      11
Commercial and industrial                           186                     324
Consumer                                             41                      31
Other                                                 -                       -
Purchased credit impaired                         1,218                   1,806
Total loans                         $             6,734     $             3,258


The increase in non-performing assets is solely related to one relationship in
the Company's commercial real estate portfolio for which the Company feels the
risk of loss is nominal.

(c) Liquidity

Liquidity risk is the risk that we will be unable to meet our obligations as
they become due because of an inability to liquidate assets or obtain adequate
funding. To manage liquidity risk, management has established a comprehensive
management process for identifying, measuring, monitoring and controlling
liquidity risk. Because of its critical importance to the viability of the Bank,
liquidity risk management is fully integrated into our risk management
processes. Critical elements of our liquidity risk management include: effective
corporate governance consisting of oversight by the board of directors and
active involvement by management; appropriate strategies, policies, procedures,
and limits used to manage and mitigate liquidity risk; comprehensive liquidity
risk measurement and monitoring systems (including assessments of the current
and prospective cash flows or sources and uses of funds) that are commensurate
with the complexity and business activities of the Bank; active management of
intraday liquidity and collateral; an appropriately diverse mix of existing and
potential future funding sources; adequate levels of highly liquid marketable
securities free of legal, regulatory, or operational impediments, that can be
used to meet liquidity needs in stressful situations; comprehensive contingency
funding plans that sufficiently address potential adverse liquidity events and
emergency cash flow requirements; and internal controls and internal audit
processes sufficient to determine the adequacy of the institution's liquidity
risk management process.

The role of liquidity management is to ensure funds are available to meet
depositors' withdrawal and borrowers' credit demands while at the same time
maximizing profitability. This is accomplished by balancing changes in demand
for funds with changes in the supply of those funds. Liquidity is provided by
short-term liquid assets that can be converted to cash, investment securities
available-for-sale, various lines of credit available to us, and the ability to
attract funds from external sources, principally deposits.

Our most liquid assets are comprised of cash and due from banks,
interest-bearing deposits in financial institutions, available-for-sale
marketable investment securities and federal funds sold. Interest-bearing
deposits in financial institutions totaled $164.4 million at September 30, 2022,
representing a decrease of $182.6 million from $347.0 million at December 31,
2021 as the Company deployed excess liquidity to fund loan growth. The fair
value of the available-for-sale investment portfolio was $401.3 million at
September 30, 2022, a $58.1 million decrease from December 31, 2021. We pledge
portions of our investment securities portfolio to secure public fund deposits,
derivative positions and Federal Home Loan Bank advances. At September 30, 2022,
total investment securities pledged for these purposes comprised 53% of the
estimated fair value of the investment portfolio, leaving $188.7 million of
unpledged securities.

                                       40

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Other sources of funds available to meet daily needs include $439.7 million of
borrowing capacity from the FHLB of Cincinnati, $303.2 million of borrowing
capacity from the Federal Reserve Bank of Atlanta's discount window and federal
funds lines with correspondent banks totaling $165.0 million at September 30,
2022.

The principal source of cash for CapStar Financial Holdings, Inc. (the "Parent
Company") is dividends paid to it as the sole shareholder of the Bank. At
September 30, 2022, the Bank was able to pay up to $85.3 million in dividends to
the Parent Company without regulatory approval subject to the ongoing capital
requirements of the Bank.

Accordingly, management currently believes that our funding sources are at
sufficient levels to satisfy our short-term and long-term liquidity needs.

(d) Capital Resources


At September 30, 2022, shareholders' equity totaled $347.4 million, a decrease
of $32.7 million from December 31, 2021. The decrease was driven by a decline in
the fair value of available for sale securities included within other
comprehensive income, which more than offset a $23.0 million increase in
retained earnings. As of September 30, 2022, the Company and the Bank were
well-capitalized under the regulatory framework for prompt corrective action.

Off-Balance Sheet Arrangements


In the normal course of business, we enter into various transactions that, in
accordance with U.S. GAAP, are not included in our consolidated balance sheet.
We enter into these transactions to meet the financing needs of our clients.
These transactions include commitments to extend credit and standby letters of
credit, which involve, to varying degrees, elements of credit risk and interest
rate risk in excess of the amounts recognized in our consolidated balance
sheets. Most of these commitments mature within two years and are expected to
expire without being drawn upon. Standby letters of credit are included in the
determination of the amount of risk-based capital that the Company and the Bank
are required to hold.

We enter into contractual loan commitments to extend credit, normally with fixed
expiration dates or termination clauses, at specified rates and for specific
purposes. Substantially all of our commitments to extend credit are contingent
upon clients maintaining specific credit standards until the time of loan
funding.

Standby letters of credit are written conditional commitments issued by us to
guarantee the performance of a client to a third party. In the event that the
client does not perform in accordance with the terms of the agreement with the
third party, we would be required to fund the commitment. The maximum potential
amount of future payments we could be required to make is represented by the
contractual amount of the commitment. If the commitment is funded, we would be
entitled to seek recovery from the client. Our policies generally require that
standby letter of credit arrangements contain security and debt covenants
similar to those contained in loan agreements.

We minimize our exposure to loss under loan commitments and standby letters of
credit by subjecting them to the same credit approval and monitoring procedures
as we do for on-balance sheet instruments. We assess the credit risk associated
with certain commitments to extend credit and establish a liability for probable
credit losses. The effect on our revenue, expenses, cash flows and liquidity of
the unused portions of these commitments cannot be reasonably predicted because
there is no guarantee that the lines of credit will be used.

Our off-balance sheet arrangements are summarized in Note 8 of the consolidated
financial statements.

(e) Non-GAAP Financial Measures


This Report may include the following financial measures that have been prepared
other than in accordance with U.S. GAAP ("non-GAAP financial measures"):
tangible common equity, tangible book value per share of common stock, tangible
book value per share of common stock less after-tax unrealized available for
sale investment (gains) losses, tangible common equity to tangible assets, and
tangible common equity to tangible assets less after-tax unrealized available
for sale investment (gains) losses. The Company believes that these non-GAAP
financial measures (i) provide useful information to management and investors
that is supplementary to its financial condition, results of operations and cash
flows computed in accordance with U.S. GAAP, (ii) enable a more complete
understanding of factors and trends affecting the Company's business, and (iii)
allow investors to evaluate the Company's performance in a manner similar to
management, the financial services industry, bank stock analysts and bank
regulators; however, the Company acknowledges that its non-GAAP financial
measures have a number of limitations. As such, you should not view these
disclosures as a substitute for results determined in accordance with U.S. GAAP,
and they are not necessarily comparable to non-GAAP financial measures that
other companies use.

                                       41

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The following table presents a reconciliation of these measures to the most
directly comparable U.S. GAAP financial measures.


(dollars in thousands, except share and per
share data)                                    September 30, 2022   December 31, 2021
Tangible Equity:
Total shareholders' equity                               $347,365            $380,094
Less: intangible assets                                  (46,468)            (47,759)
Tangible equity                                          $300,897            $332,335

Tangible book value per share of common
stock:
Tangible equity                                          $300,897           

$332,335

Total shares of common stock outstanding               21,931,624          

22,166,129

Tangible book value per share of common
stock                                                      $13.72           

$14.99


Tangible book value per share of common
stock
 less after-tax unrealized available for
sale investment
 (gains) losses:
Total shareholders' equity                               $347,365            $380,094
Less: intangible assets                                  (46,468)            (47,759)
Add: after-tax unrealized available for sale
investment (gains) losses                                  53,488           

2,978

Tangible equity less after-tax unrealized
available for sale investment (gains) losses             $354,385           

$335,313

Total shares of common stock outstanding               21,931,624          

22,166,129

Tangible book value per share of
common stock less after-tax unrealized
available for sale investment (gains) losses               $16.16           

$15.13


Tangible common equity to tangible assets:
Tangible equity                                          $300,897            $332,335

Assets                                                 $3,165,706          $3,133,046
Less: intangible assets                                  (46,468)            (47,759)
Tangible assets                                        $3,119,238          $3,085,287
Tangible common equity to tangible
assets                                                      9.65%           

10.77%


Tangible common equity to tangible assets
less after-tax unrealized available for sale
investment (gains) losses:
Tangible equity less after-tax unrealized
available for sale investment (gains) losses             $354,385           

$335,313


Tangible assets                                        $3,119,238          

$3,085,287

Add: after-tax unrealized available for sale
investment (gains) losses                                  53,488           

2,978

Tangible assets less after-tax unrealized
available for sale investment (gains) losses           $3,172,726          

$3,088,265

Tangible common equity to tangible

 assets less after-tax unrealized available
for sale investment
 (gains) losses                                            11.17%              10.86%



(f) Recently Issued Accounting Pronouncements

ASU 2016-13, Financial Instruments – Credit Losses


In June 2016, the FASB issued guidance to change the accounting for credit
losses and modify the impairment model for certain debt securities. The
amendments were originally supposed to be effective for the Company for
reporting periods beginning after December 15, 2019 with early adoption
permitted for all organizations for periods beginning after December 15, 2018.
However, in November 2019, the FASB issued ASU 2019-10, Financial Instruments -
Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases
(Topic 842): Effective Dates, which finalizes effective date delays for private
companies, not-for-profit organizations, and certain smaller reporting companies
applying the credit losses standard. The Company is not required to adopt this
standard until January 1, 2023. The Company has established a Current Expected
Credit Loss (CECL) Steering Committee which includes the appropriate members of
management to evaluate the impact this ASU will have on the Company's financial
position, results of operations and

                                       42

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financial statement disclosures. Additionally, the Company selected a
third-party vendor to provide allowance for loan loss software as well as
advisory services in developing a new methodology and a parallel model.

ASU 2022-02 – Financial Instruments- Credit Losses- Troubled Debt Restructurings
and Vintage Disclosures:


In March 2022, the FASB issued troubled debt restructurings accounting guidance
requiring entities to evaluate whether a modification provided to a borrower
results in a new loan or continuation of an existing loan. The amendments
enhance existing disclosures and require new disclosures for receivables when
there has been a modification in contractual cash flows due to a borrower
experiencing financial difficulties. Additionally, the amendments require public
business entities to disclose gross charge-off information by year of
origination in the vintage disclosures. The guidance is effective for entities
that have adopted ASU 2016-13 for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2022. Early adoption is permitted,
including early adoption in an interim period. An entity should apply ASU
2022-02 prospectively. If an entity elects to early adopt ASU 2022-02 in an
interim period, the guidance should be applied as of the beginning of the fiscal
year that includes the interim period. The Company is assessing ASU 2022-02 and
its impact on its financial statements.

ASU 2019-05 – Applicable to entities that hold financial instruments:


In May 2019, the FASB issued guidance to provide entities with an option to
irrevocably elect the fair value option, applied on an instrument-by-instrument
basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of
Credit Losses on Financial Instruments. The amendments will be effective for the
Company upon adoption of ASU 2016-13 in fiscal year 2023. The Company does not
expect these amendments to have a material effect on its financial statements.

ASU 2020-04 – Applicable to entities within the scope of Topic 848, Reference
Rate Reform:


In March 2020, the FASB issued guidance which provides temporary optional
guidance to ease the potential burden in accounting for reference rate reform.
The ASU provides optional expedients and exceptions for applying generally
accepted accounting principles to contract modifications and hedging
relationships, subject to meeting certain criteria, that reference LIBOR or
another reference rate expected to be discontinued. It is intended to help
stakeholders during the global market-wide reference rate transition period. In
January 2021, the FASB issued ASU 2021-01 which clarifies that certain optional
expedients and exceptions in Topic 848 for contract modifications and hedge
accounting apply to derivatives that are affected by the discounting transition.
The guidance is effective for all entities as of March 12, 2020 through December
31, 2022. The Company continues to implement its transition plan towards
cessation of LIBOR and the modification of its outstanding financial instruments
with attributes that are either directly or indirectly influenced by LIBOR. The
Company expects to utilize the LIBOR transition relief allowed under ASU 2020-04
and ASU 2021-01, as applicable, and does not expect such adoption to have a
material impact on its accounting and disclosures. The Company will continue to
assess the impact as the reference rate transition approaches June 30, 2023.

(g) Impact of Inflation


The consolidated financial statements and related consolidated financial data
presented herein have been prepared in accordance with U.S. GAAP and practices
within the banking industry which require the measurement of financial position
and operating results in terms of historical dollars without considering the
changes in the relative purchasing power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates have a
more significant impact on a financial institution's performance than the
effects of general levels of inflation.

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