(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Executive Summary The following is a summary of the Company's (as defined below) financial highlights and significant events for the six months ended June 30, 2019:
Net income attributable to common shareholders totaled $8.1 million, or $0.71 per diluted common share, for the six months ended June 30, 2019 compared to $5.9 million, or $0.51 per diluted common share, during same period in 2018.
Loans increased $81.5 million for the six months ended June 30, 2019.
Deposits increased $112.4 million for the six months ended June 30, 2019.
Asset quality remained strong with nonperforming assets to total assets of just 0.38 percent.
The following discussion and analysis is intended to assist in the understanding and assessment of significant changes and trends related to our financial position and operating results. This discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included elsewhere herein along with our Annual Report on Form 10-K for the year ended December 31, 2018. Amounts in the narrative are shown in thousands, except for economic and demographic information, numbers of shares, per share amounts and as otherwise noted.
Critical Accounting Policies
The accounting principles we follow and our methods of applying these principles conform to accounting principles generally accepted in the United States of America ("U.S. GAAP") and with general practices within the banking industry. There have been no significant changes to our critical accounting policies as described in our Annual Report on Form 10-K for the year ended December 31, 2018. The following is a brief summary of the more significant policies.
Principles of Consolidation
The consolidated financial statements as of and for the periods presented include the accounts of Reliant Bancorp, Inc. ("Reliant Bancorp"), Reliant Bank (the "Bank"), Community First Trups Holding Company, which is wholly owned by Reliant Bancorp ("TRUPS"), Reliant Investment Holdings, LLC ("Holdings"), which is wholly owned by the Bank, and Reliant Mortgage Ventures, LLC ("RMV"), of which the Bank controls 51% of the governance rights (Reliant Bancorp, the Bank, TRUPS, Holdings, and RMV are, collectively, referred to herein as the "Company"). As described in the notes to our consolidated financial statements, RMV is considered a variable interest entity for which the Bank is deemed to be the primary beneficiary. All significant intercompany balances and transactions have been eliminated in consolidation. As described in Note 12 to our consolidated financial statements, effective on January 1, 2018, Reliant Bancorp and Community First, Inc. merged. The accounting and reporting policies of the Company conform to U.S. GAAP and to general practices in the banking industry.
During 2011, the Bank and another entity organized RMV. Under the RMV operating agreement, the non-controlling member receives 70% of the cash flow distributions of RMV, and the Bank receives 30% of the cash flow distributions, once the non-controlling member recovers its capital contributions to RMV. The non-controlling member is required to fund RMV's losses via additional capital contributions to RMV. As of June 30, 2019, RMV's cumulative losses to date totaled $11,121. RMV will have to generate net income of this amount before the Company will participate in future cash flow distributions.
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The Company maintains an allowance for loan losses on purchased loans based on credit deterioration subsequent to the acquisition date. In accordance with the accounting guidance for business combinations, because we recorded all acquired loans at fair value as of the date of the Merger (as defined below), we did not establish an allowance for loan losses on any of the loans we purchased as of the acquisition date as any credit deterioration evident in the loans was included in the determination of the acquisition date fair values. For purchased credit-impaired loans accounted for under ASC 310-30, management establishes an allowance for loan losses subsequent to the date of acquisition by re-estimating expected cash flows on these loans on a quarterly basis, with any decline in expected cash flows due to a credit triggering impairment recorded as provision for loan losses. The allowance established is the excess of the loan's carrying value over the present value of projected future cash flows, discounted at the current accounting yield of the loan or the fair value of collateral (less estimated costs to sell) for collateral dependent loans. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. While the determination of specific cash flows involves estimates, each estimate is unique to the individual loan, and none is individually significant. For non-purchased credit-impaired loans acquired in the Merger and that are accounted for under ASC 310-20, the historical loss estimates are based on the historical losses experienced by the Bank for loans with similar characteristics as those acquired other than purchased credit-impaired loans. We record an allowance for loan losses only when the calculated amount exceeds the remaining credit mark established at acquisition.
Allowance for Loan Losses
The allowance for loan losses is 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 historical loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, current economic conditions (national and local), and other factors such as changes in interest rates, portfolio concentrations, changes in the experience, ability, and depth of the lending function, levels of and trends in charged-off loans, recoveries, past-due loans and volume and severity of classified loans. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The entire allowance is available for any loan that, in management's judgment, should be charged off.
A loan is impaired when full payment under the loan terms is not expected. All classified loans and loans on non-accrual status are individually evaluated for impairment. Factors considered in determining if a loan is impaired include the borrower's ability to repay amounts owed, collateral deficiencies, the risk rating of the loan and economic conditions affecting the borrower's industry, among other things. 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 (less estimated costs to sell) of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless the principal amount is deemed fully collectible, in which case interest is recognized on a cash basis. When recognition of interest income on a cash basis is appropriate, the amount of income recognized is limited to what would have been accrued on the remaining principal balance at the contractual rate. Cash payments received over this limit, and not applied to reduce the loan's remaining principal balance, are recorded as recoveries of prior charge-offs until these charge-offs have been fully recovered.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note to our consolidated financial statements. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2019 AND 2018
grew consolidated total assets from $1,125.0 million to $1,636.0 million after giving effect to purchase accounting;
increased total loans from $762.5 million to $1,075.5 million;
increased total deposits from $883.5 million to $1,316.9 million; and
expanded its employee base from 167 to 272 full time equivalent employees.
Net income attributable to common shareholders amounted to $4,239 and $8,063, or $0.38 and $0.71 per basic share, for the three and six months ended June 30, 2019, respectively, compared to $2,139 and $5,880, or $0.19 and $0.52 per basic share, for the same periods in 2018. Diluted net income attributable to common shareholders was $0.38 and $0.71 per share and $0.19 and $0.51 per share for the three and six months ended June 30, 2019 and June 30, 2018, respectively. The major components contributing to the increases when compared to the prior year are a decrease of 6.5% and 1.3% in non-interest expense for the three and six months ended June 30, 2019, respectively, and an increase of 3.1% and 1.8% in net interest income for the three and six months ended June 30, 2019, respectively, compared to the same periods in 2018. These and other components of earnings are discussed further below.
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Net Interest Income Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest-bearing liabilities and is the most significant component of our revenues. The following table sets 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 six months ended June 30, 2019, and 2018 (dollars in thousands): Three Months Ended June 30, 2019 Three Months Ended June 30, 2018 Change Interest Interest Rates / Income / Rates / Income / Average Balances Yields (%) Expense Average Balances Yields (%) Expense Due to Volume Due to Rate Total Interest earning assets Loans $ 1,276,197 5.18 $ 16,178 $ 1,119,884 4.81 $ 13,393 $ 1,795 $ 989 $ 2,785 Loan fees - 0.25 782 - 0.24 673 109 - 109 Loans with fees 1,276,197 5.43 16,960 1,119,884 5.05 14,066 1,905 989 2,894 Mortgage loans held for sale 14,502 5.48 198 24,611 5.31 326 (196 ) 68 (128 ) Deposits with banks 30,342 1.53 116 36,550 1.21 110 (89 ) 95 6 Investment securities - taxable 77,405 3.04 587 67,647 2.69 453 70 64 134 Investment securities - tax-exempt 222,149 3.77 1,650 231,874 3.75 1,708 (134 ) 76 (58 ) Federal funds sold and other 13,308 5.46 181 11,441 5.85 167 73 (59 ) 14 Total earning assets 1,633,903 5.02 19,692 1,492,007 4.66 16,830 1,629 1,233 2,862 Nonearning assets 139,123 137,707 Total assets $ 1,773,026 $ 1,629,714 Interest bearing liabilities Interest bearing demand 141,997 0.24 86 143,811 0.23 84 (6 ) 8 2 Savings and money market 374,406 1.13 1,051 357,475 0.64 574 28 449 477 Time deposits - retail 612,148 2.14 3,263 517,209 1.43 1,848 382 1,033 1,415 Time deposits - wholesale 169,956 2.61 1,106 92,197 1.53 351 411 344 755 Total interest bearing deposits 1,298,507 1.70 5,506 1,110,692 1.03 2,857 815 1,834 2,649 Federal Home Loan Bank advances 23,668 2.97 175 79,520 2.00 397 (1,044 ) 822 (222 ) Subordinated debt 11,634 6.83 198 11,556 5.97 172 1 25 26 Total borrowed funds 35,302 4.24 373 91,076 2.51 569 (1,043 ) 847 (196 ) Total interest-bearing liabilities 1,333,809 1.77 5,879 1,201,768 1.14 3,426 (228 ) 2,681 2,453 Net interest rate spread (%) / Net interest income ($) 3.25 $ 13,813 3.52 $ 13,404 $ 1,857 $ (1,448 ) $ 409 Non-interest bearing deposits 218,512 (0.25 ) 219,860 (0.17 ) Other non-interest bearing liabilities 8,057 5,781 Stockholder's equity 212,648 202,305 Total liabilities and stockholders' equity $ 1,773,026 $ 1,629,714 Cost of funds 1.52 0.97 Net interest margin 3.57 3.74
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Six Months Ended June 30, 2019 Six Months Ended June 30, 2018 Change Interest Interest Rates / Income / Rates / Income / Average Balances Yields (%) Expense Average Balances Yields (%) Expense Due to Volume Due to Rate Total Interest earning assets Loans $ 1,257,373 5.17 $ 31,641 $ 1,104,025 4.81 $ 26,268 $ 3,492 $ 1,881 $ 5,373 Loan fees - 0.24 1,488 - 0.25 1,356 132 - 132 Loans with fees 1,257,373 5.41 33,129 1,104,025 5.06 27,624 3,624 1,881 5,505 Mortgage loans held for sale 12,635 5.60 351 31,923 5.10 807 (667 ) 211 (456 ) Deposits with banks 29,000 1.63 234 43,378 1.28 276 (189 ) 147 (42 ) Investment securities - taxable 74,948 2.93 1,090 70,162 2.76 960 68 62 130 Investment securities - tax-exempt 225,305 3.82 3,368 225,060 3.66 3,212 4 152 156 Federal funds sold and other 12,981 5.64 363 10,688 5.91 313 89 (39 ) 50 Total earning assets 1,612,242 5.01 38,535 1,485,236 4.63 33,192 2,929 2,414 5,343 Nonearning assets 139,964 136,163 Total assets $ 1,752,206 $ 1,621,399 Interest bearing liabilities Interest bearing demand 145,304 0.27 197 149,065 0.22 161 (11 ) 47 36 Savings and money market 387,296 1.14 2,181 351,058 0.60 1,052 116 1,013 1,129 Time deposits - retail 594,805 2.10 6,184 516,816 1.37 3,512 589 2,083 2,672 Time deposits - wholesale 138,466 2.56 1,756 93,970 1.47 683 418 655 1,073 Total interest bearing deposits 1,265,871 1.64 10,318 1,110,909 0.98 5,408 1,112 3,798 4,910 Federal Home Loan Bank advances and other 40,101 2.78 552 74,846 1.80 669 (729 ) 612 (117 ) Subordinated debt 11,634 6.78 391 11,546 5.75 329 2 60 62 Total borrowed funds 51,735 3.68 943 86,392 2.33 998 (727 ) 672 (55 ) Total interest-bearing liabilities 1,317,606 1.72 11,261 1,197,301 1.08 6,406 385 4,470 4,855 Net interest rate spread (%) / Net interest income ($) 3.29 $ 27,274 3.55 $ 26,786 $ 2,544 $ (2,056 ) $ 488 Non-interest bearing deposits 214,838 (0.24 ) 216,237 (0.11 ) Other non-interest bearing liabilities 8,698 5,992 Stockholder's equity 211,064 201,869 Total liabilities and stockholders' equity $ 1,752,206 $ 1,621,399 Cost of funds 1.48 0.97 Net interest margin 3.60 3.76
Table Assumptions-Average loan balances are inclusive of nonperforming loans. Yields computed on tax-exempt instruments are on a tax equivalent basis including a state tax credit included in loan yields of $300 and $600 for the three and six months ended June 30, 2019, respectively, and $25 and $50 for the same periods in 2018. Net interest spread is calculated as the yields realized on interest-bearing assets less the rates paid on interest-bearing liabilities. Net interest margin is the result of net interest income calculated on a tax-equivalent basis divided by average interest earning assets for the period. Changes in net interest income are attributed to either changes in average balances (volume change) or changes in average rates (rate change) for earning assets and sources of funds on which interest is received or paid. Volume change is calculated as change in volume times the previous rate while rate change is change in rate times the previous volume. Changes not due solely to volume or rate changes have been allocated to volume change and rate change in proportion to the relationship of the absolute dollar amounts of the change in each category.
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Analysis-For the three and six months ended June 30, 2019, we recorded net interest income of approximately $13.8 million and $27.3 million, respectively, which resulted in a net interest margin (net interest income divided by the average balance of interest earning assets) of 3.57% and 3.60%, respectively. For the three and six months ended June 30, 2018, we recorded net interest income of approximately $13.4 million and $26.8 million, respectively, which resulted in a net interest margin of 3.74% and 3.76%, respectively. The main factor contributing to the slight increase in our net interest income was an increase in our loans and the related yield. Our net interest income increase was partially offset by the increase in our cost of funds.
Our year-over-year average loan volume increased by approximately 13.9% for the first six months of 2019 compared to the first six months of 2018. Our combined loan and loan fee yield increased from 5.06% to 5.41% for the first six months of 2019 compared to 2018, while our combined loan and loan fee yield increased from 5.05% to 5.43% for the three months ended June 30, 2019 compared to the same period in 2018. The increased yield for the six months ended June 30, 2019 is primarily attributable to a 28 basis points increase in contractual loan yields and an eight basis points increase in state tax credits, and partially offset by a one basis point decrease in loan fees. The increased yield for the three months ended June 30, 2019 is primarily attributable to a 26 basis points increase in contractual loan yields, a six basis points increase in state tax credits, a two basis points increase in accretion and a one basis point increase in loan fees.
Our tax equivalent yield on tax-exempt investments increased to 3.77% and 3.82% for the three and six months ended June 30, 2019, respectively, from 3.75% and 3.66% for the same periods in 2018, respectively. This increase was primarily driven by investment restructurings in the first and second quarters of 2019. Our year-over-year average tax-exempt investment volume remained flat for the first six months of 2019 compared to the same period in 2018. Our year-over-year average taxable securities volume increased by 6.8% for the first six months of 2019 compared to the same period in 2018.
Our cost of funds increased to 1.52% and 1.48% from 0.97% and 0.97% for the three and six months ended June 30, 2019, respectively, compared to the same periods in 2018. The increase in our cost of funds was primarily driven by an across the board increase in all of our interest bearing deposits and interest bearing liabilities as well as an increase in our wholesale deposits from 28.6% of our deposit portfolio at March 31, 2019 to 30.3% at June 30, 2019. We experienced a 0.6% increase in our average non-interest bearing deposits for the three and six months ended June 30, 2019 when compared to the same periods in 2018.
The Bank strives to maintain a strong net interest margin that is insulated from changes in market interest rates. Our net interest margin, while generally considered fairly neutral, is currently subject to slightly contract in a rising rate environment and slightly expand in a falling rate environment. In the lowering interest rate environment that we anticipate, the shorter durations of our non-core funding sources are expected to contribute to interest expense savings that are expected to be slightly higher than (i) the anticipated loss of interest income that are likely to be driven by certain variable rate loans and investments repricing and (ii) the increased expenses to be incurred on our interest rate swaps.
Provision for Loan Losses
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net recoveries have been added bringing the allowance to a level which, in management's best estimate, is necessary to absorb inherent losses within the existing loan portfolio.
Based upon our evaluation of the loan portfolio, we believe the allowance for loan losses to be adequate to absorb our estimate of probable losses existing in the loan portfolio at June 30, 2019. While 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 market, 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.
We recorded a provision of $200 for loan losses for each of the three and six months ended June 30, 2019 compared to $300 and $437 for loan losses recorded for the three and six months ended June 30, 2018, respectively. Our provision for loan losses was impacted by the level of loan growth, the credit quality of the loan portfolio, and the amount of net recoveries for the three and six months ended June 30, 2019. Additionally, four out of the five previous quarters have ended with net recoveries. See "Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Comparison of Balance Sheets at June 30, 2019 and December 31, 2018 - Allowance for Loan Losses" included herein for further analysis of the provision for loan losses.
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Aug 06, 2019
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