(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 financial highlights and significant events for the three months ended March 31, 2020:
Net income (loss) attributable to common shareholders totaled $(0.2) million, or $(0.02) per diluted common share, for the three months ended March 31, 2020 compared to $3.8 million, or $0.33 per diluted common share, during same period in 2019.
In accordance with the terms of the FABK Agreement, on April 1, 2020, (i) Merger Sub merged with and into FABK, with FABK being the surviving corporation and becoming a wholly-owned subsidiary of Reliant Bancorp, and (ii) immediately following the FABK Merger, FABK merged with and into Reliant Bancorp, with Reliant Bancorp being the surviving corporation. Additionally, immediately following the Second Step Merger, FAB merged with and into Reliant Bank, with Reliant Bank being the surviving bank.
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The accounting principles we follow and our methods of applying these principles conform to 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, 2019. The following is a brief summary of the more significant policies.
Recent Events - COVID-19 Pandemic
In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of Tennessee, and most other states, have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential.
The impact of the COVID-19 pandemic is fluid and continues to evolve, adversely affecting many of the Bank's clients. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and has had an adverse effect on our business, financial condition and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.
Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. The COVID-19 pandemic has begun to have a significant impact on our business and operations. As part of our efforts to exercise social distancing, in March 2020, we closed all of our banking lobbies and are conducting most of our business at this time through drive-thru tellers and through electronic and online means. To support the health and well-being of our employees, a significant percentage of our workforce is working from home. We are focused on servicing the financial needs of our commercial and consumer clients.
We are an SBA-approved lender and have begun processing customer applications under the PPP, established under the CARES Act.
At March 31, 2020, our non-performing assets were not materially impacted by the economic pressures of COVID-19. We are closely monitoring credit risk and our exposure to increased loan losses resulting from the impact of COVID-19 on our commercial and other clients.
We are also monitoring the impact of the COVID-19 pandemic on the operations and value of our investments. Because of changing economic and market conditions affecting issuers, we may be required to recognize further impairments on the securities we hold as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio.
The market for the sale of mortgage loans has been impacted by the COVID-19 pandemic on the operations and value of our investments. Because of changing economic and market conditions affecting the sale of these types of loans, we may be required to recognize an impairment on mortgage loans held for sale.
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Critical Accounting Policies
The accounting principles we follow and our methods of applying these principles conform to 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, 2019. 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, the Bank, TRUPS, Holdings, and RMV. 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, 2020, Reliant Bancorp and TCB Holdings merged.
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 in arrears via additional capital contributions to RMV. As of March 31, 2020, RMV's cumulative losses to date totaled $14,399. RMV will have to generate net income of at least this amount before the Bank will participate in future income distributions.
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 TCB Holdings Transaction with the Company, 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 is required to establish 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 for loan losses 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 TCB Holdings Transaction 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. The Bank records 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 ("allowance") 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.
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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.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019
increased consolidated total assets from $1,898.5 million to $2,157.1 million;
Net income (loss) attributable to common shareholders amounted to $(215), or $(0.02) per basic share, for the three months ended March 31, 2020 compared to $3,824, or $0.34 per basic share, for the same period in 2019. Diluted net income (loss) attributable to common shareholders was $(0.02) per share for the three months ended March 31, 2020 compared to $0.33 per share for the three months ended March 31, 2019. The major components contributing to the change when compared to the prior year are an increase of 53.8% in noninterest expense (mainly driven by merger expenses) for the three months ended March 31, 2020, and an increase of $2,900 in provision for loan losses for the three months ended March 31, 2020, compared to the same period in 2019. These and other components of earnings are discussed further below.
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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 months ended March 31, 2020, and 2019 (dollars in thousands):
Three Months Ended Three Months Ended March 31, 2020 March 31, 2019 Change Rates / Yields Interest Income Rates / Yields Interest Income / Average Balances (%) / Expense Average Balances (%) Expense Due to Volume Due to Rate Total Interest earning assets Loans $ 1,613,033 5.01 $ 20,077 $ 1,238,341 5.16 $ 15,766 $ 7,323 $ (3,012) $ 4,311 Loan fees - 0.22 890 - 0.23 706 184 - 184 Loans with fees 1,613,033 5.23 20,967 1,238,341 5.39 16,472 7,507 (3,012) 4,495 Mortgage loans held for sale 47,685 4.72 560 10,747 5.77 153 601 (194) 407 Deposits with banks 36,062 1.38 124 27,643 1.73 118 120 (114) 6 Investment securities - taxable 74,688 2.43 451 72,464 2.82 503 93 (145) (52) Investment securities - tax-exempt 197,241 3.56 1,748 228,497 3.86 2,175 (272) (155) (427) Federal funds sold and other 16,323 3.82 155 12,650 5.83 182 220 (247) (27) Total earning assets 1,985,032 4.86 24,005 1,590,342 5.00 19,603 8,269 (3,866) 4,403 Nonearning assets 193,386 140,835 Total assets $ 2,178,418 $ 1,731,177 Interest bearing liabilities Interest bearing demand 186,236 0.22 100 148,649 0.30 111 110 (121) (11) Savings and money market 459,756 0.85 975 400,328 1.14 1,130 799 (954) (155) Time deposits - retail 541,545 1.85 2,496 577,270 2.05 2,921 (165) (260) (425) Time deposits - wholesale 229,820 2.22 1,266 106,625 2.47 650 1,057 (441) 616 Total interest bearing deposits 1,417,357 1.37 4,837 1,232,872 1.58 4,812 1,801 (1,776) 25 Federal Home Loan Bank advances 109,349 1.33 361 56,718 2.70 377 994 (1,010) (16) Subordinated debt 70,607 5.66 993 11,613 6.74 193 1,019 (219) 800 Total borrowed funds 179,956 3.03 1,354 68,331 3.38 570 2,013 (1,229) 784 Total interest-bearing liabilities 1,597,313 1.56 6,191 1,301,203 1.68 5,382 3,814 (3,005) 809 Net interest rate spread (%) / Net interest income ($) 3.30 $ 17,814 3.32 $ 14,221 $ 4,455 $ (862) $ 3,594 Noninterest bearing deposits 312,137 (0.26) 211,122 (0.24) Other noninterest bearing liabilities 27,069 9,391 Stockholder's equity 241,899 209,461 Total liabilities and stockholders' equity $ 2,178,418 $ 1,731,177 Cost of funds 1.30 1.44 Net interest margin 3.61 3.63
Table Assumptions-Average loan balances are inclusive of nonperforming loans. Interest income and yields computed on tax-exempt instruments are on a tax equivalent basis including a state tax credit included in loan yields of $304 for the three months ended March 31, 2020 and $300 for the same period in 2019. 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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Our year-over-year average loan volume increased by approximately 30.3% for the three months ended March 31, 2020 compared to the three months ended March 31, 2019 and was mainly driven by the merger with CBT. Our combined loan and loan fee yield decreased from 5.39% to 5.23% for the three months ended March 31, 2020 compared to the same period in 2019. The decreased yield for the three months ended March 31, 2020 is primarily attributable to a 13 basis points decrease in contractual loan yields including adjustment for purchase accounting accretion, a two basis points decrease in state tax credits, and a one basis point decrease in loan fees.
Our tax-equivalent yield on tax-exempt investments was 3.56% for the three months ended March 31, 2020 compared to 3.86% and for the same period in 2019. Our year-over-year average tax-exempt investment volume decreased by 13.7% for the three months ended March 31, 2020 compared to the same period in 2019 due to investment sales in the fourth quarter of 2019. Our year-over-year average taxable securities volume increased by 3.1% for the three months ended March 31, 2020 compared to the same period in 2019.
Our cost of funds decreased to 1.30% from 1.44% for the three months ended March 31, 2020 compared to the same period in 2019. The decrease in our cost of funds was primarily driven by an across the board decrease in the cost of our interest bearing deposits and other interest-bearing liabilities due to the recent decrease in rates by the Federal Reserve. We experienced a 47.8% increase in our average noninterest bearing deposits for the three months ended March 31, 2020 when compared to the same period in 2019 which is mainly attributable to the merger with CBT.
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 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. The Company has interest rate floors on certain loans and those floors will mitigate further declines in interest rates.
Provision for Loan Losses
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May 08, 2020
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