FRANKLIN FINANCIAL NETWORK, INC. The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. This discussion and analysis should be read in conjunction with the accompanying unaudited financial statements, the audited financial statements and accompanying notes included in the Company's Annual Report on Form 10-K filed with theSEC onMarch 16, 2020 , which includes additional information about critical accounting policies and practices and risk factors. Historical results and trends that might appear in the consolidated financial statements should not be interpreted as being indicative of future operations. Company Overview We are a financial holding company headquartered inFranklin, Tennessee . Through our wholly-owned bank subsidiary,Franklin Synergy Bank , aTennessee -chartered commercial bank and a member of theFederal Reserve System , we provide a full range of banking and related financial services with a focus on service to small businesses, corporate entities, local governments and individuals. We operate through 15 branches in the growingWilliamson ,Rutherford andDavidson Counties and one loan production and deposit production office inWilson County , all within the Nashville MSA. As used in this report, unless the context otherwise indicates, any reference to "Franklin Financial," "our Company," "the Company," "us," "we" and "our" refers toFranklin Financial Network, Inc. together with its consolidated subsidiaries (includingFranklin Synergy Bank ), any reference to "FFN" refers toFranklin Financial Network, Inc. only and any reference to "Franklin Synergy " or the "Bank" refers to our banking subsidiary,Franklin Synergy Bank . As ofJune 30, 2020 , we had consolidated total assets of$3,775,741 , total loans, including loans held for sale, of$2,855,910 , total deposits of$3,143,259 and total equity of$422,063 . Our principal executive office is located at722 Columbia Avenue ,Franklin, Tennessee 37064-2828, and our telephone number is (615) 236-2265. Our website is www.franklinsynergybank.com. The information contained on or accessible from our website does not constitute a part of this report and is not incorporated by reference herein. 36 -------------------------------------------------------------------------------- Table of Contents Recent Developments: Merger with FB Financial Corporation OnJanuary 21, 2020 , the Company announced a strategic merger with FB Financial Corporation that is expected to close in the third quarter of 2020, with an anticipated closing date ofAugust 15, 2020 . COVID-19 and the CARES Act The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the temporary, and in some cases permanent, shutting of businesses across the country, significant job loss, and aggressive measures by the government at the federal, state and local levels. The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company's customers operate and could impair their ability to fulfill their financial obligations to the Company. During the first quarter of 2020, theWorld Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the pandemic has caused significant disruptions in theU.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. The pandemic and its adverse consequences continued throughout the second quarter of 2020 and will likely present significant economic risks for at least the next several quarters. While there has been no material impact to the Company's employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company. TheUnited States Congress , the President ofthe United States , and theFederal Reserve have taken a multitude of actions designed to cushion the economic fallout from the COVID-19 pandemic. Most notably, the Coronavirus Aid, Relief and Economic Security ("CARES") Act was signed into law onMarch 27, 2020 as a$2.2 trillion legislative relief package. The goal of the CARES Act is to limit the impact of a potentially severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and medical providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts, together with the proposed and/or pending legislature and regulatory actions, are expected to have a material impact on our operations. It is not possible to know at this time the full universe or extent of these impacts as of the date this filing, but such impacts could be material and adverse.
Financial position and results of operations
Pertaining to ourJune 30, 2020 financial condition and results of operations, COVID-19 had an impact on our allowance for loan and lease losses ("ALLL"), and the resulting provision for loan losses was impacted by changes in economic conditions. Should economic conditions worsen, we could experience further increases in our ALLL and record additional provision expense. The execution of the payment deferral program discussed below assisted our ratio of past due loans to total loans. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged. Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we continue to work with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods. Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued may need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers' ability to repay in future periods. In an agreement with a third party provider, we sold substantially all of our SBA PPP loan portfolio that were originated and funded during the first and second quarter of 2020. This transaction allowed us to immediately recognize the origination fees paid by the SBA during the second quarter of 2020. We no longer retain the servicing or other risks associated with the administration of this transferred loan portfolio. 37 -------------------------------------------------------------------------------- Table of Contents Capital and liquidity As ofJune 30, 2020 , all of our capital ratios, and our subsidiary bank's capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses. We rely on cash on hand as well as dividends from our subsidiary bank to service our debt. If our capital deteriorates such that our subsidiary bank is unable to pay dividends to us for an extended period of time, we may not be able to service our debt. We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
Asset valuation
As ofJune 30, 2020 , following a thorough analysis and testing for goodwill impairment, management has determined that our goodwill was not impaired. It is possible that subsequent impacts of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform a subsequent goodwill impairment test and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. AtJune 30, 2020 we had goodwill of$18,176 , representing approximately 4.3% of equity.
Our processes, controls and business continuity plan
We implemented our business continuity plans in the aftermath of the earlyMarch 2020 tornadoes that severely impacted communities across Middle Tennessee and as COVID-19 was declared a global pandemic. Shortly after invoking those plans, we deployed a successful remote working strategy, provided timely communication to employees and customers, implemented protocols for employee safety, and initiated strategies for monitoring and responding to local COVID-19 impacts - including customer relief efforts. Our preparedness efforts, coupled with quick and decisive plan implementation, resulted in minimal impacts to operations as a result of COVID-19. Prior technology planning resulted in the successful deployment of the majority of our operational teams to a remote environment. These strategies and plans have continued through the second quarter and into the third quarter 2020. Due to the nature of their functions, a portion of our employees continue to operate from physical Company locations, while effectively employing social distancing standards. As ofJune 30, 2020 , more than 50% of the Company's 309 employees continued to work remotely. As our local communities begin to gradually lift workplace and social distancing restrictions, the Company plans to slowly bring employees back to their physical workplaces, in a conservative and methodical phased approach. To achieve implementation of the remote working strategy, throughout the duration of the COVID-19 pandemic thus far, we did not incur significant costs to effectively provide for proper equipment to team memberswho were required to work remotely. We do not anticipate incurring material costs related to our continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date as a result of the pandemic. To prepare for potential staffing shortages resulting from an anticipated peak in COVID-19 cases, we have assessed critical team members and determined that appropriate contingency and succession plans are in place to ensure continued operations. OurCOVID-19 Response Team continues to meet regularly to anticipate and respond to any future COVID-19 interruptions or developments. We do not anticipate significant challenges to our ability to maintain our systems and controls in light of the measures we have taken to prevent the spread of COVID-19. We do not currently face any material resource constraint through the implementation of our business continuity plans.
Lending operations and accommodations to borrowers
In keeping with regulatory guidance to work with borrowers during this
unprecedented situation, we are executing a payment deferral program for our
commercial lending clients that are adversely affected by the pandemic.
Depending on the demonstrated need of the client, the Company is deferring
either the full loan payment or the principal component of the loan payment for
typically 90 days.
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As of June 30, 2020 , the Company had 437 loans with outstanding loan balances of
$730,696 that were on temporary loan payment deferral, in accordance with the
COVID-19 relief provided by the CARES Act. As of July 31, 2020 , we had
approximately 305 loans with a balance of approximately $478,000 that had
returned to regular payment status, and we had approximately 101 loans with a
balance of approximately $253,000 that remained on a temporary payment deferral
program. In accordance with the interagency guidance issued during the period
ended June 30, 2020 , these short-term deferrals are not considered TDRs.
Credit
The Company could experience further increases in its required allowance for loan and lease losses and record additional loan loss provision expense should economic conditions worsen. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged. While all industries have and will continue to experience adverse impacts as a result of the COVID-19 pandemic, we had exposures (loans held for investment and commitments to lend) in the following loan categories considered to be "at-risk" of significant impact as ofJune 30, 2020 . Our exposure to the retail industry atJune 30, 2020 equated to approximately$253,151 , or 9.1% of total loans HFI. Our exposure to the health care industry atJune 30, 2020 equated to$345,376 , or 12.4% of total loans HFI. We have approximately 8.2% of the loans in the health care industry segment risk rated as substandard or worse. Our exposure to hotels atJune 30, 2020 equated to approximately$143,879 , or 5.1% of total loans HFI. Our exposure to restaurants atJune 30, 2020 equated to approximately$77,636 , or 2.8% of total loans HFI. AtJune 30, 2020 , our exposure to the transportation and warehousing industry was$27,236 , or 1.0% of total loans HFI. These "at-risk" loan categories as ofJune 30, 2020 totaled$847,278 , or 30.3% of total loans HFI. Commercial real estate Commercial and Commercial real non-owner occupied real % of Total Loans Industries industrial estate owner occupied estate Total HFI Retail$ 5,390 $ 39,342 $ 208,419$ 253,151 9.1 % Healthcare - Institutional 262,417 - - 262,417 9.4 % Healthcare - non-Institutional 21,354 10,900 50,705 82,959 3.0 % Total healthcare 283,771 10,900 50,705 345,376 12.4 % Hotels 371 4,293 139,215 143,879 5.1 % Restaurants 5,023 44,153 28,460 77,636 2.8 % Transportation and warehousing 19,558 1,087 6,591 27,236 1.0 % Total$ 314,113 $ 99,775 $ 433,390$ 847,278 30.3 % Transportation and Risk Rating Retail Healthcare - Institutional
Healthcare - Non-Institutional
Warehousing
Pass 95.2 % 87.0 % 97.9 % 89.6 % 90.1 % 92.0 % 93.5 %
Management Attention /
Watch(1) 1.8 % 2.3 % 2.1 % 2.2 % 9.9 % 7.0 % 6.3 %
Special mention 1.6 % - % - % - % - % 0.8 % 0.2 %
Substandard or worse 1.4 % 10.7 % - % 8.2 % - % 0.2 % - %
Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
(1) Assets included in this category are currently protected but potentially weak and require close management attention.
As a part of our continued strategic reduction in non-core assets, we reduced our Institutional loan portfolio from$429,543 atDecember 31, 2019 to$357,567 atJune 30, 2020 . Subsequent toJune 30, 2020 , we sold an additional$10,100 of loans from the Institutional portfolio, with an immaterial sales discount.
Retail operations
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We are committed to assisting our customers and communities in this time of
need. As of August 3, 2020 , the Bank was utilizing all of its fifteen branches
per normal operating procedures, except that nine of its fifteen branches were
available to customers on a drive-thru basis or by appointment only. Further, we
also continue to temporarily reduce, suspend, or eliminate certain fees for
customers eligible for relief under regulatory guidance who have been adversely
affected, and we have temporarily suspended adverse credit bureau reporting for
customers eligible for such relief under applicable regulatory guidelines.
We continue to serve our customers through our branch and drive-thru operations,
as well as through the use of our mobile banking operations, all of which are
supported by our Customer Call Center, which has operated under extended hours
during the pandemic. We have been able to conduct the vast majority of customer
business with minimal disruption to date, and our bankers and entire customer
service team are proactively and successfully managing the volume of customer
requests and issues.
The Company continues to monitor the safety of our employees, customers and
communities. At this time, our staffing is adequate to address the requests for
time off by any of our employees
Critical Accounting Policies The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted inthe United States of America and conform to general practices within the banking industry. To prepare financial statements in conformity with accounting principles generally accepted inthe United States of America , management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. Our accounting policies are integral to understanding the results reported. Accounting policies are described in Note 1 of the notes to the consolidated financial statements (unaudited) which begins on page 11. The critical accounting policies require judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. Management has established policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief summary of the more significant policies. Allowance for Loan Losses (ALLL) The ALLL is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes a loan balance has become uncollectible. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings ("TDR" or "TDRs") and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. All loans classified by management as substandard or worse are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. 40 -------------------------------------------------------------------------------- Table of Contents TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan's effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, we determine the amount of reserve in accordance with the accounting policy for the ALLL. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on a combination of the Bank's loss history and loss history from the Bank's peer group over the past three years. This actual loss experience is supplemented with other qualitative factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.Goodwill Due to the estimation process and the potential materiality of the amounts involved, the Company has also identified the accounting for goodwill as an accounting policy critical to our consolidated financial statements.Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.Goodwill acquired in a business combination has an indefinite useful life and is not systematically amortized. On at least an annual basis, with the annual evaluation occurring onDecember 31 of each year, goodwill is evaluated for impairment. The Company has only one reporting unit with$18,176 in goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, the Company would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess, not to exceed the carrying value of goodwill. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions. In our 2019 goodwill impairment evaluation, we concluded that the goodwill was not impaired. Additionally, during the period endedJune 30, 2020 , the economic turmoil and market volatility resulting from the COVID-19 crisis resulted in a decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis. In this analysis, the Company determined that none of its goodwill was impaired as ofJune 30, 2020 . Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.Goodwill is the only intangible asset with an indefinite life on the balance sheet. Status of New Accounting Standard for Allowance for Credit Losses OnJanuary 1, 2020 , ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, became effective for the Company which replaces the existing incurred loss impairment methodology for loans that are collectively evaluated for impairment with a methodology that reflects management's best estimate of lifetime expected credit losses and requires consideration of reasonable and supportable economic forecasts to develop a lifetime credit loss estimate. Topic 326 requires additional qualitative and quantitative disclosure to allow users to better understand the credit risk within the portfolio and the methodologies for determining the ACL. The CECL standard also simplifies the accounting model for purchased credit impaired loans. Additionally, Topic 326 requires expected credit losses on AFS debt securities be recorded as an ACL. For certain types of debt securities, such asU.S. Treasuries and other securities with government guarantees, entities may expect zero credit losses. In accordance with Section 4014 of the CARES Act that was signed into law onMarch 27, 2020 , we deferred implementation of CECL and thus elected to continue to utilize the ILM to calculate loan loss reserves as ofJune 30, 2020 . The temporary deferral of CECL will remain effective until the earlier of the termination of the national emergency declaration concerning the COVID-19 pandemic orDecember 31, 2020 , with an effective retrospective implementation date ofJanuary 1, 2020 . There is increased uncertainty on the local, regional, and national economy as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level. We have taken actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as actively participating in the SBA's PPP. These conditions significantly impact management's determination of a reasonable and supportable forecast, an essential requirement in the calculation of expected credit losses under CECL methodology. We believe that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses, and as such, our allowance for loan losses and provision should not be compared to those under a different accounting method (e.g., CECL). 41
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Our CECL implementation efforts will remain in process in order to adequately comply with the provisions of CECL once the deferral period ceases. Management will continue to measure and monitor the estimated impacts of CECL adoption through continued parallel testing of model simulations based on our portfolio composition and current expectations of future economic conditions. Prior to the CARES Act being signed and our decision to delay the implementation of CECL, we were completing our CECL implementation plan, under the direction of our Chief Financial Officer,Chief Credit Officer , Chief Operating Officer, and Controller. The working group also included individuals from various functional areas including credit, risk management, accounting and information technology, among others. Our implementation plan included assessment and documentation of processes, internal controls and data sources; model development, documentation and validation; Board approval of a CECL Policy; and system configuration, among other things. Additionally, a third-party vendor remains under contract to assist us in the implementation of CECL.
We are unable as of the date of this report to provide an estimate of our
allowance for loan losses under the CECL model as of
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COMPARISON OF RESULTS OF OPERATIONS FOR
THE THREE MONTHS ENDED JUNE 30, 2020 and 2019
(Dollar Amounts in Thousands)
Overview
The Company's net income was $10,182 and $9,034 for the three and six months
ended June 30, 2020 compared to net income of $5,181 and $8,083 for the three
and six months ended June 30, 2019 , an increase of $5,001 quarter-over-quarter
and an increase of $951 year-over-year. After earnings attributable to
noncontrolling interest, the Company's net earnings available to common
shareholders for the three and six months ended June 30, 2020 was $10,174 and
$9,026 , respectively, compared to $5,173 and $8,075 for the three and six months
ended June 30, 2019 , respectively. Net income available to common shareholders
increased by $5,001 and $951 for the three and six months ended June 30, 2020 ,
respectively, compared to the three and six months ended June 30, 2019 . The
increase in net income was primarily related to a decrease of $15,762 and $9,802
in interest expense paid when comparing the same three and six month periods.
Net Interest Income Margin (NIM)
Net interest income consists of interest income generated by earning-assets less
interest expense paid on interest-bearing liabilities and is the most
significant component of our revenues. Net interest income for the three and six
months ended June 30, 2020 totaled $29,528 and $56,992 , respectively, compared
to $27,365 and $54,785 for the same periods in 2019, an increase of $2,163 and
$2,207 , between the respective periods.
The net interest margin was 3.26% for the three months ended June 30, 2020 , a 42
basis point increase quarter-over-quarter, and a 32 basis point increase
year-over-year. The current increase was primarily driven by the accelerated
loan fees due to the third party PPP loan sale, which contributed 13 basis
points to the NIM. Excluding the recognition of $1,491 of PPP loan fees, NIM
would have been 3.13%.
Tax-equivalent interest income was $40,314 and $82,458 for the three and six
months ended June 30, 2020 , when compared to $48,009 and $96,067 for the same
periods last year, a decrease of 16.0% and 14.2%. The yield on average interest
earning assets, adjusted for tax equivalent yield, decreased 51 and 39 basis
points to 4.38% and 4.46% when comparing the three and six months ended June 30,
2020 to the same periods during 2019. For the three and six months ended
June 30, 2020 , the tax equivalent yield on loans held for investment was 5.10%
and 5.15%, compared to 5.61% and 5.61% during the same periods in 2019. The
primary driver for the decrease in yields on loans was the decrease in market
interest rates when compared to the same periods in the previous year.
Interest-earning assets averaged $3,701,515 and $3,940,266 during the three
months ended June 30, 2020 and 2019, respectively, a decrease of $238,751 , or
6.1%. Interest-earning assets averaged $3,714,179 and $3,991,961 during the six
months ended June 30, 2020 and 2019, respectively, a decrease of $277,782 , or
7.0%. These decreases were due to the strategically planned asset rotation and
decrease in the total investment securities during 2019 and 2020. Average
investment securities decreased $355,218 and $417,465 , or decreased 40.3% and
42.1%, and average loans held for investment increased $11,512 and $40,242 or
0.4% and 1.4% when comparing the three and six months ended June 30, 2020 with
the same periods in 2019.
Interest-bearing liabilities averaged $2,950,106 and $3,340,033 during the three
months ended June 30, 2020 and 2019, respectively, a decrease of $389,927 , or
11.7%. Interest-bearing liabilities averaged $3,013,187 and $3,416,223 during
the six months ended June 30, 2020 and 2019, respectively, a decrease of
$403,036 , or 11.8%. Total average money market deposits increased $302,348 and
$275,204 , respectively, or 29.5% and 27.3%, respectively for the three and six
months ended June 30, 2020 , as compared to the same periods during 2019.
Average FHLB advances decreased $208,282 and $219,305 , or decreases of 59.6% and
61.2%, respectively when comparing the three and six months ended June 30, 2020
with the same periods in 2019 as a result of the organic growth in the loan
portfolio. For the three and six months ended June 30, 2020 and 2019, the cost
of average interest-bearing liabilities decreased 101 and 74 basis points,
respectively to 1.40% from 2.41% comparing three month periods and to 1.63% from
2.37% comparing six month periods.
Total non-interest deposits averaged $455,540 , an increase of $142,436 , or
45.5%, during the three months ended June 30, 2020 , compared to the same period
during 2019. Total non-interest deposits averaged $394,712 , an increase of
$92,512 , or 30.6%, during the six months ended June 30, 2020 , compared to the
same period during 2019.
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The tables below summarize average balances, annualized yields and rates, cost
of funds, and the analysis of changes in interest income and interest expense
for the three and six months ended June 30, 2020 and 2019:
Average Balances-Yields & Rates (7)
(Dollars are in thousands)
Three Months Ended
2020 2019
Average Average
Average Interest Yield / Average Interest Yield /
Balance Inc / Exp Rate Balance Inc / Exp Rate
ASSETS:
Loans(1)(6) $ 2,870,460 $ 36,401 5.10 % $ 2,858,948 $ 40,003 5.61 %
Loans held for sale 48,899 290 2.39 23,883 256 4.30
Securities:
Taxable 299,546 1,700 2.28 673,386 4,614 2.75
Tax-exempt(6) 227,039 1,651 2.92 208,417 1,909 3.67
Restricted equity securities 24,675 220 3.59 24,331 350 5.77
Certificates of deposit at
other financial institutions 3,445 20 2.33 3,759 22 2.35
Federal funds sold and
other(2) 227,451 32 0.06 147,542 855 2.32
TOTAL INTEREST EARNING ASSETS $ 3,701,515 $ 40,314 4.38 % $ 3,940,266 $ 48,009 4.89 %
Allowance for loan and lease
losses (38,211) (28,007)
All other assets 205,647 192,843
TOTAL ASSETS $ 3,868,951 $ 4,105,102
LIABILITIES & EQUITY
Deposits:
Interest checking $ 800,030 $ 1,913 0.96 % $ 816,429 $ 4,357 2.14 %
Money market 1,328,548 3,758 1.14 1,026,200 6,103 2.39
Savings 42,662 29 0.27 38,882 27 0.28
Time deposits 567,477 3,229 2.29 1,036,904 6,192 2.40
Federal Home Loan Bank
advances and other (8) 141,333 265 0.75 349,615 2,237 2.57
Federal funds purchased and
other(3) 11,124 10 0.36 13,249 90 2.72
Subordinated notes 58,932 1,082 7.38 58,754 1,082 7.39
TOTAL INTEREST BEARING
LIABILITIES $ 2,950,106 $ 10,286 1.40 % $ 3,340,033 $ 20,088 2.41 %
Demand deposits 455,540 313,104
Other liabilities 51,943 63,505
Total equity 411,362 388,460
TOTAL LIABILITIES AND EQUITY $ 3,868,951 $ 4,105,102
NET INTEREST SPREAD(4) 2.98 % 2.48 %
NET INTEREST INCOME $ 30,028 $ 27,921
NET INTEREST MARGIN(5) 3.26 % 2.84 %
(1)Loan balances include loans held in the Bank's portfolio and are net of
deferred origination fees and costs. Non-accrual loans are included in total
loan balances.
(2)Includes federal funds sold and interest-bearing deposits at the Federal
Reserve Bank , the Federal Home Loan Bank and other financial institutions.
(3)Includes repurchase agreements.
(4)Represents the average rate earned on interest-earning assets minus the
average rate paid on interest-bearing liabilities.
(5)Represents net interest income (annualized) divided by total average earning
assets.
(6)Interest income and rates include the effects of tax-equivalent adjustments
to adjust tax-exempt interest income on tax-exempt loans and investment
securities to a fully taxable basis.
(7)Average balances are average daily balances.
(8)Includes finance lease.
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Average Balances-Yields & Rates (7)
(Dollars are in thousands)
Six Months Ended June 30,
2020 2019
Average Average
Average Interest Yield / Average Interest Yield /
Balance Inc / Exp Rate Balance Inc / Exp Rate
ASSETS:
Loans(1)(6) $ 2,852,449 $ 73,108 5.15 % $ 2,812,207 $ 78,241 5.61 %
Loans held for sale 42,783 669 3.14 % 16,565 371 4.52 %
Securities:
Taxable 349,340 4,124 2.37 % 795,788 11,008 2.79 %
Tax-exempt(6) 224,115 3,523 3.16 % 195,132 3,899 4.03 %
Restricted equity securities 24,750 382 3.10 % 23,213 679 5.90 %
Certificates of deposit at
other financial institutions 3,435 40 2.34 % 3,676 42 2.30 %
Federal funds sold and
other(2) 217,307 612 0.57 % 145,380 1,827 2.53 %
TOTAL INTEREST EARNING ASSETS $ 3,714,179 $ 82,458 4.46 % $ 3,991,961 $ 96,067 4.85 %
Allowance for loan and lease
losses (41,656) (26,041)
All other assets 201,941 196,446
TOTAL ASSETS $ 3,874,464 $ 4,162,366
LIABILITIES & EQUITY
Deposits:
Interest checking $ 838,891 $ 5,313 1.27 % $ 836,650 $ 8,777 2.12 %
Money market 1,284,817 8,688 1.36 % 1,009,613 12,082 2.41 %
Savings 41,359 56 0.27 % 39,741 55 0.28 %
Time deposits 642,885 7,118 2.23 % 1,100,929 12,755 2.34 %
Federal Home Loan Bank
advances and other (8) 139,325 1,066 1.54 % 358,630 4,196 2.36 %
Federal funds purchased and
other(3) 7,000 24 0.69 % 11,929 162 2.74 %
Subordinated notes 58,910 2,164 7.39 % 58,731 2,164 7.43 %
TOTAL INTEREST BEARING
LIABILITIES $ 3,013,187 $ 24,429 1.63 % $ 3,416,223 $ 40,191 2.37 %
Demand deposits 394,712 302,200
Other liabilities 52,625 61,133
Total equity 413,940 382,811
TOTAL LIABILITIES AND EQUITY $ 3,874,464 $ 4,162,367
NET INTEREST SPREAD(4) 2.83 % 2.48 %
NET INTEREST INCOME $ 58,029 $ 55,876
NET INTEREST MARGIN(5) 3.14 % 2.82 %
(1)Loan balances include loans held in the Bank's portfolio and are net of
deferred origination fees and costs. Non-accrual loans are included in total
loan balances.
(2)Includes federal funds sold and interest-bearing deposits at the Federal
Reserve Bank , the Federal Home Loan Bank and other financial institutions.
(3)Includes repurchase agreements.
(4)Represents the average rate earned on interest-earning assets minus the
average rate paid on interest-bearing liabilities.
(5)Represents net interest income (annualized) divided by total average earning
assets.
(6)Interest income and rates include the effects of tax-equivalent adjustments
to adjust tax-exempt interest income on tax-exempt loans and investment
securities to a fully taxable basis.
(7)Average balances are average daily balances.
(8)Includes finance lease.
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Analysis of Changes in Interest Income and Expenses
Net change three months ended
June
30, 2020 versus
Volume Rate Net Change
INTEREST INCOME
Loans $ 166 $ (3,768) $ (3,602)
Loans held for sale 267 (233) 34
Securities
Taxable (2,566) (348) (2,914)
Tax-exempt 173 (431) (258)
Restricted equity securities 5 (136) (131)
Certificates of deposit at other financial institutions (2) - (2)
Federal funds sold and other 464 (1,286) (822)
TOTAL INTEREST INCOME $ (1,493) $ (6,202) $ (7,695)
INTEREST EXPENSE
Deposits
Interest checking $ (87) $ (2,357) $ (2,444)
Money market accounts 1,805 (4,150) (2,345)
Savings 3 (1) 2
Time deposits (2,812) (151) (2,963)
Federal Home Loan Bank advances and other(1) (1,333) (639) (1,972)
Federal funds purchased and other(2) (14) (66) (80)
Subordinated notes 3 (3) -
TOTAL INTEREST EXPENSE $ (2,435) $ (7,367) $ (9,802)
NET INTEREST INCOME $ 942
(1) Includes finance lease.
(2) Includes repurchase agreements.
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Net change six months ended
June 30, 2020 versus June 30, 2019
Volume Rate Net Change
INTEREST INCOME
Loans $ 1,120 $ (6,253) $ (5,133)
Loans held for sale 587 (289) 298
Securities
Taxable (6,176) (708) (6,884)
Tax-exempt 579 (955) (376)
Restricted equity securities 45 (342) (297)
Certificates of deposit at other financial (3) 1 (2)
institutions
Federal funds sold and other 904 (2,119) (1,215) TOTAL INTEREST INCOME$ (2,944) $ (10,665) $ (13,609) INTEREST EXPENSE Deposits Interest checking$ 24 $ (3,488) $ (3,464) Money market accounts 3,293 (6,687) (3,394) Savings 2 (1) 1 Time deposits (5,307) (330) (5,637) Federal Home Loan Bank advances and other(1) (2,566) (564) (3,130) Fed funds purchased and other(2) (67) (71) (138) Subordinated Notes 7 (7) - TOTAL INTEREST EXPENSE$ (4,614) $ (11,148) $ (15,762) NET INTEREST INCOME$ 1,670
(1) Includes finance lease. (2) Includes repurchase agreements. Provision for Loan Losses The provision for loan losses represents a charge to earnings necessary to establish an ALLL that, in management's evaluation, should be adequate to provide coverage for the probable losses incurred in the loan portfolio. The allowance is increased by the provision for loan losses and is decreased by charge-offs, net of recoveries on prior loan charge-offs. The provision for loan losses was$3,195 and$7,031 for the three months endedJune 30, 2020 and 2019, respectively, and$16,217 and$12,086 for the six months endedJune 30, 2020 , and 2019. The loan loss provision of$3,195 recorded for the three months endedJune 30, 2020 was mostly due to increased quantitative loss factors, as well as an increase in qualitative risk factors due to COVID-19. When combined with the cumulative$32,000 in loan loss provisions recorded in the fourth quarter of 2019 and the first quarter of 2020, and netted against the cumulative$23,600 in net charge-offs recorded in the fourth quarter of 2019 through the second quarter of 2020, the$3,195 loan loss provision recorded for the second quarter of 2020 resulted in a net ALLL build of approximately$11,600 , or an increase of approximately 43.9% since the third quarter of 2019. Non-Interest Income Non-interest income for the three and six months endedJune 30, 2020 was$10,555 and$16,448 compared to$4,923 and$8,410 for the same periods in 2019, respectively. The$5,632 quarter-over-quarter increase during the second quarter of 2020 and the$8,038 increase during the six months endedJune 30, 2020 , was primarily the result of strong mortgage banking revenue, driven by a combination of historically low interest rates, strong origination pipelines and team, as well as favorable secondary market execution and pricing during the quarter. 47
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The following is a summary of the components of non-interest income (in
thousands):
Three Months Ended $ %
June 30, Increase Increase
2020 2019 (Decrease) (Decrease)
Service charges on deposit accounts
$ (3) (3.9) % Other service charges and fees 1,397 903 494 54.7 Mortgage banking revenue 8,688 2,473 6,215 251.3 % Wealth management 702 673 29 4.3 % Gain on sale or call of securities 166 367 (201) (54.8) Net loss on sale of loans (372) 3 (375) NM Net gain on sale of foreclosed assets 5 3 2 66.7 Other (105) 424 (529) (124.8) Total non-interest income$ 10,555 $ 4,923 $ 5,632 114.4 % Six Months Ended $ % June 30, Increase Increase 2020 2019 (Decrease) (Decrease)
Service charges on deposit accounts
9.9 %
Other service charges and fees 2,294 1,660 634 38.2
Mortgage banking revenue 11,373 4,145 7,228 174.4
Wealth management 1,516 1,300 216 16.6
Gain on sale or call of securities 1,562 517 1,045 202.1
Net loss on sale of loans (788) (214) (574) 268.2
Net gain on sale of foreclosed assets 7 7 - - %
Other 318 844 (526) (62.3)
Total non-interest income $ 16,448 $ 8,410 $ 8,038 95.6 %
Mortgage banking revenue increased $6,215 and $7,228 , or 251.3% and 174.4% for
the three and six months ended June 30, 2020 , compared to the same periods in
2019. The increase was due to the volume of mortgage loans originated, the sales
related to those loans and more favorable market rates in 2020, which resulted
in favorable fair value adjustments on mortgage derivatives. The Federal Reserve
increased rates 100 basis points in 2018 but then decreased rates 75 basis
points during the third and fourth quarters of 2019 and then decreased rates by
an additional 150 basis points in the first quarter of 2020, resulting in a
current target rate range of zero to 25 basis points at the end of June 30,
2020 .
Gain (loss) on sale or call of securities decreased $201 for the three months
ended June 30, 2020 and increased $1,045 for the six months ended June 30, 2020 ,
when compared with the same periods in 2019. The decrease and increase was due
to the Company's election to sell certain securities to take advantage of the
market conditions that existed during that period, at which time, management
elected to sell certain of its securities as part of its balance sheet
management initiatives.
Net loss on sale of loans was $375 and $574 for the three and six months ended
June 30, 2020 compared to the same periods in 2019. The loss for the three and
six months ended June 30, 2020 was attributed to sales of the PPP loans to a
third party during the second quarter of 2020 and sales of SNC loans during the
first quarter of 2020.
Non-Interest Expense
Non-interest expense increased for the three and six months ended June 30, 2020
to $23,976 and $46,397 from $19,370 and $41,986 for the same periods in 2019.
The increases were the result of the following components listed in the table
below (in thousands):
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Three Months Ended $ %
June 30, Increase Increase
2020 2019 (Decrease) (Decrease)
Salaries and employee benefits $ 14,762 $ 11,365 $ 3,397 29.9 %
Occupancy and equipment 2,832 3,283 (451) (13.7) %
FDIC assessment expense 900 660 240 36.4 %
Marketing 133 301 (168) (55.8) %
Professional fees 2,345 1,073 1,272 118.5 %
Amortization of core deposit intangible 82 132 (50) (37.9) %
Other 2,922 2,556 366 14.3 %
Total non-interest expense $ 23,976 $ 19,370 $ 4,606 23.8 %
Six Months Ended $ %
June 30, Increase Increase
2020 2019 (Decrease) (Decrease)
Salaries and employee benefits $ 27,342 $ 26,108 $ 1,234 4.7 %
Occupancy and equipment 5,918 6,396 (478) (7.5)
FDIC assessment expense 1,350 1,650 (300) (18.2)
Marketing 378 620 (242) (39.0)
Professional fees 5,413 1,996 3,417 171.2
Amortization of core deposit intangible 177 277 (100) (36.1)
Other 5,819 4,939 880 17.8
Total non-interest expense $ 46,397 $ 41,986 $ 4,411 10.5 %
Salaries and employee benefits increased $3,397 , or 29.9%, while professional
fees increased $1,272 , or 118.5% when comparing the three months ended June 30,
2020 with the same period in 2019. Salaries and employee benefits increased
$1,234 , or 4.7%, respectively, while professional fees increased $3,417 , or
171.2% when comparing the six months ended June 30, 2020 with the same period in
2019. These variations are attributable to employee-related adjustments and
professional fees occurring due to our upcoming strategic merger with FB
Financial Corporation expected to close in third quarter 2020, with an
anticipated closing date of August 15, 2020 .
Income Tax Expense
We recognized income tax expense for the three and six months ended June 30,
2020 of $2,730 and $1,792 compared to an income tax expense of $706 and $1,040
for the three and six months ended June 30, 2019 . Our quarter-to-date income tax
expense for the period ended June 30, 2020 reflects an effective income tax rate
of 21.1% which is an increase compared to 12.0% for the same period in 2019. Our
year-to-date income tax expense for the period ended June 30, 2020 reflects an
effective income tax rate of 16.6% which is an increase compared to 11.4% for
the same period in 2019. The primary drivers are from pre-tax income increasing
7,025 and $1,703 compared to the same periods in 2019 as a result of recognizing
a decrease in provision for loan losses of 3,836 for the three months ended June
30, 2020 when compared to the same periods in 2019, and recognizing an increase
in provision for loan losses of $4,131 for the six months ended June 30, 2020
when compared to the same periods in 2019.
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COMPARISON OF BALANCE SHEETS AT
(Dollar Amounts in Thousands)Overview
Our total assets decreased by$120,421 , or a 12.4% annualized rate, fromDecember 31, 2019 toJune 30, 2020 . The decrease in total assets has primarily been the result of the continued balance sheet rotation and optimization strategies and the planned sales of investment securities during the twelve months betweenJune 30, 2020 andJune 30, 2019 , and a planned offset by organic growth in the loan portfolio. Loans Lending-related income is the most important component of our net interest income and is a major contributor to profitability. The loan portfolio is the largest component of earning assets, and therefore generates the largest portion of revenues. For purposes of the discussion in this section, the term "loans" refers to loans, excluding loans held for sale, unless otherwise noted. The absolute volume of loans and the volume of loans as a percentage of earning assets is an important determinant of net interest margin as loans are expected to produce higher yields than securities and other earning assets. Total loans, net of deferred fees, atJune 30, 2020 andDecember 31, 2019 were$2,794,768 and$2,812,444 , respectively, a decrease of$17,676 or a decrease of 2.5% annualized. As a percentage of total assets, total loans, net of deferred fees, atJune 30, 2020 andDecember 31, 2019 were 74.0% and 72.2%, respectively. The decrease in the loans HFI is primarily due to the continued reduction in the Institutional loan portfolio that occurred during the second quarter of 2020. The table below provides a summary of the loan portfolio composition for the periods noted. June 30, 2020 December 31, 2019 % of Total % of Total Types of Loans Amount Loans Amount Loans Total loans Real estate: Construction and land development$ 645,281 23.1 %$ 591,541 21.0 % Commercial 1,017,429 36.3 % 993,912 35.2 % Residential 611,532 21.9 % 643,601 22.9 % Commercial and industrial 520,413 18.6 % 582,641 20.7 % Consumer and other 3,570 0.1 % 4,769 0.2 % Total gross loans$ 2,798,225 100.0 %$ 2,816,464 100.0 % Less: deferred loan fees, net (3,457) (4,020) Total loans, net of deferred loan fees$ 2,794,768 $ 2,812,444 Less: allowance for loan losses (38,100) (45,436) Total loans, net allowance for loan losses$ 2,756,668 $ 2,767,008 Real estate loans comprised 81.3% of the loan portfolio atJune 30, 2020 . The largest portion of the real estate segments as ofJune 30, 2020 , was commercial real estate loans, which totaled 44.7% of real estate loans. Commercial real estate loans totaled$1,017,429 atJune 30, 2020 , and comprised 36.3% of the total loan portfolio. The commercial real estate loan classification primarily includes commercial-based mortgage loans that are secured by nonfarm, nonresidential real estate properties and other properties. Construction and land development loans totaled$645,281 atJune 30, 2020 , and comprised 28.4% of total real estate loans and 23.1% of the total loan portfolio. Loans in this classification provide financing for the construction and development of residential properties and commercial income properties, multi-family residential development, and land designated for future development. This portfolio has remained steady in absolute dollar terms since 2017, representing a lower corresponding portion of the loan portfolio. The residential real estate classification primarily includes 1-4 family residential loans which are typically conventional first-lien home mortgages, not including loans held-for-sale in the secondary market, and it also includes home equity lines of credit 50 -------------------------------------------------------------------------------- Table of Contents and other junior lien mortgage loans. Residential real estate loans totaled$611,532 and comprised 26.9% of real estate loans and 21.9% of total loans atJune 30, 2020 . Commercial and industrial loans totaled$520,413 atJune 30, 2020 . Loans in this classification comprised 18.6% of total loans atJune 30, 2020 . The commercial and industrial classification consists of commercial loans to small-to-medium sized businesses, shared national credits, and commercial healthcare loans. This net loan decline for the second quarter of 2020 was driven partly by the$5,924 linked-quarter reduction in the SNC portfolio to a balance of$99,602 , representing a 56.9% year-over-year and 22.6% annualized linked-quarter decrease. This is the lowest SNC balance held by the Company during the last six quarters, representing 3.6% of loans HFI, which is almost half of the Company's concentration of 9.3% of loans HFI at the peak of the SNC portfolio atDecember 31, 2018 . Non-SNC loan decline in the second quarter was$11,752 , representing an annualized decline of 1.7% from the first quarter of 2020 and is primarily due to the second quarter continued Institutional loan portfolio reduction. AtJune 30, 2020 , the Company estimates approximately$294,290 , or approximately 41%, of the$727,036 unused lines of credit are available to be drawn by customers without further approval by the Bank. The tables below provide a summary of the Institutional loan portfolio for the periods noted: Corporate and Healthcare June 30, March 31, December 31, September 30, June 30, QoQ YoY portfolios(1) 2020 2020 2019 2019 2019 Change* Change Corporate$ 95,150 $ 102,370 $ 139,840 $ 133,386 $ 170,125 (28.4 %) (44.1 %) Portion SNC 34,912 36,011 59,339 58,544 112,756 (12.3 %) (69.0 %) Portion not SNC 60,238 66,359 80,501 74,842 57,369 (37.1 %) 5.0 % Healthcare 262,417 306,343 289,703 273,106 329,818 (57.7 %) (20.4 %) SNC 64,690 69,515 77,319 85,932 118,460 (27.9 %) (45.4 %) Non-SNC 197,727 236,828 212,384 187,174 211,358 (66.4 %) (6.4 %) Total Institutional$ 357,567 $ 408,713 $ 429,543 $ 406,492 $ 499,943 (50.3 %) (28.5 %) Commercial and industrial(1) 519,040 579,751 580,696 576,018 666,025 (42.1 %) (22.1 %) Percent of Institutional within commercial and industrial 69 % 70 % 74 % 71 % 75 % Total SNC$ 99,602 $ 105,526 $ 136,658 $ 144,476 $ 231,216 (22.6 %) (56.9 %) Percent of total loans HFI 3.6 % 3.7 % 4.9 % 5.2 % 8.0 %
*Annualized
(1) Loan balances are net of deferred loan fees and costs.
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June 30, March 31, December 31, September 30, June 30,
Institutional loans asset quality 2020 2020 2019 2019 2019
Corporate loans $ 95,150 $ 102,370 $ 139,840 $ 133,386 $ 170,125
Loans classified as criticized or
worse - 17,608 17,598 -
Loans criticized or worse as % of
corporate loans - % - % 12.6 % 13.2 % - %
Loans requiring specific reserve $ - $ -
$ - $ -
Specific reserve - - 13,894 - -
Specific reserve as % impaired
corporate loans - % - % 78.9 % - % - %
Net (charge-offs) recoveries $ 1,586 $ (20,428) $ - $ - $ -
Healthcare loans $ 262,417 $ 306,343 $ 289,703 $ 273,106 $ 329,818
Loans classified as criticized or
worse 28,209 33,735 21,517 21,554 20,699
Loans criticized or worse as a %
of healthcare loans 10.7 % 11.0 % 7.4 % 7.9 % 6.3 %
Loans requiring specific reserve
$ - $ 2,193
Specific reserve 1,339 6,544 6,667 - 2,193
Specific reserve as % of impaired
healthcare loans 100.0 % 99.3 % - % - % 100.0 %
Net (charge-offs) recoveries
Total Institutional$ 357,567 $ 408,713 $ 429,543
The repayment of loans is a source of additional liquidity for the Company. The
following table sets forth the loans maturing within specific intervals at
Loan Maturity Schedule
June 30, 2020
Over one
One year year to five Over five
or less years years Total
Real estate:
Construction and land development $ 276,339 $ 199,263 $ 169,679 $ 645,281
Commercial 46,066 303,813 667,550 1,017,429
Residential 30,604 158,439 422,489 611,532
Commercial and industrial 103,934 337,695 78,784 520,413
Consumer and other 1,772 1,576 222 3,570
Total $ 458,715 $ 1,000,786 $ 1,338,724 $ 2,798,225
Fixed interest rate $ 140,884 $ 442,891 $ 451,154 $ 1,034,929
Variable interest rate 317,831 557,895 887,570 1,763,296
Total $ 458,715 $ 1,000,786 $ 1,338,724 $ 2,798,225
The information presented in the above table is based upon the contractual
maturities of the individual loans, including loans which may be subject to
renewal at their contractual maturity. Renewal of such loans is subject to
review and credit approval, as well as modification of terms upon their
maturity. Consequently, management believes this treatment presents fairly the
maturity structure of the loan portfolio.
Allowance for Loan Losses (ALLL)
The Company maintains an ALLL that management believes is adequate to absorb the
probable incurred losses inherent in the Company's loan portfolio. The allowance
is increased by provisions for loan losses charged to earnings and is decreased
by loan charge-offs net of recoveries of prior period loan charge-offs. The
level of the allowance is determined on a quarterly
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basis, although management is engaged in monitoring the adequacy of the
allowance on a more frequent basis. In estimating the allowance balance, the
following factors are considered:
•past loan experience;
•the nature and volume of the portfolio;
•risks known about specific borrowers;
•underlying estimated values of collateral securing loans;
•current and anticipated economic conditions; and
•other factors which may affect the allowance for probable incurred losses.
The ALLL consists of two primary components: (1) a specific component which
relates to loans that are individually classified as impaired; and (2) a general
component which covers non-impaired loans and is based on historical loss
experience adjusted for current factors. The historical loss experience is
determined by portfolio segment and is based on a combination of the Company's
loss history and loss history from peer group data over the past three years.
This actual loss experience is supplemented with other economic factors based on
the risks present for each portfolio segment.
The following loan portfolio segments have been identified: (1) Construction and
land development loans; (2) Commercial real estate loans; (3) Residential real
estate loans; (4) Commercial and industrial loans; and (5) Consumer and other
loans. Management evaluates the risks associated with these segments based upon
specific characteristics associated with the loan segments. These risk
characteristics include, but are not limited to, the value of the underlying
collateral, adverse economic conditions and the borrower's cash flow. While the
total allowance consists of a specific portion and a general portion, both
portions of the allowance are available to provide for probable incurred loan
losses in the entire portfolio.
In the table below, the components, as discussed above, of the ALLL are shown at
June 30, 2020 and December 31, 2019 .
June 30, 2020 December 31, 2019 Increase (Decrease)
ALLL to % ALLL to %
HFI Loan ALLL Total Loans HFI Loan ALLL Total Loans Loan ALLL
Balance(1) Balance HFI Balance(1) Balance HFI Balance Balance
Non impaired loans $ 2,724,103 $ 36,501 1.34 % $ 2,730,684 $ 24,588 0.90 % $ (6,581) $ 11,913 44 bps
Acquired loans (2) 47,053 71 0.15 % 58,745 77 0.13 % (11,692) (6) 2 bps
Impaired loans 27,069 1,528 5.64 % 27,035 20,771 76.83 % 34 (19,243) (7,119) bps
Total loans $ 2,798,225 $ 38,100 1.36 % $ 2,816,464 $ 45,436 1.61 % $ (18,239) $ (7,336) (25) bps
(1) HFI loan balance is before net deferred loan fees and costs.
(2) Acquired loans are performing loans recorded at estimated fair value at the acquisition date. Based on the analysis performed by management as of
AtJune 30, 2020 , the ALLL was$38,100 , compared to$45,436 atDecember 31, 2019 . The ALLL as a percentage of total loans HFI was 1.36% atJune 30, 2020 and 1.61% atDecember 31, 2019 . As ofJune 30, 2020 , the Company's total non-performing assets ("NPAs") were 0.65% of assets, or$24,433 , a decrease of approximately$3,256 fromDecember 31, 2019 . The NPA/ALLL coverage ratio was 1.56 atJune 30, 2020 , a decrease of 8 basis points from the 1.64 coverage present atDecember 31, 2019 . Criticized and Classified Assets were$50,683 atJune 30, 2020 , representing 1.81% of loans HFI, consistent with 1.86% of loans HFI atDecember 31, 2019 . Potential problem loans, which are not included in nonperforming assets, amounted to$17,914 , or 0.64% of total loans held for investment atJune 30, 2020 , compared to$22,228 , or 0.79% of total loans held for investment atDecember 31, 2019 . Potential problem loans represent those loans where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is for substandard loans, which are still accruing interest and excluding the impact of substandard nonaccrual loans. The Company also monitors the aging of loans less than 90 days past due and the loans that have been deferred under the Company's COVID-19 related payment deferral program as reported in Notes 1 and 3 in the Condensed Notes to Interim Consolidated Financial Statements. 53
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The table below sets forth the activity in the ALLL for the periods presented.
Six Months Ended Six Months Ended
June 30, 2020 June 30, 2019
Beginning balance $ 45,436 $ 23,451
Loans charged-off:
Residential real estate 8 15
Commercial & industrial 25,664 8,131
Consumer & other 24 99
Total loans charged-off 25,696 8,245
Recoveries on loans previously charged-off:
Residential real estate 1 15
Commercial & industrial 2,130 71
Consumer & other 12 65
Total loan recoveries 2,143 151
Net charge-offs (23,553) (8,094)
Provision for loan losses charged to expense 16,217 12,086
Total allowance at end of period $ 38,100 $ 27,443
Total loans, gross, at end of period(1) $ 2,798,225 $ 2,884,510
Average gross loans(1) $ 2,856,722 $ 2,811,954
Allowance to total loans 1.36 % 0.95 %
Net charge-offs (recoveries) to average loans, annualized 1.66 % 0.58 %
(1)Loan balances exclude loans held for sale
While no portion of the allowance is in any way restricted to any individual
loan or group of loans, and the entire allowance is available to absorb losses
from any and all loans, the following table summarizes the allocation of ALLL by
loan category and loans in each category as a percentage of total loans, for the
periods presented.
June 30, 2020 December 31, 2019
% of % of
Loan Segment to Loan Segment to
Amount Total Loans Amount Total Loans
Real estate loans:
Construction and land development $ 6,519 23.1 % $ 4,847 21.0 %
Commercial 9,558 36.3 8,113 35.3
Residential 4,479 22.0 4,462 22.8
Total real estate $ 20,556 81.3 $ 17,422 79.1
Commercial and industrial 16,677 18.6 27,957 20.7
Consumer and other 867 0.1 57 0.2
$ 38,100 100.0 % $ 45,436 100.0 %
Nonperforming Assets
Non-performing loans consist of non-accrual loans and loans that are past due 90
days or more and still accruing interest. Non-performing assets consist of
non-performing loans plus foreclosed real estate. Loans are placed on
non-accrual status when they are past due 90 days and/or management believes the
borrower's financial condition, after giving consideration to economic
conditions and collection efforts, is such that collection of interest is
doubtful. When a loan is placed on non-accrual status, interest accruals cease,
and uncollected interest is reversed and charged against current income. The
interest on these loans is accounted for on the cash-basis, or cost-recovery
method, until qualifying for return to accrual. Loans are returned to accrual
status when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
The primary component of non-performing loans is non-accrual loans, which as of
June 30, 2020 totaled $24,433 . At June 30, 2020 , there were no loans past due
greater than 90 days and still accruing interest which is the other component of
non-
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performing loans. Loans past due greater than 90 days are placed on non-accrual
status, unless they are both well-secured and in the process of collection.
The table below summarizes non-performing loans and assets for the periods
presented.
June 30, December 31,
2020 2019
Non-accrual loans $ 24,433 $ 27,035
Past due loans 90 days or more and still accruing interest - 654
Total non-performing loans $ 24,433 $ 27,689
Foreclosed real estate and repossessed assets - -
Total non-performing assets $ 24,433 $ 27,689
Total non-performing loans as a percentage of total loans 0.87 % 0.98 %
Total non-performing assets as a percentage of total assets 0.65 % 0.71 %
Allowance for loan losses as a percentage of non-performing loans 156 %
164 %
As of June 30, 2020 , there were 29 loans on non-accrual status. The amount and
number are further delineated by loan segment and number of loans in the table
below.
Number of
Percentage of TotalNon-Accrual Non-Accrual
Total Amount Loans Loans
Commercial real estate $ 5,760 23.6 % 2
Residential real estate 3,480 14.2 9
Commercial & industrial 15,193 62.2 18
Total non-accrual loans $ 24,433 100.0 % 29
Investment Securities and Other Earning Assets
The investment securities portfolio is intended to provide the Company with
adequate liquidity and a source of stable income. The portfolio is structured
with minimal credit exposure to the Company and consists of securities
classified as AFS. All AFS securities are carried at fair value and may be used
for liquidity purposes should management deem it to be in the Company's best
interest. Securities AFS, consisting primarily of mortgage-backed securities,
totaled $503,877 at June 30, 2020 , compared to $652,132 at December 31, 2019 , a
decrease of $148,255 , or 22.7%. The decrease in AFS securities was primarily
attributed to security sales during the six months ended June 30, 2020 .
There were no HTM securities at June 30, 2020 , or December 31, 2019 .
The Company also had other investments of $24,110 and $24,802 at June 30, 2020
and December 31, 2019 , respectively, primarily consisting of capital stock in
the Federal Reserve and the Federal Home Loan Bank required as members of the
Federal Reserve Bank System ("FRB") and the Federal Home Loan Bank System
("FHLB"). The FHLB and FRB investments are "restricted" in that they can only be
sold back to the respective institutions or another member institution at par,
and are thus, not liquid, have no ready market or quoted market value, and are
carried at cost.
Bank Premises and Equipment
Bank premises and equipment totaled $47,305 at June 30, 2020 compared to $12,141
at December 31, 2019 , an increase of $35,164 , due to the purchase of the
properties at Columbia Avenue and 120 9th Avenue locations in Franklin,
Tennessee, therefore ending the lease agreements by the Company on February 5,
2020 . In May 2020 , the Company was notified that the landlord of an office space
located in Williamson County had sold the property, therefore, terminating the
lease. One branch in Williamson County, Tennessee plans to relocate to another
leased facility within the same general area.
Deposits
At June 30, 2020 , total deposits were $3,143,259 , a decrease of $64,325 , or 8.1%
annualized, compared to $3,207,584 at December 31, 2019 . Included in the
Company's funding strategy are brokered deposits, public funds deposits and
reciprocal deposits. Total brokered deposits decreased $225,782 , or 143.6%
annualized, to $406,459 at June 30, 2020 , when compared with $632,241 at
December 31, 2019 , which reflects the Company's strategy to reduce its
dependence on non-core funding. Public funds deposits decreased $157,218 , or
163.4% annualized, to $229,685 at June 30, 2020 when compared with $386,903
55
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at December 31, 2019 due to the Company's strategy to redirect some of the
Company's local government customers into the reciprocal account relationships,
thereby decreasing the Company's requirements to collateralize those public
funds deposits. As a result, reciprocal deposits increased $96,434 , or 80.5%
annualized, to $578,175 at June 30, 2020 , compared to $481,741 at December 31,
2019 .
Time deposits, excluding brokered deposits and public funds, as of June 30,
2020 , were $379,879 , compared to $399,258 as of December 31, 2019 , a decrease of
$19,379 , or 19.5% annualized.
The following table shows time deposits in denominations of $100 or more based
on time remaining until maturity:
June 30,
2020
Three months or less $ 729
Three through six months 31,525
Six through twelve months 57,874
Over twelve months 179,150
Total $ 269,278
Federal Funds Purchased and Repurchase Agreements
The Company had no federal funds purchased from correspondent banks or
repurchase agreements as of June 30, 2020 , and December 31, 2019 .
Federal Home Loan Bank Advances
The Company has established a line of credit with the FHLB of Cincinnati which
is secured by a blanket pledge of 1-4 family residential mortgages and home
equity lines of credit. At June 30, 2020 and at December 31, 2019 advances
totaled $100,000 and $155,000 , respectively, and the scheduled maturities and
interest rates of these advances were as follows:
Weighted
Scheduled Maturities Amount Average Rates 2020
$ 100,000 0.30 % Subordinated Notes AtJune 30, 2020 , the Company's subordinated notes, net of issuance costs, totaled$58,961 compared with$58,872 atDecember 31, 2019 . For more information related to the subordinated notes and the related issuance costs, please see Note 12 of the consolidated financial statements. Liquidity Liquidity is defined as the ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. Liquidity planning and management are necessary to ensure the ability to fund operations cost-effectively and to meet current and future potential obligations such as loan commitments, lease obligations, and unexpected deposit outflows. In this process, management focuses on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet the Company's needs. Our source of funds to pay interest on ourMarch 2016 Subordinated Notes andJune 2016 Subordinated Notes is generally in the form of a dividend from the Bank to the Company, or those payments may be serviced from cash balances held by the Company. The Bank's ability to pay a dividend may be restricted due to regulatory requirements as well as the Bank's future earnings and capital needs. Funds are available from a number of basic banking activity sources including the core deposit base, the repayment and maturity of loans, payments of principal and interest as well as sales of investments classified as AFS, and sales of brokered deposits. As ofJune 30, 2020 ,$503,877 of the investment securities portfolio was classified as AFS and is reported at fair value on the consolidated balance sheet. Approximately$283,970 of the total$503,877 investment securities portfolio on hand atJune 30, 2020 was pledged to secure public deposits and repurchase agreements. Other funding sources available include 56 -------------------------------------------------------------------------------- Table of Contents repurchase agreements, federal funds purchased, and borrowings from theFederal Home Loan Bank and theFederal Reserve Bank . Equity As ofJune 30, 2020 , the Company's equity was$422,063 , as compared with$410,426 as ofDecember 31, 2019 . The$11,637 increase in equity was mainly driven by the Company's net income of$10,174 in the three months endedJune 30, 2020 . OnJanuary 23, 2019 , our board of directors announced they had authorized a share repurchase program for up to$30,000 of our outstanding common stock. The repurchase program expired onJanuary 23, 2020 , and no additional shares were purchased afterDecember 31, 2019 . Effects on Inflation and Changing Prices The accompanying consolidated financial statements have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation affects financial institutions' increased cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and shareholders' equity. Commercial and other loan originations and refinancing tend to slow as interest rates increase, and can reduce the Company's earnings from such activities. Off Balance Sheet Arrangements The Company generally does not have any off-balance sheet arrangements other than unused lines of credit, outstanding standby letters of credit, and outstanding mortgage loan commitments to customers in the ordinary course of business. AtJune 30, 2020 , the Company had unused lines of credit of$727,036 , outstanding standby letters of credit of$95,517 , and outstanding mortgage loan commitments of$136,235 . GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures Some of the financial data included in our selected historical consolidated financial information are not measures of financial performance recognized by GAAP. Our management uses these non-GAAP financial measures in its analysis of our performance: •"Common equity" is defined as total shareholders' equity at end of period less the liquidation preference value of the preferred stock; •"Tangible common equity" is common equity less goodwill and other intangible assets; •"Tangible book value per share" is defined as tangible common equity divided by total common shares outstanding. This measure is important to investors interested in changes from period-to-period in book value per share exclusive of changes in intangible assets; and •"Return on Average Tangible Common Equity" is defined as net income available to common shareholders divided by average tangible common shareholders' equity. We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our 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 GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. 57
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Table of Contents The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
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