SmartFinancial, Inc. 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018; filed March 18, 2019. SmartFinancial is a Tennessee bank holding company whose primary subsidiary is SmartBank, operating 29 full-service branches in Tennessee, Alabama, and Florida, plus loan production offices and service centers.
Business Context and Strategic Developments
- SmartBank attracts deposits and invests primarily in commercial, commercial and residential real estate, construction, and consumer loans.
- Completed the Tennessee Bancshares/Southern Community Bank merger on May 1, 2018, and the Foothills Bancorp/Foothills Bank merger on November 1, 2018. These acquisitions increased assets by approximately $444 million in aggregate.
- At December 31, 2018, the Company had approximately 387 full-time equivalent employees, $2.3 billion of assets, 13.9 million common shares outstanding, and no preferred stock outstanding.
Financial Performance and Key Metrics
| Metric | 2018 | 2017 | Change or commentary |
|---|---|---|---|
| Total assets | $2.274 billion | $1.721 billion | Increased approximately 32.2%, primarily from acquisitions |
| Net loans | $1.769 billion | $1.317 billion | Increased approximately $451.6 million |
| Total deposits | $1.922 billion | $1.439 billion | Increased approximately $483.4 million |
| Net interest income | $76.6 million | $46.3 million | Increased $30.3 million |
| Net interest margin, taxable equivalent | 4.43% | 4.29% | Improved 14 basis points |
| Net income | $18.1 million | $5.0 million | Significant increase; 2017 included a $2.4 million after-tax deferred-tax write-down |
| Diluted EPS | $1.45 | $0.55 | Increased with higher earnings, partly offset by share issuance |
| Noninterest income | $6.6 million | $5.0 million | Increased $1.6 million |
| Noninterest expense | $59.0 million | $39.1 million | Higher due to acquired operations and $3.8 million of merger expenses |
| Efficiency ratio | 70.7% | 76.0% | Improved due to scale economies |
| Effective tax rate | 15.2% | 56.2% | 2018 benefited from a tax benefit related to stock-option exercises |
Average earning assets increased from $1.1 billion to $1.7 billion, while average loans increased by $592.1 million. The cost of interest-bearing liabilities increased from 0.66% to 1.10%, reflecting higher deposit and funding costs. More than 92% of revenue was generated from net interest income.
Credit Quality, Capital, Debt, and Liquidity
- Nonperforming loans were $3.3 million, or 0.18% of gross loans, compared with 0.25% in 2017. Nonperforming assets were 0.25% of total assets, compared with 0.34% in 2017.
- The allowance for loan losses increased to $8.3 million from $5.9 million, or 0.47% of total loans versus 0.44%. Provision expense increased to $2.9 million from $0.8 million; net charge-offs were $0.5 million.
- Approximately 82% of loans were secured by real estate, including 11% secured by construction and development collateral. Commercial real estate, including commercial construction, represented approximately 55% of loans.
- Cash and cash equivalents totaled $115.8 million. Securities available for sale totaled $201.7 million and provide an additional liquidity source.
- Brokered deposits represented approximately 12.6% of total deposits. Three customers held approximately $160.6 million of deposits, creating concentration and runoff risk.
- Short-term borrowings totaled $11.2 million and subordinated debt totaled $39.2 million at year-end. In September 2018, the Company issued $40 million of fixed-to-floating subordinated notes due 2028; proceeds repaid the $15 million revolving credit line, funded the Foothills transaction, and supported liquidity and capital.
- SmartBank was categorized as well capitalized. Its total risk-based capital ratio was 12.74%, common equity Tier 1 ratio was 12.31%, and Tier 1 leverage ratio was 11.17%, each above applicable minimums.
- Off-balance-sheet commitments included $333.9 million of unused credit commitments and $12.2 million of standby letters of credit.
- Operating cash flow was $20.8 million; investing activities used $94.9 million, primarily for loan growth and securities purchases; financing activities provided $76.8 million. Cash and cash equivalents increased $2.8 million.
Material Changes Versus 2017
- Results benefited materially from the full-year contribution of the Capstone acquisition and partial-year contributions from Tennessee Bancshares and Foothills.
- Common shares outstanding increased from 11.2 million to 13.9 million, principally due to merger-related share issuances.
- Goodwill and core deposit intangible assets increased to $79.0 million from $50.8 million; reported goodwill was approximately $66.1 million.
- Noninterest expenses increased $19.8 million, including merger expenses that rose to $3.8 million from $2.4 million.
- The Company adopted revenue recognition guidance that caused interchange and debit-card network costs to be presented net against related fees. Gross 2018 interchange fees were $1.6 million, related network costs were $1.0 million, and reported net fees were $573,000.
- Accumulated other comprehensive loss increased to $2.8 million, primarily from unrealized losses on available-for-sale securities.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2019 pressure on net interest margin and net interest income relative to assets as deposit rates rise, partly offset by higher yields on floating-rate assets.
- Management expected 2019 noninterest expense ratios to increase temporarily as additional merger expenses offset expected reductions in core operating expenses.
- Management expected a 2019 effective tax rate of approximately 25% and an allowance-to-organic-loans ratio of approximately 0.70% to 0.80%.
- On January 15, 2019, SmartFinancial agreed to acquire Entegra Financial in an all-stock transaction with an exchange ratio of 1.215 SmartFinancial shares per Entegra share. Management expected completion in mid-2019, subject to customary conditions. The transaction could increase consolidated assets above $3 billion, affecting eligibility for certain regulatory relief measures.
- Key risks include commercial real estate and construction concentration, local economic and tourism exposure, interest-rate and deposit-cost volatility, reliance on acquisitions and integration, cybersecurity and third-party systems, liquidity concentration, regulatory capital requirements, and potential credit-loss increases under CECL, which was scheduled to become effective for the Company in 2020.
- The filing reports no material litigation, no unresolved SEC staff comments, effective disclosure controls, and unqualified audit opinions on the financial statements and internal control over financial reporting. However, the internal-control assessment excluded the acquired Southern Community Bank and Foothills operations, which represented approximately 10% each of consolidated assets at year-end.
Most Important Facts for Investors to Verify
- Whether acquisition-related revenue and cost synergies, including those from Foothills and the proposed Entegra transaction, are realized without weakening credit quality or diluting returns.
- The sustainability of the 4.43% net interest margin as deposit costs increase and interest rates change.
- Credit performance of the heavily real-estate-secured loan portfolio, including construction and commercial real estate exposures, allowance adequacy, and CECL implementation effects.
- Liquidity sensitivity to brokered deposits and the three large deposit relationships, as well as the availability and cost of wholesale funding.
- Capital ratios after the Entegra transaction, merger-related share issuance, subordinated debt, goodwill, and any required regulatory capital adjustments.
- The effect of the 2018 tax benefit and prior-year tax adjustments on normalized earnings and the expected 2019 tax rate.
- The potential impact of the proposed Entegra merger on regulatory relief eligibility, integration costs, dilution, and consolidated asset size.