SmartFinancial, Inc. — Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended September 30, 2015; comparative periods ended September 30, 2014. Financial statements are unaudited. SmartFinancial is a bank holding company serving Tennessee and the Florida Panhandle, with additional loan-production offices in Georgia and Florida.
Business Context and Major Transaction
On August 31, 2015, SmartFinancial completed its merger with Cornerstone Bancshares, Inc. The transaction was accounted for as a reverse merger using acquisition accounting, with Cornerstone’s assets and liabilities consolidated beginning on the closing date. The merger added approximately $436 million of assets, $310 million of loans and $332 million of deposits based on Cornerstone’s June 30, 2015 balances.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Interest income | $7.154 million | $5.444 million | $17.186 million | $15.488 million |
| Net interest income before provision | $6.427 million | $4.918 million | $15.450 million | $13.961 million |
| Net interest income after provision | $6.395 million | $5.062 million | $15.094 million | $13.662 million |
| Noninterest income | $174 thousand | $390 thousand | $1.088 million | $905 thousand |
| Noninterest expense | $6.493 million | $4.305 million | $15.114 million | $12.170 million |
| Net income (loss) | $(77) thousand | $705 thousand | $328 thousand | $1.476 million |
| Basic EPS | $(0.03) | $0.22 | $0.07 | $0.45 |
Margins: Tax-equivalent net interest margin was 4.02% in Q3 2015 versus 4.22% in Q3 2014, and 3.92% for the first nine months versus 4.17% in the prior-year period. The net interest spread declined to 3.94% from 4.16% in Q3 and to 3.86% from 4.10% for the nine-month period.
Balance sheet at September 30, 2015: Total assets were $1.007 billion, securities available for sale were $152.150 million, gross loans were $710.439 million, and net loans were $706.611 million. Total deposits were $846.992 million, total liabilities were $908.621 million, and stockholders’ equity was $98.436 million.
Debt and liquidity: Federal Home Loan Bank advances and other borrowings were $39.278 million, compared with none at December 31, 2014. Federal funds purchased and securities sold under repurchase agreements were $18.442 million. Cash and cash equivalents were $89.936 million. Securities with fair value of approximately $124.5 million were pledged as collateral.
Credit quality: The allowance for loan losses was $3.828 million, or 0.54% of gross loans, compared with 1.07% at December 31, 2014. Nonperforming assets were $11.773 million, including $1.715 million of nonaccrual loans, $411 thousand of loans 90 days past due and accruing, and $9.647 million of foreclosed assets. Net charge-offs for the nine-month period were $408 thousand, calculated as $476 thousand of charge-offs less $68 thousand of recoveries.
Cash Flow
- Operating activities provided $2.199 million of cash, compared with $79 thousand in the prior-year period.
- Investing activities provided $19.315 million, primarily reflecting $33.502 million of cash received in the merger, partly offset by net loan originations and collections of $(33.221) million.
- Financing activities provided $21.682 million, including a $42.723 million increase in deposits and $3.016 million of common-stock issuance proceeds.
- Cash and cash equivalents increased $43.196 million to $89.936 million.
Material Changes Versus Prior Comparable Period
- The merger substantially increased scale: assets rose from $533.714 million at December 31, 2014 to $1.007 billion; loans increased from $363.403 million to $710.439 million; deposits increased from $454.807 million to $846.992 million; and equity increased from $55.888 million to $98.436 million.
- Q3 net income declined to a $77 thousand loss from $705 thousand of income. Nine-month net income declined 78% to $328 thousand from $1.476 million.
- Net interest income increased, but the benefit was more than offset by a 50.8% increase in Q3 noninterest expense and a 24.2% increase for the nine-month period.
- Merger-related expenses were approximately $748 thousand in Q3 and $1.003 million for the nine-month period. Salary and benefit expense increased primarily from the addition of Cornerstone personnel.
- Q3 noninterest income was pressured by a $446 thousand net loss on foreclosed assets, compared with a $51 thousand loss in the prior-year quarter.
- Common shares outstanding increased to 5,732,143 at September 30, 2015 from 2,965,783 at December 31, 2014. The company also completed a private placement intended to generate $15 million of gross proceeds and redeemed all 600,000 Series A preferred shares for $15.625 million.
Guidance, Outlook, Risks and Unusual Items
No formal earnings guidance was provided. Management expects continued loan growth during the remainder of 2015, but expects loan yields and net interest margin to remain under pressure from refinancing, historically low interest rates, and competition for loans and deposits. Management indicated that the net interest margin may remain near the September 30, 2015 level and expects foreclosed and nonperforming assets to decline over time.
- Key risks include credit deterioration, loan losses, concentration in real estate and construction lending, declining loan yields, compressed net interest margin, deposit-funding competition, liquidity needs, rising interest rates, regulatory changes, cybersecurity and operational failures, and local economic or real estate-market weakness.
- Management identified the realization of a significant deferred tax asset as an area of uncertainty.
- Foreclosed assets and other real-estate-related valuations involve significant judgment; foreclosed assets were measured using Level 3 inputs with an average appraisal discount of 30.1%.
- Off-balance-sheet exposure included $116.1 million of commitments to extend credit and $2.9 million of standby letters of credit.
- Management stated that pending legal claims were not expected to have a material effect. Disclosure controls were evaluated as effective, with no material changes to internal control over financial reporting reported during the quarter.
Most Important Facts to Verify
- Whether merger-related cost savings and revenue synergies materialize and whether reported profitability normalizes after the acquisition.
- The sustainability of the 3.92% nine-month net interest margin and the effect of further loan-yield compression.
- Credit performance of the expanded real-estate, construction and land-development portfolio, including the $9.647 million of foreclosed assets and $11.773 million of nonperforming assets.
- The adequacy of the $3.828 million allowance for loan losses relative to portfolio growth, acquired loans and future economic conditions.
- Liquidity and funding needs associated with the enlarged balance sheet, including $39.278 million of FHLB advances and pledged securities.
- Final merger accounting, including the $4.166 million of goodwill, $2.868 million of core deposit intangibles and any subsequent fair-value adjustments.
- Completion and use of the $15 million private-placement proceeds, preferred-stock redemption, and the resulting dilution and capital position.