SmartFinancial, Inc. 10-Q Summary
Business context and reporting period
SmartFinancial, Inc. is a Tennessee bank holding company whose wholly owned subsidiary, SmartBank, provides commercial and consumer banking services through 36 full-service branches and two loan production offices in Tennessee, Alabama, and the Florida Panhandle. This unaudited Form 10-Q covers the three and six months ended June 30, 2020. The March 1, 2020 acquisition of Progressive Financial Group, Inc. (PFG) is included from the acquisition date.
Financial performance and condition
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Net interest income | $25.7 million | $20.8 million | $48.3 million | $41.8 million |
| Provision for loan losses | $2.9 million | $0.4 million | $6.0 million | $1.2 million |
| Noninterest income | $3.5 million | $8.4 million | $6.3 million | $10.1 million |
| Noninterest expense | $18.8 million | $16.8 million | $37.6 million | $32.4 million |
| Net income | $6.2 million | $9.1 million | $8.9 million | $13.9 million |
| Diluted EPS | $0.41 | $0.65 | $0.60 | $0.99 |
| Tax-equivalent net interest margin | 3.63% | 3.94% | 3.75% | 4.04% |
At June 30, 2020, total assets were $3.27 billion, compared with $2.45 billion at December 31, 2019. Total loans were $2.41 billion, including $2.39 billion net of the allowance for loan losses, versus $1.90 billion gross and $1.89 billion net at year-end 2019. Deposits were $2.54 billion, compared with $2.05 billion at December 31, 2019.
The allowance for loan losses was $16.3 million, or 0.67% of total loans, versus $10.2 million, or 0.54%, at year-end 2019. Net nonperforming assets were $9.3 million, or 0.28% of total assets, compared with $5.1 million, or 0.21%, at year-end 2019. Nonperforming loans were $3.8 million, including $2.9 million of nonaccrual loans and $0.9 million of loans accruing while 90 days or more past due.
Six-month operating cash flow was $1.3 million, compared with $17.9 million in the prior-year period. Investing activities used $289.8 million, primarily due to a $321.2 million net increase in loans. Financing activities provided $504.0 million, including $220.1 million of net deposit growth and $287.8 million of net borrowing proceeds. Cash and cash equivalents increased to $399.5 million from $184.0 million at December 31, 2019.
Total borrowings were $318.9 million at June 30, 2020, compared with $31.6 million at year-end 2019. Borrowings included $237.8 million from the Federal Reserve Payroll Protection Program Liquidity Facility and $75.0 million of Federal Home Loan Bank borrowings. The Company had no borrowings under its $25.0 million revolving credit line, which remained fully available. Management reported $312.2 million of unused borrowing capacity from the Federal Reserve, FHLB, correspondent banks, and the revolving credit line.
The Company and Bank exceeded minimum regulatory capital requirements and the thresholds for “well capitalized” status. At June 30, 2020, SmartBank’s total risk-based capital ratio was 12.82%, Tier 1 risk-based capital ratio was 12.14%, common equity Tier 1 ratio was 12.14%, and Tier 1 leverage ratio was 9.82%.
Material changes versus prior comparable periods
- Net income declined 32.3% in the second quarter and 35.7% for the first six months, primarily because the prior-year periods included a $6.4 million merger termination fee.
- Net interest income increased 23.8% in the second quarter and 15.6% for the first six months, driven by PFG, loan growth, and lower funding costs. The net interest margin nevertheless declined because of Federal Reserve rate cuts and lower loan yields.
- Noninterest income decreased 58.3% in the quarter and 37.4% year to date, mainly because of the prior-year merger termination fee. Mortgage banking, investment services, insurance commissions, and debit-card fees increased.
- Noninterest expense increased 11.9% in the quarter and 16.1% year to date, reflecting PFG-related personnel, facilities, professional services, and merger-related costs.
- The March 1 PFG acquisition added approximately $301 million of assets and $272 million of liabilities. SmartFinancial issued 1,292,578 shares and paid approximately $9.8 million in cash; preliminary goodwill recognized was $8.5 million.
- The Company originated approximately 2,800 PPP loans totaling $292.8 million during the second quarter. Deferred PPP fees totaled approximately $11.0 million, of which $1.9 million was accreted into income during the quarter.
- Total COVID-19-modified loans were $616.7 million, or 25.6% of total loans, at June 30, 2020. Approximately $340.6 million was expected to mature during the third quarter, with the remainder maturing in the fourth quarter.
Guidance, outlook, management commentary, risks, and unusual items
The filing does not provide formal earnings or revenue guidance. Management expects liquidity to be adequate for customer obligations based on cash, securities, anticipated security cash flows, deposits, and available borrowing capacity.
COVID-19 was identified as the principal source of uncertainty. Management increased the allowance for loan losses in response to deteriorating unemployment and GDP assumptions. Hospitality and restaurant exposures within modified loans were identified as particularly vulnerable. The Company also identified potential risks from declining collateral values, higher credit losses, reduced economic activity, liquidity pressures, PPP-related litigation or regulatory actions, cyber threats, and operational disruptions.
All COVID-19-modified loans were placed on internal watchlists, although qualifying short-term modifications were not treated as troubled debt restructurings under applicable CARES Act and interagency guidance. The filing states that goodwill was assessed qualitatively at June 30, 2020, with no impairment indicated.
Unusual and nonrecurring items included PFG acquisition-related costs of $1.5 million in the second quarter and $3.6 million year to date, the prior-year $6.4 million merger termination fee, and significant PPPLF borrowing related to PPP lending. The Company adopted lease-related accounting updates without a material impact and does not expect to adopt the current expected credit loss standard until required for smaller reporting companies.
The Company had $506.7 million of commitments to extend credit and $6.5 million of standby letters of credit at June 30, 2020. Management stated that pending and threatened litigation was not expected to have a material adverse effect.
Important facts for investors to verify
- Whether COVID-19-modified loans transition to delinquency or require additional provisions as deferrals expire, particularly the $340.6 million scheduled to mature in the third quarter.
- Whether the $16.3 million allowance for loan losses adequately covers deterioration in commercial real estate, construction, hospitality, restaurant, and commercial loan exposures.
- The pace and profitability of PPP loan forgiveness, including recognition of remaining deferred fees and the repayment performance of unforgiven loans.
- The sustainability of earnings after excluding the prior-year $6.4 million termination fee and after the expiration of merger-related costs and PFG integration benefits.
- The effect of lower interest rates on the 3.63% second-quarter net interest margin and future loan yields.
- The effect of increased borrowings, including $237.8 million of PPPLF funding, on liquidity, leverage, and future funding costs.
- The realization of expected PFG revenue synergies and cost savings, as well as the finalization of preliminary acquisition accounting.
- The Company’s ability to maintain dividends and share repurchases while preserving regulatory capital and responding to economic uncertainty.