SmartFinancial, Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The unaudited filing covers SmartFinancial, Inc., a bank holding company for SmartBank, serving customers through offices in Tennessee, Alabama, Florida, and Georgia. Results were materially affected by the November 2017 Capstone Bancshares merger and the May 2018 Tennessee Bancshares merger, limiting comparability with 2017.
Financial Performance and Position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|
| Net interest income | $18.9 million | $10.9 million | $55.2 million | $31.0 million |
| Provision for loan losses | $0.3 million | $0.03 million | $1.6 million | $0.3 million |
| Noninterest income | $1.8 million | $1.2 million | $4.9 million | $3.4 million |
| Noninterest expense | $14.8 million | $9.6 million | $43.3 million | $26.6 million |
| Net income available to common shareholders | $4.3 million | $1.7 million | $11.7 million | $4.8 million |
| Diluted EPS | $0.34 | $0.20 | $0.96 | $0.59 |
- Q3 net income available to common shareholders increased approximately 157% year over year; nine-month income increased approximately 144%.
- Q3 net interest income increased approximately 73%, and nine-month net interest income increased approximately 78%, primarily from merger-related balance growth and higher earning-asset yields.
- Tax-equivalent net interest margin was 4.11% in Q3 and 4.34% for the first nine months, compared with 4.26% and 4.13%, respectively, in the prior-year periods. Q3 margin declined because funding costs increased.
- Tax-equivalent yield on earning assets was 5.03% in Q3 and 5.14% for the first nine months, versus 4.80% and 4.63% in the comparable 2017 periods.
- Annualized return on average assets was 0.85% in Q3 and 0.82% for the first nine months. Noninterest expense to average assets declined to 2.90% in Q3 and 3.06% for the first nine months.
Balance Sheet, Liquidity and Capital
| Balance-sheet item | September 30, 2018 | December 31, 2017 |
|---|
| Total assets | $2.05 billion | $1.72 billion |
| Gross loans | $1.59 billion | $1.32 billion |
| Net loans | $1.58 billion | $1.32 billion |
| Total deposits | $1.71 billion | $1.44 billion |
| Cash and cash equivalents | $130.1 million | $113.0 million |
| Shareholders’ equity | $251.6 million | $205.9 million |
- Loans increased approximately 20% from year-end, while deposits increased approximately 19%.
- Organic net loans increased 32.2% to approximately $1.0 billion. Purchased non-credit-impaired loans totaled approximately $499.9 million, and purchased credit-impaired loans had a $29.1 million carrying value.
- The allowance for loan losses increased to $7.2 million from $5.9 million, equal to 0.45% of total loans versus 0.44% at year-end. Net charge-offs were $311 thousand for the first nine months.
- Nonperforming loans were $2.7 million, or 0.17% of gross loans, compared with $3.3 million, or 0.25%, at December 31, 2017. Nonperforming assets were $6.9 million, or 0.34% of assets.
- Deposits included approximately 11.7% brokered deposits. Management stated that regulatory capital ratios exceeded minimum requirements, although specific ratios were not provided in the filing text.
- Cash flow from operations was $16.6 million for the first nine months. Investing activities used $76.6 million, primarily because net loan originations and collections used $79.7 million. Financing activities provided $77.0 million, resulting in a $17.1 million increase in cash and cash equivalents.
Material Changes Versus Prior Period
- The Capstone and Tennessee Bancshares mergers substantially increased assets, loans, deposits, revenue and operating expenses. Management cautioned that post-merger results are not directly comparable with prior periods.
- Merger expenses increased to $838 thousand in Q3 and $2.5 million for the first nine months, compared with $303 thousand and $723 thousand, respectively, in 2017.
- Interest-bearing deposit costs increased to 1.11% in Q3 and 0.96% for the first nine months, compared with 0.68% and 0.65% in 2017, respectively, reflecting higher rates and changes in deposit mix.
- The effective tax rate declined to approximately 23.2% in Q3 and 23.3% for the first nine months, compared with approximately 34.4% and 33.9% in 2017, primarily because of the Tax Cuts and Jobs Act.
- Accumulated other comprehensive loss increased to $3.7 million from $1.2 million at year-end, primarily reflecting unrealized losses on available-for-sale securities as interest rates changed.
- The company adopted revenue recognition and financial-instrument accounting changes in 2018 without a material effect on reported results. Interchange and debit-card fees are now presented net of related network costs.
Debt, Outlook, Risks and Unusual Items
- On September 28, 2018, the company issued $40 million of fixed-to-floating subordinated notes due October 2, 2028. The notes bear interest at 5.625% through October 2, 2023, then reset to three-month LIBOR plus 2.55%, and initially qualify as Tier 2 capital.
- Net proceeds were used partly to repay a $15 million revolving credit balance and to fund the Foothills Bancorp acquisition and general corporate purposes.
- The Foothills Bancorp merger closed on November 1, 2018, after the reporting date. SmartFinancial paid approximately $3.1 million in cash and issued 1,183,232 common shares.
- Off-balance-sheet commitments included $304.2 million of commitments to extend credit and $10.6 million of standby letters of credit. These amounts are not recorded as liabilities unless drawn.
- Management projected that a 100- or 200-basis-point increase in rates would increase next-twelve-month net interest income by 3.05% or 4.77%, while a 100-basis-point decrease would reduce it by 6.94%.
- Management expected adequate liquidity from cash, securities, mortgage-backed-security principal payments, unused borrowing capacity and other funding sources. No quantitative earnings or revenue guidance was provided.
- Key risks include merger integration and realization of cost savings or revenue synergies, dilution from stock issuance, interest-rate and funding-cost volatility, credit losses, local economic conditions, securities valuation changes, liquidity demands and regulatory capital requirements.
- Management reported no material pending litigation, no material changes to the risk factors in the 2017 Form 10-K, and effective disclosure controls as of September 30, 2018.
Investor Verification Checklist
- Verify the effect of the Capstone, Tennessee Bancshares and subsequent Foothills Bancorp mergers on pro forma earnings, tangible capital, goodwill and operating efficiency.
- Monitor deposit pricing, brokered-deposit reliance and the effect of rising funding costs on net interest margin.
- Reconcile loan growth, credit classifications, nonperforming assets, troubled debt restructurings and the allowance for loan losses, particularly after the acquisitions.
- Review the subordinated notes’ terms, interest-rate reset exposure, capital treatment and use of proceeds.
- Assess liquidity coverage for $304.2 million of unfunded credit commitments and $10.6 million of standby letters of credit.
- Evaluate the impact of unrealized securities losses and the company’s interest-rate sensitivity assumptions.
- Confirm future effects of the current expected credit loss standard, lease accounting implementation and other pending accounting changes; the filing states that the credit-loss standard may increase reserves but does not quantify the impact.
