SmartFinancial, Inc. 2019 Form 10-K Summary
Business context and reporting period
SmartFinancial, Inc. is a Tennessee bank holding company operating primarily through SmartBank, a commercial bank serving East and Middle Tennessee, Alabama, and the Florida Panhandle. The filing covers the fiscal year ended December 31, 2019; it is an annual report rather than a quarterly filing. SmartBank had 35 full-service branches, two loan production offices, two service centers, and 399 full-time equivalent employees as of year-end.
The company’s strategy emphasizes organic loan and deposit growth supplemented by acquisitions. The Progressive Financial Group merger was announced on October 29, 2019 and completed on March 1, 2020, after the reporting period. PFG reported $295.3 million of assets, $189.4 million of loans, and $258.9 million of deposits at December 31, 2019.
Financial performance and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net income | $26.5 million | $18.1 million | Up 46.7% |
| Diluted EPS | $1.89 | $1.45 | Up 30.3% |
| Net interest income | $83.9 million | $76.6 million | Up 9.4% |
| Taxable-equivalent net interest margin | 3.95% | 4.43% | Down 48 basis points |
| Noninterest income | $15.3 million | $6.6 million | Up $8.7 million |
| Noninterest expense | $63.2 million | $59.0 million | Up 7.1% |
| Efficiency ratio | 63.7% | 70.8% | Improved |
| Provision for loan losses | $2.6 million | $2.9 million | Down 11.5% |
| Total assets at year-end | $2.45 billion | $2.27 billion | Up 7.7% |
| Net loans at year-end | $1.89 billion | $1.77 billion | Up 6.8% |
| Total deposits at year-end | $2.05 billion | $1.92 billion | Up 6.5% |
Average earning assets increased to $2.14 billion from $1.74 billion, and average loans increased by $329.1 million. Loan growth increased net interest income, but lower asset yields and higher funding costs reduced the net interest margin. Average interest-bearing liability costs rose to 1.46% from 1.10%, while average deposit costs rose to 1.12% from 0.86%.
Noninterest income benefited substantially from a one-time $6.4 million termination fee related to the cancelled Entegra merger. Other noninterest income also included a $720 thousand payment associated with the dissolution of the ADECA loan-guarantee program. Income tax expense was $6.9 million, representing a 20.6% effective tax rate, including a $1.1 million benefit related to Tennessee’s community investment loan program.
Balance sheet, credit quality, debt, and liquidity
- Gross loans were $1.90 billion, including $905.3 million of commercial real estate loans, $423.3 million of consumer real estate loans, and $227.6 million of construction and land-development loans.
- Approximately 82% of loans had real estate as a primary or secondary collateral component; commercial real estate and commercial construction represented approximately 56% of the loan portfolio.
- The allowance for loan losses increased to $10.2 million, or 0.54% of total loans, from $8.3 million, or 0.47%. Net charge-offs were $631 thousand, and nonperforming loans were $3.35 million, or 0.18% of gross loans.
- Total nonperforming assets were $5.1 million, or 0.21% of total assets, compared with $5.8 million, or 0.25%, in 2018. Other real estate owned declined to $1.8 million.
- Cash and cash equivalents increased to $184.0 million from $115.8 million. The securities portfolio declined to $178.3 million from $201.7 million as funds were redirected toward loans.
- Borrowings included $25.4 million of FHLB advances and other borrowings and $39.3 million of subordinated debt. The principal FHLB advance was $25.0 million, fixed at 0.93%, with a stated maturity in 2029 and a put option beginning in September 2020.
- Liquidity sources included $69.6 million of unsecured federal funds lines, $6.7 million of Federal Reserve discount-window capacity, and $47.1 million of additional FHLB borrowing availability, with no borrowings outstanding on the federal funds or discount-window lines.
- Pre-approved but unused credit commitments totaled $384.4 million, and standby letters of credit totaled $11.7 million.
- Brokered deposits represented approximately 12.8% of total deposits, and $507.8 million of time deposits were scheduled to mature within one year.
Cash flow and capital
| Cash flow item | 2019 | 2018 |
|---|---|---|
| Cash provided by operating activities | $29.9 million | $20.8 million |
| Cash used in investing activities | $(94.8) million | $(94.9) million |
| Cash provided by financing activities | $133.1 million | $76.8 million |
| Net increase in cash and equivalents | $68.1 million | $2.8 million |
At December 31, 2019, SmartBank exceeded applicable well-capitalized standards: total capital was 13.31%, Tier 1 risk-based capital was 12.81%, CET1 was 12.81%, and the leverage ratio was 11.41%. SmartFinancial’s corresponding ratios were 14.02%, 11.61%, 11.61%, and 10.34%, respectively. The Bank could pay approximately $55.5 million of additional dividends to the holding company without prior TDFI approval, subject to other regulatory and legal limitations.
Material changes versus the prior comparable period
- Net income increased by $8.4 million, while diluted EPS increased despite higher average shares outstanding following prior acquisitions.
- Loan growth and merger-related scale increased earning assets and net interest income, but margin compressed because funding costs rose faster than asset yields.
- Noninterest income more than doubled, primarily because of the $6.4 million Entegra termination fee; this benefit is not recurring.
- Noninterest expense increased, but declined as a percentage of average assets and produced a materially improved efficiency ratio.
- Organic loans increased 31.9% to approximately $1.5 billion, while purchased non-credit-impaired loans declined by $235.4 million due to paydowns and repayments.
- The company initiated a quarterly dividend in the fourth quarter, paying $700 thousand in 2019, or $0.05 per share.
- The company adopted the new lease accounting standard, recognizing approximately $5.5 million of operating lease liabilities and $5.5 million of right-of-use assets, without a material income-statement impact.
Guidance, outlook, management commentary, risks, and unusual items
The filing does not provide formal numerical earnings or revenue guidance. Management stated that SmartBank was expected to remain above well-capitalized regulatory requirements in 2020 and continued to pursue organic growth and disciplined merger-and-acquisition opportunities. Management also expects loan growth among small and medium-sized businesses, while acknowledging that acquired-loan accretion will decline as purchased credit-impaired loans pay down.
- Progressive integration: The March 1, 2020 PFG merger creates integration, employee-retention, customer-retention, systems, credit, cost-savings, and revenue-synergy risks. Consideration included 1,292,592 SmartFinancial shares and $9.8 million in cash.
- Interest-rate risk: Management characterized the company as asset-sensitive. Its model estimated that a 200-basis-point immediate increase in short-term rates would raise 12-month net interest income by approximately $2.5 million, while a 200-basis-point decrease would reduce it by approximately $6.0 million.
- Credit and concentration risk: The loan portfolio is concentrated in commercial real estate, construction, and local markets affected by tourism and real estate conditions. Management noted that CRE growth may be constrained by regulatory concentration guidance.
- Funding risk: Deposit pricing pressure, reliance on wholesale or brokered deposits, market disruption, and inability to access secondary funding sources could adversely affect liquidity and margins.
- Accounting risk: CECL implementation is expected to increase the reserve for credit losses, although the filing does not provide a clear estimate of the amount. As a smaller reporting company, the company expected adoption in its first fiscal year beginning after December 15, 2022.
- Other unusual items: The company recorded the Entegra termination fee, the ADECA-related payment, merger-related and restructuring expenses of $3.2 million, and held $77.2 million of goodwill and other intangible assets, including $65.6 million of goodwill.
- Legal and controls: Management reported no material litigation, and both management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2019.
Most important facts for investors to verify
- Whether the PFG merger produces the expected cost savings, revenue synergies, loan growth, and deposit retention without increasing credit losses or dilution.
- Underlying recurring earnings excluding the $6.4 million Entegra termination fee, the ADECA-related income, and other nonrecurring items.
- Net interest margin trends, deposit repricing, brokered-deposit usage, and sensitivity to changes in short-term interest rates.
- Commercial real estate and construction exposure, local-market conditions, large borrower concentrations, and the adequacy of the $10.2 million allowance for loan losses.
- The eventual capital and earnings impact of CECL adoption and the timing of implementation.
- Liquidity coverage relative to $507.8 million of time deposits maturing within one year and $384.4 million of unused loan commitments.
- Future dividend capacity, regulatory restrictions, and the company’s ability to maintain well-capitalized status following the PFG transaction.