SmartFinancial, Inc. 2017 Form 10-K Summary
Business context and reporting period
SmartFinancial is a Tennessee-based bank holding company whose principal subsidiary is SmartBank, a community bank operating in Tennessee, Alabama, Florida and Georgia. SmartBank had 22 full-service branches, one loan production office, two mortgage production offices and two service centers at December 31, 2017. The filing covers the fiscal year ended December 31, 2017; results include only two months of Capstone Bancshares and Capstone Bank following the November 1, 2017 merger, so year-over-year comparability is limited.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets | $1.721 billion | $1.062 billion |
| Net loans | $1.317 billion | $808.3 million |
| Total deposits | $1.439 billion | $907.1 million |
| Net interest income | $46.3 million | $38.3 million |
| Net income | $5.0 million | $5.8 million |
| Net income available to common shareholders | $4.8 million | $4.8 million |
| Diluted EPS | $0.55 | $0.78 |
| Net interest margin, taxable equivalent | 4.30% | 4.06% |
| Efficiency ratio | 76.0% | 76.4% |
- Interest income increased to $52.0 million from $42.6 million, while interest expense increased to $5.7 million from $4.3 million.
- Noninterest income increased to $5.0 million from $4.2 million. Noninterest expense increased to $39.1 million from $32.5 million, including $2.4 million of merger expenses.
- Net cash provided by operating activities was $6.6 million, compared with $11.6 million in 2016. Investing activities used $56.1 million, while financing activities provided $93.8 million, resulting in a $44.3 million increase in cash and cash equivalents to $113.0 million.
- Borrowings totaled $43.6 million at year-end, including $33.6 million of federal funds purchased and $10.0 million under a line of credit maturing in 2022. Securities sold under repurchase agreements totaled $24.1 million.
- Stockholders’ equity was $205.9 million. The Company had no preferred stock outstanding after redeeming $12.0 million of SBLF preferred stock in March 2017. No common dividends were paid in 2017 or 2016.
- SmartBank remained well capitalized. Its total risk-based capital ratio was 11.29%, Tier 1 risk-based capital ratio was 10.90%, CET1 ratio was 10.90% and Tier 1 leverage ratio was 11.26% at December 31, 2017.
Material changes versus the prior comparable period
- The Capstone merger increased assets by approximately $536 million and liabilities by approximately $466 million; it added approximately $38.0 million of goodwill and caused the issuance of 2.9 million SmartFinancial shares. Capstone contributed $5.0 million of revenue and $0.2 million of net income during the post-closing period.
- The Cleveland, Tennessee branch acquisition was completed in May 2017 for approximately $1.2 million and added approximately $27 million of assets and liabilities.
- Total assets, net loans and deposits reached record levels. Organic loans increased 29.7% to $793.8 million, while purchased non-credit-impaired loans increased to $490.9 million, primarily due to Capstone.
- Net income declined because of higher merger expenses and a $2.4 million after-tax deferred-tax-asset write-down resulting from the Tax Cuts and Jobs Act. The effective tax rate increased to 56.2% from 36.7%.
- Credit metrics remained generally stable: nonperforming loans were 0.25% of gross loans versus 0.26%, and nonperforming assets were 0.38% of total assets versus 0.42%. The allowance for loan losses increased to $5.9 million, but declined to 0.44% of total loans from 0.63% because acquired loans comprised a larger share of the portfolio.
- Common shares outstanding increased to 11.2 million from 5.9 million, reflecting the Capstone transaction, a January 2017 common stock offering and option exercises. Diluted EPS declined because of the higher share count and lower net income.
Guidance, outlook, risks and unusual items
- Management expected 2018 net interest income and net interest margin to face pressure from higher deposit costs, partly offset by higher yields on floating-rate assets. Management expected noninterest income to assets to improve, noninterest expense to assets to decline as assets grow faster than core expenses, and the effective tax rate to be approximately 26%.
- Management expected the allowance for loan losses on organic loans to remain in the 0.70% to 0.85% range in 2018.
- The Company was slightly asset-sensitive; management estimated that an immediate 200-basis-point increase in short-term rates could increase net income by approximately $4.0 million over 12 months, although actual results could differ materially.
- The Company announced a proposed Tennessee Bancshares acquisition expected to close in the second quarter of 2018, subject to customary conditions. Risks include integration costs, dilution, regulatory approval, customer or employee attrition and failure to achieve expected synergies.
- Loan concentration remains a key risk: approximately 81% of loans had real estate as a primary or secondary component of collateral, and commercial real estate, including commercial construction, represented 56% of the portfolio. The ten largest borrowing relationships totaled approximately $149 million of commitments, or 11% of the loan portfolio.
- Liquidity risks include reliance on deposits and wholesale funding. Brokered deposits represented approximately 14.1% of total deposits, and three customers represented approximately $116.1 million of deposits at year-end.
- Other significant risks include interest-rate volatility, local economic and tourism exposure, commercial real estate losses, cybersecurity and third-party technology failures, regulatory changes, capital constraints, goodwill impairment, mortgage banking performance and the adequacy of loan-loss reserves.
- The Company did not meet a return-on-assets covenant under its $15 million revolving credit facility because of the tax-law-related deferred tax write-down; the lender waived the December 2017 breach. Management reported compliance with the other loan covenants.
- Management and the independent auditor reported effective internal control over financial reporting, with an unqualified audit opinion. The Capstone acquisition was excluded from management’s internal-control assessment under SEC guidance because it represented approximately 28.1% of consolidated assets at year-end.
Most important facts for investors to verify
- Review the full-year and pro forma impact of the Capstone and pending Tennessee Bancshares transactions, including goodwill, fair-value marks, dilution and expected cost savings.
- Assess whether loan growth, particularly in commercial real estate and construction lending, is supported by sustainable deposits and sufficient regulatory capital.
- Monitor deposit retention, brokered-deposit usage, large depositor concentrations and the maturity of time deposits as interest rates rise.
- Evaluate credit quality trends, acquired-loan accretion, the allowance relative to organic loans and potential losses on real estate collateral.
- Confirm compliance with the revolving-credit facility’s financial covenants and the effect of the tax-law-related covenant waiver.
- Reconcile reported earnings with cash generation, merger expenses, deferred-tax adjustments and the substantially higher common share count.