SmartFinancial, Inc. 2020 Q3 10-Q Summary
Business context and reporting period
SmartFinancial, Inc. is a Tennessee bank holding company for SmartBank, which provides commercial and consumer banking services through 36 branches and two loan production offices in Tennessee, Alabama and the Florida Panhandle. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, with comparisons to the same 2019 periods and December 31, 2019 balance-sheet figures. The March 1, 2020 acquisition of Progressive Financial Group, Inc. (PFG) is included from the acquisition date.
Financial condition and key metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net income | $6.4 million | $6.0 million | $15.3 million | $19.8 million |
| Diluted EPS | $0.42 | $0.42 | $1.02 | $1.41 |
| Net interest income | $26.0 million | $21.1 million | $74.4 million | $62.9 million |
| Provision for loan losses | $2.6 million | $0.7 million | $8.7 million | $1.9 million |
| Noninterest income | $4.1 million | $2.2 million | $10.5 million | $12.3 million |
| Noninterest expense | $19.2 million | $14.7 million | $56.8 million | $47.1 million |
| Tax-equivalent net interest margin | 3.39% | 3.91% | 3.62% | 3.99% |
- Total assets were $3.39 billion at September 30, 2020, up from $2.45 billion at December 31, 2019.
- Gross loans were $2.40 billion, up from $1.90 billion; net loans were $2.39 billion, up 26.4% from year-end 2019.
- Total deposits were $2.65 billion, up from $2.05 billion. Brokered deposits represented approximately 3.0% of total deposits.
- Cash and cash equivalents increased to $541.8 million from $184.0 million at year-end.
- Shareholders’ equity was $349.8 million, compared with $312.7 million at December 31, 2019.
- Annualized return on average assets was 0.76% at September 30, 2020, compared with 1.01% a year earlier.
Cash flow, debt and liquidity
- For the nine months, operating activities provided $22.2 million of cash, investing activities used $280.5 million, and financing activities provided $616.1 million. Cash and cash equivalents increased by $357.8 million.
- Total borrowings rose to $319.4 million from $31.6 million at year-end, primarily reflecting $237.8 million of Federal Reserve Payroll Protection Program Liquidity Facility borrowings and $50.0 million of additional Federal Home Loan Bank borrowings.
- The company had no outstanding balance on its $25.0 million revolving line of credit at September 30, 2020.
- Management reported $304.2 million of unused borrowing capacity and stated that available liquidity was adequate for expected customer obligations.
- Off-balance-sheet commitments included $468.4 million of unused commitments to extend credit and $5.5 million of standby letters of credit.
- On October 8, 2020, the company repaid the $237.8 million PPPLF borrowing using excess liquidity.
Material changes versus comparable periods
- Third-quarter net income increased 7.2% year over year, while nine-month net income declined 22.8%. The nine-month comparison was materially affected by a $6.4 million merger termination fee recognized in the second quarter of 2019.
- Net interest income increased because of the PFG acquisition, loan growth, PPP loan fee accretion and lower deposit funding costs. The benefit was partly offset by lower earning-asset yields and a decline in net interest margin.
- Q3 noninterest income increased 87.7%, driven by mortgage banking, deposit service charges, investment services, insurance commissions and debit-card fees. Nine-month noninterest income declined 15.1% because 2019 included the $6.4 million merger termination fee.
- Noninterest expense increased 30.3% in Q3 and 20.5% for the nine months, primarily due to franchise growth, PFG integration, higher occupancy and data-processing costs, FDIC insurance expense and merger-related costs.
- The PFG acquisition added approximately $301 million of assets and $272 million of liabilities. Consideration consisted of $9.8 million in cash and 1,292,578 SmartFinancial shares and generated approximately $9.3 million of goodwill.
- The company originated approximately 2,950 PPP loans totaling $300.8 million. PPP loan fees of approximately $11.0 million were deferred, with $3.7 million accreted into income during the first nine months.
Credit quality, COVID-19 and other risks
- The allowance for loan losses increased to $18.8 million, or 0.78% of total loans, from $10.2 million, or 0.54%, at December 31, 2019. Management attributed the increase primarily to COVID-19-related economic uncertainty and expanded qualitative factors for modified loans, hospitality and restaurants.
- COVID-19-modified loans totaled $232.5 million, or 9.7% of total loans, at September 30, 2020. Approximately all were expected to mature under their original schedules in the fourth quarter, creating a key near-term credit-performance risk.
- Hospitality and restaurant loans included in the modified portfolio totaled $56.2 million and $30.4 million, respectively. Modified loans were internally classified as watchlist loans.
- Nonperforming loans were $2.2 million, and total nonperforming assets were $6.2 million, or 0.18% of total assets. Potential problem loans were approximately $1.1 million.
- The company identified COVID-19-related risks including borrower credit losses, collateral-value declines, liquidity pressure, PPP-related litigation or regulatory actions, cyber and payment fraud, operational disruptions and possible additional loan-loss provisions.
- Management concluded that goodwill was not impaired at September 30, 2020. Securities available-for-sale had $468 thousand of gross unrealized losses, which management considered temporary.
- Regulatory capital ratios exceeded minimum requirements and the thresholds for “well capitalized” status. Future dividends remain subject to earnings, capital, liquidity, regulatory and other conditions.
- The filing provides no formal earnings or financial guidance. Management’s outlook remains subject to COVID-19 developments, economic conditions, interest rates, asset quality, PFG integration and regulatory changes.
Investor verification points
- Verify the performance, forgiveness and repayment status of the $300.8 million PPP portfolio and the $232.5 million of COVID-19-modified loans.
- Monitor whether the $18.8 million allowance adequately reflects subsequent credit deterioration, particularly in commercial real estate, construction, hospitality and restaurants.
- Assess the sustainability of earnings excluding PPP fee accretion, acquisition-related effects and the prior-year merger termination fee.
- Confirm the post-October 8, 2020 liquidity and funding profile following repayment of the $237.8 million PPPLF borrowing.
- Evaluate the effect of lower interest rates on net interest margin, loan yields, deposit costs and the fair value of securities and hedges.
- Review PFG integration progress, preliminary purchase-accounting adjustments, goodwill and expected revenue or cost synergies.
- Consider the company’s $468.4 million of unused lending commitments, $319.4 million of borrowings before the PPPLF repayment, and applicable regulatory limits on dividends and repurchases.