Table of Contents
.
United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 001-37661
(Exact name of registrant as specified in its charter)
Tennessee
62-1173944
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
5401 Kingston Pike, Suite 600 Knoxville, Tennessee
37919
(Address of principal executive offices)
(Zip Code)
865-437-5700
Not Applicable
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of Exchange on which Registered
Common Stock, par value $1.00
SMBK
The Nasdaq Stock Market
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or and emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check market if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
As of November 04, 2022, there were 16,888,305 shares of common stock, $1.00 par value per share, issued and outstanding.
TABLE OF CONTENTS
PART I –FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (Unaudited)
3
Consolidated Balance Sheets at September 30, 2022 and December 31, 2021
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2022 and 2021
4
Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2022 and 2021
5
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2022 and 2021
6
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2022 and 2021
7
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
45
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
62
Item 4.
Controls and Procedures
PART II – OTHER INFORMATION
63
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
64
Item 5.
Other Information
Item 6.
Exhibits
65
2
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SMARTFINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except for share data)
(Unaudited)
September 30,
December 31,
2022
2021*
ASSETS:
Cash and due from banks
$
46,351
110,333
Interest-bearing deposits with banks
428,318
897,244
Federal funds sold
68,360
37,500
Total cash and cash equivalents
543,029
1,045,077
Securities available-for-sale, at fair value
519,723
482,453
Securities held-to-maturity, at amortized cost
287,104
76,969
Other investments
15,528
16,494
Loans held for sale
2,742
5,103
Loans and leases
3,099,116
2,693,397
Less: Allowance for loan and lease losses
(22,769)
(19,352)
Loans and leases, net
3,076,347
2,674,045
Premises and equipment, net
91,944
85,958
Other real estate owned
1,226
1,780
Goodwill and other intangibles, net
110,460
105,852
Bank owned life insurance
81,001
79,619
Other assets
67,807
38,229
Total assets
4,796,911
4,611,579
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Noninterest-bearing demand
1,186,209
1,055,125
Interest-bearing demand
962,901
899,158
Money market and savings
1,663,355
1,493,007
Time deposits
467,944
574,648
Total deposits
4,280,409
4,021,938
Borrowings
18,423
87,585
Subordinated debt
41,994
41,930
Other liabilities
41,374
30,696
Total liabilities
4,382,200
4,182,149
Shareholders' equity:
Preferred stock, $1 par value; 2,000,000 shares authorized; No shares issued and outstanding
—
Common stock, $1 par value; 40,000,000 shares authorized; 16,887,555 and 16,802,990 shares issued and outstanding, respectively
16,888
16,803
Additional paid-in capital
293,907
292,937
Retained earnings
144,723
118,247
Accumulated other comprehensive income (loss)
(40,807)
1,443
Total shareholders' equity
414,711
429,430
Total liabilities and shareholders' equity
* Derived from audited financial statements.
The accompanying notes are an integral part of the financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share data)
Three Months Ended
Nine Months Ended
2021
Interest income:
Loans and leases, including fees
35,127
31,674
96,300
88,015
Securities:
Taxable
3,135
832
8,463
2,472
Tax-exempt
561
331
1,369
894
Federal funds sold and other earning assets
3,474
474
5,389
1,074
Total interest income
42,297
33,311
111,521
92,455
Interest expense:
Deposits
4,866
2,153
9,384
6,733
97
121
371
360
626
655
1,877
1,823
Total interest expense
5,589
2,929
11,632
8,916
Net interest income
36,708
30,382
99,889
83,539
Provision for loan and lease losses
974
1,149
3,230
1,211
Net interest income after provision for loan and lease losses
35,734
29,233
96,659
82,328
Noninterest income:
Service charges on deposit accounts
1,611
1,220
4,376
3,278
Gain on sale of securities
Mortgage banking
170
994
1,475
3,238
Investment services
1,051
448
3,186
1,546
Insurance commissions
864
745
2,363
2,768
Interchange and debit card transaction fees, net
1,356
1,078
4,107
2,839
Other
1,198
1,779
5,083
3,429
Total noninterest income
6,250
6,309
20,590
17,143
Noninterest expense:
Salaries and employee benefits
16,317
13,594
47,036
36,666
Occupancy and equipment
3,167
2,536
9,020
7,170
FDIC insurance
705
525
2,022
1,266
Other real estate and loan related expense
565
407
1,930
1,514
Advertising and marketing
288
235
985
654
Data processing and technology
1,872
1,753
5,185
4,642
Professional services
822
810
2,809
2,300
Amortization of intangibles
650
711
1,919
1,597
Merger related and restructuring expenses
87
464
607
939
2,757
2,274
7,361
6,822
Total noninterest expense
27,230
23,309
78,874
63,570
Income before income tax expense
14,754
12,233
38,375
35,901
Income tax expense
3,211
2,633
8,357
7,767
Net income
11,543
9,600
30,018
28,134
Earnings per common share:
Basic
0.69
0.62
1.79
1.85
Diluted
0.68
0.61
1.78
1.84
Weighted average common shares outstanding:
16,749,255
15,557,528
16,734,298
15,192,919
16,872,022
15,691,126
16,867,970
15,312,755
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
Other comprehensive income (loss):
Investment securities:
Unrealized holding gains (losses) on securities available-for-sale
(20,147)
284
(51,899)
(971)
Tax effect
5,205
(74)
13,406
264
Reclassification of unrealized loss on securities transferred from available-for-sale to held-to-maturity
(2,009)
519
Amortization of unrealized gains on investment securities transferred from available-for-sale to held-to-maturity
43
70
(12)
(18)
Reclassification adjustment for realized gains included in net income
(45)
12
Unrealized gains (losses) on securities available-for-sale, net of tax
(14,911)
177
(39,931)
(740)
Fair value hedging activities:
Unrealized gains (losses) on fair value municipal security hedges
92
59
(1,351)
1,510
(23)
(15)
349
(394)
Unrealized gains (losses) on fair value municipal security hedge instruments arising during the period, net of tax
69
44
(1,002)
1,116
Cash flow hedging activities:
Unrealized gains (losses) on cash flow hedges
(1,775)
458
Unrealized gains (losses) on cash flow hedge instruments arising during the period, net of tax
(1,317)
Total other comprehensive income (loss)
(16,159)
221
(42,250)
376
Comprehensive income (loss)
(4,616)
9,821
(12,232)
28,510
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY - (Unaudited)
For the Three and Nine Months Ended September 30, 2022 and 2021
Accumulated
Common Stock
Additional
Retained
Comprehensive
Shares
Amount
Paid-in Capital
Earnings
Income (Loss)
Total
Balance, December 31, 2020
15,107,214
15,107
252,693
87,185
2,183
357,168
Other comprehensive income
Common stock issued pursuant to:
Stock options exercised
19,165
19
175
194
Restricted stock
43,143
(43)
Shareholders' of Sevier County Bancshares, Inc.
1,691,535
1,691
40,563
42,254
Stock compensation expense
521
Common stock dividend ($0.18 per share)
(2,719)
Repurchases of common stock
(59,610)
(59)
(1,149)
(1,208)
Balance, September 30, 2021
16,801,447
16,801
292,760
112,600
2,559
424,720
Balance, December 31, 2021
16,802,990
Other comprehensive (loss)
32,003
32
238
270
Restricted stock, net of forfeitures
60,515
61
(61)
Shares withheld for payment of taxes
(7,953)
(8)
(198)
(206)
991
Common stock dividend ($0.21 per share)
(3,542)
Balance, September 30, 2022
16,887,555
Balance, June 30, 2021
15,109,736
15,110
252,039
103,906
2,338
373,393
176
158
Common stock dividend ($0.06 per share)
(906)
Balance, June 30, 2022
16,898,405
16,898
293,815
134,362
(24,648)
420,427
603
1
(3,500)
(3)
Restricted stock withheld for taxes
281
Common stock dividends ($0.07 per share)
(1,182)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
7,474
4,739
Accretion of fair value purchase accounting adjustments, net
(762)
(4,086)
Gain from redemption and sale of securities available-for-sale
Deferred income tax expense (benefit)
(500)
731
Increase in cash surrender value of bank owned life insurance
(1,382)
(1,240)
Net losses from sale and write downs of other real estate owned
66
Net gains from mortgage banking
(1,475)
(3,238)
Origination of loans held for sale
(47,840)
(97,360)
Proceeds from sales of loans held for sale
51,676
108,901
Net gain from sale of loans
(137)
Net gain from sale of fixed assets
(261)
Net change in:
Accrued interest receivable
(2,062)
2,074
Accrued interest payable
(993)
(125)
(25,079)
(414)
28,480
5,709
Net cash provided by operating activities
41,581
45,551
Cash flows from investing activities:
Available-for-sale:
Proceeds from sales
16,771
Proceeds from maturities, calls and paydowns
32,143
65,101
Purchases
(295,347)
(145,316)
Held-to-maturity:
1,345
(50,575)
Proceeds from sales of other investments
1,054
436
Purchases of other investments
(88)
(80)
Purchases of bank owned life insurance
(40,000)
Proceeds from bank owned life insurance benefits
427
Net (increase) decrease in loans and leases
(404,770)
4,444
Proceeds from sale of fixed assets
1,460
Purchases of premises and equipment
(10,690)
(603)
Proceeds from sale of other real estate owned
488
2,171
Proceeds received from sale of loans
83,745
Net cash (paid) received from business combinations
(4,881)
15,364
Net cash (used in) provided by investing activities
(729,861)
2,460
Cash flows from financing activities:
Net increase in deposits
258,872
558,410
Net increase (decrease) in securities sold under agreements to repurchase
838
(351)
Proceeds from borrowings
5,000
7,500
Repayment borrowings
(75,000)
(396)
Cash dividends paid
Issuance of common stock, net of restricted shares withheld for taxes
Net cash provided by financing activities
186,232
561,430
Net change in cash and cash equivalents
(502,048)
609,441
Cash and cash equivalents, beginning of period
481,719
Cash and cash equivalents, end of period
1,091,160
Supplemental disclosures of cash flow information:
Cash paid during the period for interest
12,624
8,745
Net cash paid/received during the period for income taxes
8,255
8,223
Noncash investing and financing activities:
Acquisition of real estate through foreclosure
580
Transfer of securities from available-for-sale to held-to-maturity
162,378
Change in goodwill due to acquisitions and sale of a portfolio of loans
4,580
15,849
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1. Presentation of Financial Information
Nature of Business:
SmartFinancial, Inc. (the "Company," “SmartFinancial,” “we,” “our” or “us”) is a bank holding company whose principal activity is the ownership and management of its wholly owned subsidiary, SmartBank (the "Bank"). The Company provides a variety of financial services to individuals and corporate customers through its offices in East and Middle Tennessee, Alabama, and the Florida Panhandle. The Bank’s primary deposit products are noninterest-bearing and interest-bearing demand deposits, savings and money market deposits, and time deposits. Its primary lending products are commercial, residential, and consumer loans.
Basis of Presentation and Accounting Estimates:
The accounting and financial reporting policies of the Company and its wholly owned subsidiary conform to U.S. generally accepted accounting principles (“GAAP”) and reporting guidelines of banking regulatory authorities and regulators. The accompanying interim consolidated financial statements for the Company and its wholly owned subsidiary have not been audited. All material intercompany balances and transactions have been eliminated.
In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments are normal and recurring accruals considered necessary for a fair and accurate presentation. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses, the valuation of foreclosed assets and deferred taxes, other than temporary impairments of securities, the fair value of financial instruments, goodwill, and the fair value of assets acquired, and liabilities assumed in acquisitions. The results for interim periods are not necessarily indicative of results for the full year or any other interim periods. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes appearing in the Company’s annual report on Form 10-K for the year ended December 31, 2021.
Recently Issued and Adopted Accounting Pronouncements:
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Interbank Offered Rate (“LIBOR”). It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020, through December 31, 2022. The Company implemented a transition plan to identify and modify its loans and other financial instruments, including certain indebtedness, with attributes that are either directly or indirectly influenced by LIBOR. As of December 31, 2021, the Company ceased issuance of new LIBOR loans. Alternative reference rates at this time are predominantly Secured Overnight Funding Rate (“SOFR”) based. Remaining LIBOR transition project activities include remediation of remaining LIBOR products by June of 2023. ASU 2020-04 did not have a material impact on the Company’s consolidated financial statements.
Recently Issued Not Yet Effective Accounting Pronouncements:
During interim periods, the Company follows the accounting policies set forth in its annual audited financial statements for the year ended December 31, 2021, as filed in its Annual Report on Form 10-K with the Securities and Exchange Commission ("SEC"). The following is a summary of recent authoritative pronouncements issued but not yet effective that could impact the accounting, reporting, and/or disclosure of financial information by the Company.
In October 2019, the Financial Accounting Standards Board approved a delay for the implementation of ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). The Financial Accounting Standards Board decided that the Current
Expected Credit Loss (“CECL”) model would be effective for larger Public Business Entities ("PBEs") that are SEC filers, excluding Smaller Reporting Companies ("SRCs") as then defined by the SEC, for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For calendar-year-end companies that were not SRCs, this was January 1, 2020. The determination of whether an entity is an SRC was based on an entity’s most recent assessment as of November 2019, in accordance with SEC regulations and the Company met the regulations as an SRC at that time. For SRCs and other entities, the Board decided that CECL will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all entities, early adoption will continue to be permitted; that is, early adoption was allowed for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (that is, effective January 1, 2019, for calendar-year-end companies). The Company does not plan to adopt this standard early and being that the Company was an SRC at the applicable time, adoption is required for fiscal years beginning after December 15, 2022.
Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
A cross-functional working group comprised of individuals from credit administration, risk management and accounting and finance are in place implementing and developing the data, forecast, processes, and portfolio segmentation that will be used in the models that will estimate the expected credit loss for each loan segment. The Company has contracted with a third party vendor solution to assist us in the application, analysis, and model development required with implementation of ASU 2016-13.
During the third quarter of 2022, the Company analyzed the results of ongoing parallel runs and continue to monitor the impact of various model assumptions. The model has been validated and our CECL Steering Committee remains focused on developing the CECL policy, procedures, and internal control structure in preparation for adoption. SmartFinancial has concluded that an increase in the allowance for loan losses is likely upon adoption of CECL.
In March 2022, the FASB issued ASU 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging - Portfolio Layer Method, which allows multiple hedged layers to be designated for a single closed portfolio of financial assets resulting in a greater portion of the interest rate risk in the closed portfolio being eligible to be hedged. The amendments allow the flexibility to use different types of derivatives or combinations of derivatives to better align with risk management strategies. Furthermore, among other things, the amendments clarify that basis adjustments of hedged items in the closed portfolio should be allocated at the portfolio level and not the individual assets within the portfolio. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption is permitted, including early adoption in an interim period. An entity should apply ASU 2022-01 prospectively. If an entity elects to early adopt ASU 2022-01 in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim period. The Company is assessing ASU 2022-01 and its impact on its accounting and disclosures.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which removes the accounting guidance for troubled debt restructurings and requires entities to evaluate whether a modification provided to a borrower results in a new loan or continuation of an existing loan. The amendments enhance existing disclosures and require new disclosures for receivables when there has been a modification in contractual cash flows due to a borrower experiencing financial difficulties. Additionally, the amendments require public business entities to disclose gross charge-off information by year of origination in the vintage
9
disclosures. The guidance is effective for entities that have adopted ASU 2016-13 for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. Early adoption is permitted, including early adoption in an interim period. An entity should apply ASU 2022-02 prospectively. If an entity elects to early adopt ASU 2022-02 in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes the interim period. The Company will adopt ASU 2022-02 when adopting ASU 2016-13 in January 2023 and is assessing its impact on its accounting and disclosures
In June 2022, the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions, which clarifies that a contractual sale restriction should not be considered in measuring fair value. It also requires entities with investments in equity securities subject to contractual sale restrictions to disclose certain qualitative and quantitative information about such securities. The guidance is effective for public companies for fiscal years beginning after December 15, 2023. All other entities have an extra year to adopt; early adoption is permitted. The Company is assessing ASU 2022-03 and its impact on its accounting and disclosures.
Note 2. Business Combinations
Sunbelt Group, LLC
On September 1, 2022, Rains Agency Inc. (“Rains Agency”), an indirect wholly-owned subsidiary of SmartFinancial, Inc., completed the acquisition of substantially all the assets of Sunbelt Group, LLC (“Sunbelt”), a Tennessee limited liability company, pursuant to the Asset Purchase Agreement (the “Purchase Agreement”), dated September 1, 2022, by and among Rains Agency, Sunbelt, and A. Mark Slater, the sole member of Sunbelt.
In connection with the acquisition, Rains Agency acquired $349 thousand of assets and assumed $364 thousand of liabilities from Sunbelt. Pursuant to the Purchase Agreement, Rains Agency paid an aggregate amount of consideration to Sunbelt of $6.5 million, of which $5.2 million was paid in cash at the closing and the remainder of which will be payable in equal cash installments on September 1, 2023, and September 1, 2024 (the “Deferred Payments”). The Deferred Payments are subject to acceleration in certain circumstances involving a change in control of Rains Agency and are subject to set-off for any indemnification or other obligations of the Sunbelt and its sole member to Rains Agency under the terms of the Purchase Agreement.
The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $4.6 million, representing the intangible value of Sunbelt’s business and reputation within the markets it served. The goodwill recognized is expected to be deductible for income tax purposes. The Company established an intangible asset related to customer relationships of $1.9 million, amortizing sum-of-the-years digits over 168 months (14 years).
The purchased assets and assumed liabilities were recorded at their acquisition date fair values (1) and are summarized in the table below (in thousands).
10
Initial
As recorded
Fair value
Subsequent
by Sunbelt
adjustments
Adjustments
by the Company
Assets:
Cash & cash equivalents
319
Customer list intangible
1,948
Equipment, net
13
(13)
17
Total assets acquired
1,935
2,284
Liabilities:
Payables and other liabilities
364
Total liabilities assumed
Excess of liabilities acquired over assets assumed
Aggregate fair value adjustments
Total identifiable net assets
1,920
Consideration transferred:
Purchase price
6,500
Total fair value of consideration transferred
Goodwill
(1) Fair values are preliminary and are subject to refinement for a period of one year after the closing date of an acquisition as information relative to the closing date fair value becomes available.
The following table discloses the impact of the purchase of Sunbelt since the acquisition date through the three and nine months ended September 30, 2022. The table also presents certain pro-forma information (net interest income plus total noninterest income (“Revenue”) and net income) as if the Sunbelt purchase had occurred on January 1, 2021. The pro-forma financial information is not necessarily indicative of the results of operations had the acquisitions been effective as of these dates.
Merger-related costs for the three and nine months ended September 30, 2022, were $20 thousand, respectively, and have been excluded from the pro-forma information presented below. The actual results and pro-forma information were as follows (in thousands):
Revenue
Net Income
2022:
Actual Sunbelt results included in statement of income since acquisition date
168
Supplemental consolidation pro-forma as if Sunbelt had been acquired January 1, 2022
43,008
11,548
120,681
29,992
2021:
Supplemental consolidation pro-forma as if Sunbelt had been acquired January 1, 2021
37,335
9,750
102,613
28,612
Sevier County Bancshares, Inc.
On September 1, 2021, the Company completed the acquisition of Sevier County Bancshares, Inc., a Tennessee corporation (“SCB”), pursuant to an Agreement and Plan of Merger dated April 13, 2021 (the “Merger Agreement”).
In connection with the merger, the Company acquired $484.9 million of assets and assumed $443.1 million of liabilities. Pursuant to the Merger Agreement, at the effective time of the merger, SCB shareholders were entitled to receive for each share of SCB common stock, no par value per share, outstanding immediately prior to the Merger, either (i) $10.17 in cash (the “Per Share Cash Consideration”), or (ii) 0.4116 shares of Company common stock, par value $1.00 (the “Per Share Stock Consideration”). Pursuant to the terms of the Merger Agreement, (i) each SCB shareholder holding 20,000 shares or more of SCB common stock will receive the Per Share Stock Consideration and (ii) each SCB shareholder holding fewer than 20,000 shares of SCB common stock may elect to receive either the Per Share Stock Consideration or the Per Share Cash Consideration. SmartFinancial issued 1,692,168 shares of SmartFinancial common stock and paid $9.6 million in cash as consideration for the Merger. The fair value of consideration paid exceeded the fair value of the identifiable
11
assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $17.2 million, representing the intangible value of SCB’s business and reputation within the markets it served. None of the goodwill recognized is expected to be deductible for income tax purposes. The Company is amortizing the related core deposit intangible of $1.6 million using the effective yield method over 120 months (10 years), which represents the expected useful life of the asset.
The purchased assets and assumed liabilities were recorded at their acquisition date fair values and are summarized in the table below (in thousands).
by SCB
84,313
Investment securities available-for-sale
64,219
(614)
63,605
Restricted investments
533
Loans
304,620
(4,551)
(3,049)
297,020
Allowance for loan losses
(3,644)
3,644
15,579
(295)
(22)
15,262
7,116
Deferred tax asset, net
10,340
(4,007)
769
7,102
Core deposit intangible
1,550
Interest Receivable
884
920
(272)
(533)
115
484,880
(4,545)
(2,835)
477,500
435,036
Time deposit premium
888
2,500
5,563
(1,254)
4,424
443,099
1,003
442,848
Excess of assets acquired over liabilities assumed
41,781
(5,548)
(1,581)
34,652
Cash
9,568
Common stock issued (1,692,168 shares)
42,255
51,823
17,171
The following table presents additional information related to the purchased credit impaired loans (ASC 310-30) of the acquired loan portfolio at the acquisition date (in thousands):
September 1, 2021
Accounted for pursuant to ASC 310-30:
Contractually required principal and interest
30,293
Non-accretable differences
7,609
Cash flows expected to be collected
22,684
Accretable yield
3,552
19,132
Fountain Leasing, LLC
On May 3, 2021, the Company completed the acquisition of Fountain Leasing, LLC, a Tennessee limited liability company, pursuant to the Purchase Agreement (the “Purchase Agreement”), dated May 2, 2021, by and among the Bank and the members of Fountain Leasing, LLC. Following the closing of the acquisition, on May 4, 2021, the Company changed the name of Fountain Leasing, LLC to Fountain Equipment Finance, LLC (“Fountain”).
In connection with the acquisition, the Company acquired $54.1 million of assets and assumed $683 thousand of liabilities. Pursuant to the Purchase Agreement, the Company paid an aggregate amount of consideration to the Fountain members of $14.0 million in cash at closing, and the Company repaid approximately $45.8 million of Fountain’s indebtedness. In
addition to the closing consideration, the Purchase Agreement contains a performance-based earnout, pursuant to which the former members of Fountain could be entitled to up to $6.0 million, which is excluded from consideration pursuant to ASC 805, in future cash payments from the Company based on future results of the acquired business over various periods through December 31, 2026. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $2.4 million, representing the intangible value of Fountains business and reputation within the markets it served. The goodwill recognized is expected to be deductible for income tax purposes. The Company established an intangible asset related to customer relationships of $2.7 million, amortizing sum-of-the-years digits over 96 months (8 years).
by Fountain
413
Leases
54,945
(720)
54,225
Allowance for lease losses
(1,796)
1,796
2,658
Other repossessed assets
233
54,114
3,734
57,848
683
(229)
454
53,431
3,963
57,394
59,794
2,400
The following table presents additional information related to the purchased credit impaired financing leases (ASC 310-30) of the acquired lease portfolio at the acquisition date (in thousands):
May 3, 2021
6,018
447
5,571
649
4,922
Note 3. Earnings Per Share
Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding. Diluted earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding and dilutive common share equivalents using the treasury stock method. Dilutive common share equivalents include common shares issuable upon exercise of outstanding stock options and restricted stock. The effect from the stock options and restricted stock on incremental shares from the assumed conversions for net income per share-basic and net income per share-diluted are
presented below. There were no antidilutive shares for the three and nine months ended September 30, 2022, and September 30, 2021, respectively.
The following is a summary of the basic and diluted earnings per share computation (dollars in thousands, except share and per share data):
Basic earnings per share computation:
Net income available to common shareholders
Average common shares outstanding – basic
Basic earnings per share
Diluted earnings per share computation:
Incremental shares from assumed conversions:
Stock options and restricted stock
122,767
133,598
133,672
119,836
Average common shares outstanding - diluted
Diluted earnings per common share
Note 4. Securities
The amortized cost, gross unrealized gains and losses and fair value of securities available-for-sale and held-to-maturity are summarized as follows (in thousands):
September 30, 2022
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
U.S. Treasury
242,018
(20,242)
221,776
U.S. Government-sponsored enterprises (GSEs)
1,650
(17)
1,633
Municipal securities
55,422
(1,308)
54,117
Other debt securities
30,967
(2,126)
28,841
Mortgage-backed securities (GSEs)
241,531
(28,176)
213,356
571,588
(51,869)
150,353
(6,095)
144,258
50,838
(8,735)
42,103
53,935
(10,330)
43,605
31,978
(4,968)
27,010
(30,128)
256,976
14
December 31, 2021
138,212
(518)
137,758
21,898
76
(173)
21,801
67,310
512
(2)
67,820
26,989
313
(82)
27,220
228,011
971
(1,128)
227,854
482,420
1,936
(1,903)
31,023
20
(87)
30,956
45,946
(19)
45,990
83
(106)
76,946
At September 30, 2022 and December 31, 2021, securities with a carrying value totaling approximately $299.3 million and $201.2 million, respectively, were pledged to secure public funds and securities sold under agreements to repurchase.
During the first quarter of 2022, the Company transferred $162.4 million of available-for-sale securities to the held-to-maturity category, reflecting the Company’s intent to hold those securities to maturity. Transfers of investment securities into the held-to-maturity category from the available-for-sale category are made at fair value at the date of transfer. The related $2.0 million of unrealized holding loss that was included in the transfer is retained in accumulated other comprehensive income, net of tax, and in the carrying value of the held-to-maturity securities. This amount will be amortized as an adjustment to interest income over the remaining life of the securities. This will offset the impact of amortization of the net premium created in the transfer. There were no gains or losses recognized as a result of this transfer.
The Company has entered-into-various fair value hedging transactions to mitigate the impact of changing interest rates on the fair values of available for sale securities. See Note 11 – Derivatives Financial Instruments for disclosure of the gains and losses recognized on derivative instruments and the cumulative fair value hedging adjustments to the carrying amount of the hedged securities.
15
The amortized cost and estimated fair value of securities at September 30, 2022 by contractual maturity for non-mortgage backed securities are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due from one year to five years
202,625
188,431
Due from five years to ten years
80,375
71,663
Due after ten years
46,787
46,003
330,057
306,367
Mortgage-backed securities
144,257
38,311
32,465
66,462
53,244
255,126
229,966
The following tables present the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities available-for-sale and held-to-maturity have been in a continuous unrealized loss position (in thousands):
Less than 12 Months
12 Months or Greater
Number
of
Securities
207,805
(17,749)
18
13,972
(2,493)
221,777
1,267
366
(4)
53,565
25,975
(1,877)
22
2,865
(249)
28,840
25
198,452
(26,983)
102
14,833
(1,193)
213,285
116
487,064
(47,930)
186
32,036
(3,939)
21
519,100
207
19,613
(3,763)
22,491
(4,972)
42,104
43,149
(10,233)
34
455
(97)
43,604
35
234,029
(25,059)
48
22,946
(5,069)
256,975
57
16
99,959
14,156
(168)
579
(5)
14,735
2,519
5,983
159,725
31
8,233
(126)
167,958
37
282,342
(1,772)
51
8,812
(131)
291,154
21,901
4,173
26,074
The Company reviews the securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. A determination as to whether a security’s decline in fair value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Company may consider in the other-than-temporary impairment analysis include the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings, financial condition and near-term prospects of the issuer, as well as security and industry specific economic conditions.
Based on this evaluation, the Company concluded that any unrealized losses at September 30, 2022, represented a temporary impairment, as these unrealized losses are primarily attributable to changes in interest rates and current market conditions, and not credit deterioration of the issuers. As of September 30, 2022, the Company does not intend, and will not be required, to sell any of the securities, and expects to recover the entire amortized cost of all of the securities.
Other Investments:
Our other investments consist of restricted non-marketable equity securities that have no readily determinable market value. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. As of September 30, 2022, the Company determined that there was no impairment on its other investment securities.
The following is the amortized cost and carrying value of other investments (in thousands):
Federal Reserve Bank stock
9,781
9,693
Federal Home Loan Bank stock
5,397
6,451
First National Bankers Bank stock
350
Note 5. Loans and Leases and Allowance for Loan and Lease Losses
Portfolio Segmentation:
Major categories of loans and leases are summarized as follows (in thousands):
PCI
All Other
Loans and Leases1
Loans and Leases
Commercial real estate
16,148
1,520,903
1,537,051
20,875
1,363,281
1,384,156
Consumer real estate
8,695
553,713
562,408
11,833
465,439
477,272
Construction and land development
1,557
403,450
405,007
2,882
275,504
278,386
Commercial and industrial
2,523
511,757
514,280
2,516
485,508
488,024
1,472
63,326
64,798
3,170
50,538
53,708
Consumer and other
15,566
15,572
71
11,780
11,851
Total loans and leases
30,401
3,068,715
41,347
2,652,050
(167)
(22,602)
(179)
(19,173)
30,234
3,046,113
41,168
2,632,877
1 Purchased Credit Impaired loans and leases (“PCI loans and leases”) are loans and leases with evidence of credit deterioration at purchase.
For purposes of the disclosures required pursuant to ASC 310, the loan and lease portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan and lease losses. There are six loan and lease portfolio segments that include commercial real estate, consumer real estate, construction and land development, commercial and industrial, leases, and consumer and other.
The following describe risk characteristics relevant to each of the portfolio segments:
Commercial Real Estate: Commercial real estate loans include owner-occupied commercial real estate loans and loans secured by income-producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Consumer Real Estate: Consumer real estate loans include real estate loans secured by first liens, second liens, or open end real estate loans, such as home equity lines. These are repaid by various means such as a borrower’s income, sale of the property, or rental income derived from the property. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Construction and Land Development: Loans for real estate construction and development are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio segment includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial and financial loans. These loans include those loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or expansion projects. Loans are repaid by business cash flows. Collection risk in this portfolio is driven by the creditworthiness of the underlying borrower, particularly cash flows from the customers’ business operations.
Leases: The lease portfolio segment includes leases to small and mid-size companies for equipment financing leases. These leases are secured by a secured interest in the equipment being leased.
Consumer and Other: The consumer loan portfolio segment includes direct consumer installment loans, overdrafts and other revolving credit loans, and educational loans. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.
Credit Risk Management:
The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan and lease portfolio segments. Credit risk management is guided by credit policies that provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Credit Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans and leases are individually underwritten, risk-rated, approved, and monitored.
Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer real estate and consumer and other portfolio segments, the risk management process focuses on managing customers who become delinquent in their payments. For the other portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit of the portfolios, including a third party review of the largest credits on an annual basis or more frequently, as needed. To ensure problem credits are identified on a timely basis, several specific portfolio reviews occur periodically to assess the larger adversely rated credits for proper risk rating and accrual status.
Credit quality and trends in the loan and lease portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by Director, Management and Loan Committees.
The allowance for loan and lease losses is a valuation reserve established through provisions for loan and lease losses charged against income. The allowance for loan and lease losses, which is evaluated quarterly, is maintained at a level that management deems sufficient to absorb probable losses inherent in the loan and lease portfolio. Loans and leases deemed to be uncollectible are charged against the allowance for loan and lease losses, while recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses. The allowance for loan and lease losses is comprised of specific valuation allowances for loans and leases evaluated individually for impairment and general allocations for pools of homogeneous loans and leases with similar risk characteristics and trends.
The allowance for loan and lease losses related to specific loans and leases is based on management’s estimate of potential losses on impaired loans and leases as determined by (1) the present value of expected future cash flows; (2) the fair value of collateral if the loan or lease is determined to be collateral dependent or (3) the loans’ or leases’ observable market price. The Company’s homogeneous loan and lease pools include commercial real estate loans, consumer real estate loans, construction and land development loans, commercial and industrial loans, leases and consumer and other loans. The general allocations to these loan and lease pools are based on the historical loss rates for specific loan and lease types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors.
The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan and lease portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan and lease structuring and pricing; (6) the impact of the regulatory environment and changes in laws; (7) effectiveness of the Company’s loan and lease policies, procedures and internal controls. The total allowance established for each homogeneous loan and lease pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans and leases in the pool.
The determination of the adequacy of the allowance for loan and lease losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans and leases, management obtains independent appraisals for significant collateral.
The Company’s loans and leases are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Company has a diversified loan and lease portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on local economic conditions.
While management uses available information to recognize losses on loans and leases, further reductions in the carrying amounts of loans and leases may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and leases. Such agencies may require the Company to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans and leases may change materially in the near term.
The composition of loans and leases by loan classification for performing, impaired and PCI loan and leases status is summarized in the tables below (in thousands):
Construction
Commercial
Consumer
and Land
and
Real Estate
Development
Industrial
and Other
September 30, 2022:
Performing loans and leases
1,520,598
552,076
402,592
3,065,915
Impaired loans and leases
305
1,637
858
2,800
PCI loans and leases
December 31, 2021:
1,362,423
463,374
485,411
2,649,030
2,065
3,020
The following tables show the allowance for loan and lease losses allocation by loan and lease classification for impaired, PCI, and performing (in thousands):
10,552
3,868
2,781
3,835
1,034
137
22,207
395
3,176
22,602
27
140
167
10,579
4,008
22,769
9,355
3,237
1,882
3,685
330
123
18,612
396
96
9,751
3,306
3,781
19,173
30
148
179
3,454
124
19,352
The following tables detail the changes in the allowance for loan and lease losses by loan and lease classification (in thousands):
Three Months Ended September 30, 2022
Real
Estate
Beginning balance
10,600
2,904
3,659
807
133
21,938
Charged-off loans and leases
(51)
(180)
(231)
Recoveries of charge-offs
29
33
88
Provision charged to expense
(21)
166
272
208
198
151
Ending balance
Three Months Ended September 30, 2021
8,382
3,323
2,061
4,442
18,310
(41)
(68)
(132)
(241)
23
77
1,000
205
157
9,405
3,541
2,218
3,801
225
105
19,295
Nine Months Ended September 30, 2022
(33)
(240)
(108)
(482)
(863)
162
192
131
1,050
794
26
1,294
132
620
Nine Months Ended September 30, 2021
7,579
3,471
2,076
5,107
113
18,346
(60)
(341)
(514)
171
252
1,797
142
(1,274)
We maintain the allowance at a level that we deem appropriate to adequately cover the probable losses inherent in the loan and lease portfolio. Our provision for loan and lease losses for the three and nine months ended September 30, 2022, is $974 thousand million and $3.2 million, respectively and $1.1 million and $1.2 million, during the three and nine months ended September 30, 2021, respectively. As of September 30, 2022, and December 31, 2021, our allowance for loan and lease losses was $22.8 million and $19.4 million, respectively, which we deemed to be adequate at each of the respective dates. Our allowance for loan and lease losses as a percentage of total loans and leases was 0.73% at September 30, 2022 and 0.72% at December 31, 2021.
A description of the general characteristics of the risk grades used by the Company is as follows:
Pass: Loans and leases in this risk category involve borrowers of acceptable-to-strong credit quality and risk who have the apparent ability to satisfy their loan and lease obligations. Loans and leases in this risk grade would possess sufficient mitigating factors, such as adequate collateral or strong guarantors possessing the capacity to repay the debt if required, for any weakness that may exist.
Watch: Loans and leases in this risk category involve borrowers that exhibit characteristics, or are operating under conditions that, if not successfully mitigated as planned, have a reasonable risk of resulting in a downgrade within the next six to twelve months. Loans and leases may remain in this risk category for six months and then are either upgraded or downgraded upon subsequent evaluation.
Special Mention: Loans and leases in this risk grade are the equivalent of the regulatory definition of "Other Assets Especially Mentioned" classification. Loans and leases in this category possess some credit deficiency or potential weakness, which requires a high level of management attention. Potential weaknesses include declining trends in operating earnings and cash flows and /or reliance on the secondary source of repayment. If left uncorrected, these potential weaknesses may result in noticeable deterioration of the repayment prospects for the asset or in the Company’s credit position.
Substandard: Loans and leases in this risk grade are inadequately protected by the borrower’s current financial condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans and leases in this risk grade have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined.
Uncollectible: Loans and leases in this risk grade are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan or lease has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan or lease, even though partial recovery may be obtained in the future. Charge-offs against the allowance for loan and lease losses are taken in the period in which the loan or lease becomes uncollectible. Consequently, the Company typically does not maintain a recorded investment in loans or leases within this category.
The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes have been made.
The following tables outline the amount of each loan and lease classification and the amount categorized into each risk rating (in thousands):
Non PCI Loans and Leases:
Pass
1,490,337
550,409
402,317
506,920
15,535
3,028,844
Watch
23,663
1,207
227
4,647
29,765
Special mention
6,519
36
73
6,628
Substandard
384
906
117
3,478
Doubtful
PCI Loans and Leases:
12,901
7,299
1,075
25,276
1,437
47
1,678
55
67
1,798
1,147
435
3,380
1,330,888
460,190
275,124
480,677
11,724
2,609,141
27,246
1,334
237
4,345
42
33,204
4,120
1,525
228
5,943
1,027
2,390
213
3,717
16,019
9,714
2,335
33,825
1,271
539
91
1,901
68
3,570
1,512
456
5,538
Past Due Loans and Leases:
A loan or lease is considered past due if any required principal and interest payments have not been received as of the date such payments were required to be made under the terms of the loan or lease agreement. Generally, management places a loan or lease on nonaccrual when there is a clear indicator that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan or lease is 90 days past due.
The following tables present an aging analysis of our loan and lease portfolio (in thousands):
30-60 Days
61-89 Days
Past Due 90
Past Due and
Days or More
Accruing
and Accruing
Nonaccrual
Current
103
408
1,520,495
271
2,464
551,249
58
511,486
143
63,134
211
15,355
788
217
3,379
4,404
3,064,311
172
1,030
1,362,251
2,139
3,033
462,406
275,413
1,191
119
1,471
484,037
361
50,177
99
11,647
2,798
3,124
6,119
2,645,931
Impaired Loans and Leases:
A loan or lease held for investment is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both principal and interest) according to the terms of the loan or lease agreement.
24
The following is an analysis of the impaired loan and lease portfolio, including PCI loans and leases, detailing the related allowance recorded (in thousands):
Unpaid
Recorded
Principal
Related
Investment
Balance
Allowance
Impaired loans and leases without a valuation allowance:
1,638
1,805
1,806
1,942
1,943
Impaired loans and leases with a valuation allowance:
859
260
262
1,215
1,217
PCI loans and leases:
522
597
707
926
873
835
1,129
1,251
1,395
1,432
1,841
2,180
Total impaired loans and leases
4,195
4,233
562
4,861
5,203
740
Three Months Ended September 30,
Average
Interest
Income
Recognized
304
1,742
72
2,046
261
154
1,273
1,230
880
1,176
258
1,405
2,674
49
4,309
95
6,118
152
1,839
1,778
39
1,991
2,778
40
429
1,218
104
352
141
977
1,711
122
765
46
410
879
1,169
263
1,646
86
1,857
94
4,614
178
6,346
256
Troubled Debt Restructurings:
For the periods presented, impaired loans included loans that were classified as troubled debt restructurings (“TDRs”). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.
In assessing whether or not a borrower is experiencing financial difficulties, the Company considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy; and (iv) the debtor’s projected cash flow is sufficient to satisfy contractual payments due under the original terms of the loan without a modification.
The Company considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Company include the debtor’s ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan.
The most common concessions granted by the Company generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt; (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk; (iii) a temporary period of interest-only payments; and (iv) a reduction in the contractual payment amount for either a short period or remaining term of the loan.
As of September 30, 2022, and December 31, 2021, management had approximately $108 thousand and $206 thousand, respectively, in loans that met the criteria for TDR, none of which were on nonaccrual. A loan is placed back on accrual status when both principal and interest are current, and it is probable that the Company will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
There are no loans that were modified as a TDR during the nine months ended September 30, 2022 and 2021, respectively. There were no loans that were modified as TDRs during the past nine months and for which there was a subsequent payment default.
Foreclosure Proceedings and Balances:
As of September 30, 2022, there were no residential properties secured by real estate included in other real estate owned and there were three residential real estate loan in the process of foreclosure.
Purchased Credit Impaired Loans and Leases:
The Company has acquired loans and leases where there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans and leases are as follows (in thousands):
26,622
31,600
10,599
14,215
3,052
3,699
2,470
3,424
1,754
3,557
125
44,531
56,620
Less: Remaining purchase discount
(14,130)
(15,273)
Total loans and leases, net of purchase discount
Less: Allowance for loan and leases losses
Carrying amount, net of allowance
Activity related to the accretable yield on loans and leases acquired with deteriorated credit quality is as follows (in thousands):
Accretable yield, beginning of period
15,736
14,522
14,618
16,889
Additions
4,072
4,721
Accretion income
(839)
(2,151)
(2,780)
(5,180)
Reclassification
1,729
254
2,127
1,931
Other changes, net
(415)
(1,034)
2,246
(2,698)
Accretable yield, end of period
16,211
15,663
Note 6. Goodwill and Intangible Assets
In accordance with FASB ASC 350, Goodwill and Other, regarding testing goodwill for impairment provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The Company performs its annual goodwill impairment test as of December 31 of each year. For 2021, the results of the qualitative assessment provided no indication of potential impairment.
The Company’s other intangible assets consist of core deposit, customer relationships and tradename. They are initially recognized based on a valuation performed as of the consummation date. The core deposit intangible is amortized over the average remaining life of the acquired customer deposits, the customer relationships are amortized over a weighted average of 10.4 years and the tradename is amortized over five years.
28
The carrying amount of goodwill and other intangible assets as of the dates indicated is summarized below (in thousands):
Goodwill:
Balance, beginning of period
91,565
74,135
Acquisition of PFG
323
Acquisition of Fountain
Acquisition of SCB
Acquisition of Sunbelt
Adjustment, due to sale
(2,464)
Balance, end of the period
96,145
Core Deposit
Customer Relationships
Tradename
Amortized other intangible assets:
Intangibles
Beginning balance January 1, 2022, gross
17,470
3,722
21,255
-
Balance, September 30, 2022, other intangible assets, gross
5,670
23,203
Less: accumulated amortization
(7,575)
(1,280)
(8,888)
Balance, September 30, 2022, other intangible assets, net
9,895
4,390
14,315
Beginning balance January 1, 2021, gross
15,920
1,064
17,047
Balance, December 31, 2021, other intangible assets, gross
(6,212)
(733)
(6,968)
Balance, December 31, 2021, other intangible assets, net
11,258
2,989
14,287
The aggregate amortization expense for other intangible assets for the three and nine months ended September 30, 2022, was $650 thousand and $1.9 million, respectively, and for the three and nine months ended September 30, 2021, was $711 thousand and $1.6 million, respectively,
The estimated aggregate amortization expense for future periods for intangibles is as follows (in thousands):
Remainder of 2022
688
2023
2,609
2024
2,438
2025
2,258
2026
2,086
Thereafter
4,236
Note 7. Borrowings, Line of Credit and Subordinated Debt
Borrowings:
At September 30, 2022, total borrowings were $18.4 million compared to $87.6 million at December 31, 2021. During the nine month period ending September 30, 2022, the FHLB called two advances totaling $75 million. Borrowings consist of the following (dollars in thousands):
Securities sold under customer repurchase agreements
5,923
5,085
FHLB borrowings
75,000
Other borrowings
12,500
Securities Sold Under Agreements to Repurchase:
Securities sold under repurchase agreements, which are secured borrowings, generally mature within one to four days from the transaction date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. The Company monitors the fair value of the underlying securities on a daily basis.
The Company had securities sold under agreements to repurchase with commercial checking customers which were secured by government agency securities. The carrying value of investment securities pledged as collateral under repurchase agreements was $9.3 million and $10.1 million at September 30, 2022 and December 31, 2021, respectively. The average balance during the nine month period September 30, 2022, and 2021 was $5.2 million and $5.4 million, respectively. The maximum month-end outstanding balance for the nine month period ended September 30, 2022, and 2021 was $5.9 million and $7.2 million, respectively.
Other Borrowings:
The Company has a Loan and Security Agreement and revolving line of credit for an aggregate amount of $25 million. The maturity of the line of credit is March 24, 2023. At September 30, 2022, $12.5 million was outstanding under the line of credit, and $12.5 million of the line of credit remained available to the Company.
Subordinated Debt:
On September 28, 2018, the Company issued $40 million of 5.625% fixed-to-floating rate subordinated notes (the "Notes"), which was outstanding as of September 30, 2022 and December 31, 2021. Unamortized debt issuance cost was $506 thousand and $570 thousand at September 30, 2022 and December 31, 2021, respectively.
The Notes initially bears interest at a rate of 5.625% per annum from and including September 28, 2018, to but excluding October 2, 2023, with interest during this period payable semi-annually in arrears. From and including October 2, 2023, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, or an alternative rate determined in accordance with the terms of the Notes if three-month LIBOR cannot be determined, plus 255 basis points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company, in whole or in part, on or after October 2, 2023, and at any time, in whole but not in part, upon the occurrence of certain events. The Notes have been structured to qualify initially as Tier 2 capital for the Company for regulatory capital purposes.
The Notes unamortized debt issuance costs totaled $506 thousand at September 30, 2022, and will be amortized through the Notes’ maturity date. Amortization expense totaled $21 thousand and $63 thousand for the three and nine months ended September 30, 2022, and 2021, respectively.
On September 1, 2021, the Company acquired $2.5 million of subordinated notes (“sub-debt”) from the acquisition of SCB. The sub-debt bears interest at a rate of 6.75% per annum until August 14, 2024, with the interest during this period payable semi-annually in arrears. From and including August 14, 2024, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, or an alternative rate determined in accordance with the terms of the sub-debt if three-month LIBOR cannot be determined, plus 530.25 basis points, with interest during this period payable quarterly in arrears. The sub-debt is redeemable by the Company, in whole or in part, on or after August 14, 2024, and at any time, in whole but not in part, upon the occurrence of certain events. The sub-debt has been structured to qualify initially as Tier 2 capital for the Company for regulatory capital purposes.
Note 8. Employee Benefit Plans
401(k) Plan:
The Company provides a deferred salary reduction plan (“Plan”) under Section 401(k) of the Internal Revenue Code covering substantially all employees. After 90 days of service, the Company matches 100% of employee contributions up to 3% of compensation and 50% of employee contributions on the next 2% of compensation. The Company’s contribution to the Plan for the three and nine month periods ending September 30, 2022, was $419 thousand and $1,266 thousand, respectively. The Company’s contribution to the Plan for the three and nine months ended September 30, 2021, was $287 thousand and $925 thousand, respectively.
Equity Incentive Plans:
The Compensation Committee of the Company’s Board of Directors may grant or award eligible participants stock options, restricted stock, restricted stock units, stock appreciation rights, and other stock-based awards or any combination of awards (collectively referred to herein as "Rights"). At September 30, 2022, the Company had one active equity incentive plan available for future grants, the 2015 Stock Incentive Plan, which has 1,766,245 Rights available for future grants or awards.
In addition, the Company has 30,790 Rights issued from the Cornerstone Non-Qualified Plan Options. This plan does not have any Rights available for future grants or awards.
Stock Options:
A summary of the status of stock option plans is presented in the following table:
Weighted
Exercisable
Price
Outstanding at December 31, 2021
79,667
10.17
Granted
Exercised
(32,003)
8.43
Forfeited
(2,369)
11.90
Outstanding at September 30, 2022
45,295
11.31
Information pertaining to stock options outstanding at September 30, 2022, is as follows:
Options Outstanding
Options Exercisable
Weighted-
Remaining
Exercise
Contractual
Prices
Outstanding
Life
9.48
14,290
0.45 years
9.60
16,500
1.19 years
15.05
14,505
2.67 years
Outstanding, end of period
1.43 years
The Company did not recognize any stock option-based compensation expense during the three and nine months ended September 30, 2022 and 2021, respectively, as all stock options issued are fully vested, and no future compensation cost will be recognized related to nonvested stock-based compensation arrangements granted under the Plans.
The intrinsic value of options exercised during the three and nine months ended September 30, 2022, was $9 thousand and $565 thousand. No stock options were exercised during the three months ended September 30, 2021. The intrinsic value of options exercised during the nine months ended September 30, 2021, was $220 thousand. The aggregate intrinsic value of total options outstanding and exercisable options at September 30, 2022, was $607 thousand. Cash received from options exercised under all share-based payment arrangements for the nine months ended September 30, 2022, was $270 thousand.
Stock options of 603 and 32,003 shares were exercised during the three and nine month periods ended September 30, 2022, respectively. No stock options were exercised during the three months ended September 30, 2021. Stock options of 19,040 shares were exercised during the nine month period ended September 30, 2021. The income tax benefit recognized for the exercise of options during the three and nine months ended September 30, 2022, was a benefit of $64 thousand and $147 thousand, respectively, and for the nine months ended September 30, 2021, was a benefit of $9 thousand.
Restricted Stock Awards:
A summary of the activity of the Company’s unvested restricted stock awards for the period ended September 30, 2022, is presented below:
Grant-Date
Fair Value
Balance at December 31, 2021
144,367
19.49
23,115
26.57
Vested
(34,146)
24.13
Forfeited/expired
16.44
Balance at September 30, 2022
129,836
19.61
The Company measures the fair value of restricted stock awards based on the price of the Company’s common stock on the grant date, and compensation expense is recorded over the vesting period. The compensation expense for restricted stock awards during the three and nine months ended September 30, 2022, was $281 thousand and $991 thousand, respectively, and was $163 thousand and $525 thousand, during the three and nine months ended September 30, 2021, respectively. As of September 30, 2022, there was $1.2 million of unrecognized compensation cost related to non-vested restricted stock awards granted under the plan. The cost is expected to be recognized over a weighted average period of 2.08 years. The grant-date fair value of restricted stock awards vested was $824 thousand for the nine months ended September 30, 2022.
Stock Appreciation Rights ("SARs"):
A summary of the status of SARs plans is presented in the following table:
Exercisable Price
55,000
18.21
(12,500)
18.12
42,500
18.23
Information pertaining to SARs outstanding at September 30, 2022, is as follows:
SARs Outstanding
SARs Exercisable
Weighted- Average
15.19
16,000
1.25 years
0.25 years
20.70
20,000
2.25 years
1.57 years
SARs compensation expense of $31 thousand and ($12) thousand was recognized for the three and nine months ended September 30, 2022, respectively, and $49 thousand and $162 thousand for the three and nine months ended September 30, 2021. The credit in expense for the nine month period ended September 30, 2022, was due to adjustments related to the fair value evaluation of SARs.
Note 9. Commitments and Contingent Liabilities
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing and depository needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized on the balance sheet. The majority of all commitments to extend credit are variable rate instruments while the standby letters of credit are primarily fixed rate instruments. The Company’s exposure to credit loss is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.
A summary of the Company’s total contractual amount for all off-balance sheet commitments are as follows (in thousands):
Commitments to extend credit
885,945
669,770
Standby letters of credit
16,111
17,868
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit issued by the Company are conditional commitments to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies and is required in instances which the Company deems necessary. At September 30, 2022 and December 31, 2021, the carrying amount of liabilities related to the Company’s obligation to perform under standby letters of credit was insignificant.
The Company is subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company will be material to the Company’s consolidated financial position. On an on-going basis, the Company assesses any potential liabilities or contingencies in connection with such legal proceedings. For those matters where it is deemed probable that the Company will incur losses and the amount of the losses can be reasonably estimated, the Company would record an expense and corresponding liability in its consolidated financial statements.
Note 10. Fair Value Disclosures
Determination of Fair Value:
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurements and Disclosures” ASC Topic 820, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
ASC Topic 820 provides a consistent definition of fair value, which focuses on exit price in an orderly transaction between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact business at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy:
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following methodologies were used by the Company in estimating fair value disclosures for financial instruments:
Securities available-for-sale - The fair value of U.S. Treasury, U.S. Government-sponsored enterprises, municipal securities, other debt securities and mortgage-backed securities, is estimated using a third party pricing service. The third party provider evaluates securities based on comparable investments with trades and market data and will utilize pricing models that use a variety of inputs, such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids and offers as needed. These securities are generally classified as Level 2.
Derivative financial instruments and interest rate swap agreements - The fair value for derivative financial instruments is determined based on market prices, broker-dealer quotations on similar products, or other related input parameters. The derivative financial instruments are generally classified Level 2.
Recurring Measurements of Fair Value:
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis (in thousands):
Quoted Prices in
Significant
Active Markets
for Identical
Observable
Unobservable
Assets
Inputs
Description
(Level 1)
(Level 2)
(Level 3)
Securities available-for-sale:
Total securities available-for-sale
Derivative financial instruments and interest rate swap agreements
12,433
Total assets at fair value
532,156
12,457
Interest rate swaps agreements for customer loans
1,326
483,779
4,893
During the nine months ending September 30, 2022, there were no transfers between Level 1 and Level 2 in the fair value hierarchy.
Assets Measured at Fair Value on a Nonrecurring Basis:
Under certain circumstances management adjusts fair value for assets and liabilities although they are not measured at fair value on an ongoing basis. The following tables present the financial instruments carried on the consolidated balance sheets by caption and by level in the fair value hierarchy, for which a nonrecurring change in fair value has been recorded (in thousands):
Collateral dependent loans
2,280
367
For Level 3 assets measured at fair value on a non-recurring basis, the significant unobservable inputs used in the fair value measurements are presented below (dollars in thousands):
Valuation
Significant Other
Average of
Technique
Unobservable Input
Input
Appraisal
Appraisal discounts
%
Collateral dependent loans: A collateral dependent loan is measured based on the fair value of the collateral securing these loans, less selling costs. Collateral dependent loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Collateral dependent loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.
Other real estate owned: Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at fair value less estimated costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and
the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, the difference is recognized in noninterest expense.
Carrying value and estimated fair value:
The carrying amount and estimated fair value of the Company’s financial instruments are as follows (in thousands):
Fair Value Measurements Using
Carrying
Estimated
Level 1
Level 2
Level 3
Cash and cash equivalents
Securities available-for-sale
Securities held-to-maturity
N/A
Loans and leases, net and loans held for sale
3,079,089
2,992,294
Noninterest-bearing demand deposits
Interest-bearing demand deposits
Money market and savings deposits
466,371
40,202
2,679,148
2,676,181
576,598
88,082
43,374
Limitations:
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
38
Note 11.Derivatives Financial Instruments
Derivatives designated as fair value hedges:
Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative net investment hedge instrument, as well as the offsetting gain or loss on the hedged asset or liability attributable to the hedged risk, are recognized in current earnings. The gain or loss on the derivative instrument is presented on the same income statement line item as the earnings effect of the hedged item. The Company utilizes interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate tax-exempt callable securities available-for-sale. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities. The Company has adopted ASU 2017-12, Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities, which allows such partial term hedge designations.
A summary of the Company’s fair value hedge relationships for the periods presented are as follows (dollars in thousands):
Sheet
Maturity
Receive
Notional
Asset/Liability derivatives
Location
(In Years)
Pay Rate
Rate
Interest rate swap agreements - securities
5.45
3.09
3 month LIBOR
36,000
1,752
6.20
(3,567)
The effects of the Company’s fair value hedge relationships reported in interest income on tax-exempt available-for-sale securities on the consolidated income statement were as follows (in thousands):
Interest income on tax-exempt securities
403
549
1,183
1,675
Effects of fair value hedge relationships
(83)
(218)
(527)
(781)
Reported interest income on tax-exempt securities
320
656
Gain (loss) on fair value hedging relationship
Interest rate swap agreements - securities:
Hedged items
1,808
5,319
1,994
Derivative designated as hedging instruments
(1,808)
(288)
(5,319)
(1,994)
Carry amount of hedged assets - securities available-for-sale
36,165
43,258
Derivatives Designated as Cash Flow Hedges:
During the third quarter of 2022, the Company entered into interest rate derivatives contracts that were designated as qualifying cash flow hedges to hedge the exposure to variability in expected future cash flows attributable to changes in a contractually specified interest rate. Specifically, the Company executed $100 million, notional amount, in interest rate collars to hedge the variable rate index on a portion of the Company’s commercial loan portfolio. To qualify for hedge accounting, a formal assessment is prepared to determine whether the hedging relationship, both at inception and on an ongoing basis, is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge if a cash flow hedge. At inception, a statistical regression analysis is prepared to determine hedge effectiveness. At each reporting period thereafter, a statistical regression or qualitative analysis is performed. If it is determined that hedge effectiveness has not been or will not continue to be highly effective then hedge accounting ceases and any gain or loss in AOCI is recognized in earnings immediately. The cash flow hedges are recorded at fair value in other liabilities on the consolidated balance sheets with changes in fair value recorded in AOCI, net of tax, see - Consolidated Statements of Comprehensive Income (Loss). Amounts recorded to AOCI are reclassified into earnings in the same period in which the hedged asset affects earnings and are presented in the same income statement line item as the earnings effect of the hedged asset, as future interest payments are made on the underlying assets. At September 30, 2022, no interest expense or interest income is expected to be reclassified from AOCI over the next 12 months.
At September 30, 2022, cash flow hedges are as follows (in thousands):
Balance Sheet
Cash flow hedges:
Liabilities
100,000
Non-hedged derivatives:
During the second quarter of 2021, the Company initiated a loan hedging program to certain loan customers. Through this program, the Company originates a variable rate loan with the customer. The Company and the customer will then enter into a fixed interest rate swap. Lastly, an identical offsetting swap is entered into by the Company with a dealer bank. These “back-to-back” swap arrangements are intended to offset each other and allow the Company to book a variable rate loan, while providing the customer with a contract for fixed interest payments. In these arrangements, the Company’s net cash flow is equal to the interest income received from the variable rate loan originated with the customer. These customer swaps are not designated as hedging instruments and are recorded at fair value in other assets and other liabilities. Since the income statement impact of the offsetting positions is limited, any changes in fair value is recognized as other noninterest income in the current period.
At September 30, 2022 and December 31, 2021, interest rate swaps related to the Company’s loan hedging program that were outstanding are presented in the following table (in thousands):
Interest rate swap agreements:
150,997
10,682
48,125
(10,682)
(1,326)
The Company establishes limits and monitors exposures for customer swap positions. Any fees received to enter the swap agreements at inception are recognized in earnings when received and is included in noninterest income. Such fees were as follows (in thousands):
Interest rate swap agreements
53
479
1,449
489
Collateral requirements:
These derivative rate contracts have collateral requirements, both at inception of the trade and as the value of each derivative position changes. At September 30, 2022 and December 31, 2021, collateral totaling $6.7 million and $2.4 million, respectively, was pledged to the derivative counterparties to comply with collateral requirements.
Note 12. Leases
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. The Company follows the guidance of ASU No. 2016-02 and all subsequent ASUs that modified this topic (collectively referred to as "Topic 842").
Substantially all of the leases in which the Company is the lessee are comprised of real estate for branches and office space with terms extending through 2034. All of our leases are classified as operating leases. Operating lease agreements are required to be recognized on the consolidated balance sheet as a right-of-use (“ROU”) asset and a corresponding lease liability.
The following table represents the consolidated balance sheet classification of the Company’s ROU assets and lease liabilities. The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated balance sheet (in thousands):
Classification
Operating lease right-of-use assets
8,889
9,812
Operating lease liabilities
9,015
9,881
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If, at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term.
As of September 30, 2022, the weighted average remaining lease term was 9.48 years and the weighted average discount rate was 2.16%.
The following table represents lease costs and other lease information. As the Company elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance (in thousands).
41
Lease costs:
Operating lease costs
764
Variable lease costs
1,296
830
Other information:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
385
257
1,163
Future minimum payments for operating leases with initial or remaining terms of one year or more as of September 30, 2022, were as follows (in thousands):
Amounts
391
1,340
1,047
946
5,250
Total future minimum lease payments
10,090
Amounts representing interest
(1,075)
Present value of net future minimum lease payments
Note 13. Regulatory Matters
Regulatory Capital Requirements:
The final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (Basel III rules) became effective January 1, 2015. In order to avoid restrictions on capital distributions and discretionary bonus payments to executives, under the new rules a covered banking organization is also required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer is required to consist solely of common equity Tier 1, and the buffer applies to all three risk-based measurements (CET1, Tier 1 capital and total capital). As of January 1, 2019, an additional amount of Tier 1 common equity equal to 2.5% of risk-weighted assets is required for compliance with the capital conservation buffer. The ratios for the Company and the Bank are currently sufficient to satisfy the fully phased-in conservation buffer. At September 30, 2022, the Company and the Bank exceeded the minimum regulatory requirements and exceeded the threshold for the "well capitalized" regulatory classification.
Regulatory Restrictions on Dividends:
Pursuant to Tennessee banking law, the Bank may not, without the prior consent of the Commissioner of the Tennessee Department of Financial Institutions (the “TDFI”), pay any dividends to the Company in a calendar year in excess of the total of the Bank’s retained net income for that year plus the retained net income for the preceding two years. Because this test involves a measure of net income, any charge on the Bank’s income statement, such as an impairment of goodwill, could impair the Bank’s ability to pay dividends to the Company. Under Tennessee corporate law, the Company is not permitted to pay dividends if, after giving effect to such payment, it would not be able to pay its debts as they become due in the usual course of business, or its total assets would be less than the sum of its total liabilities plus any amounts needed to satisfy any preferential rights if it were dissolving. In addition, in deciding whether to declare a dividend of any particular size, the Company’s board of directors must consider its and the Bank’s current and prospective capital, liquidity, and other needs. In addition to state law limitations on the Company’s ability to pay dividends, the Federal Reserve imposes limitations on the Company’s ability to pay dividends. Federal Reserve regulations limit dividends, stock repurchases and
discretionary bonuses to executive officers if the Company’s regulatory capital is below the level of regulatory minimums plus the applicable capital conservation buffer.
During the three and nine months ended September 30, 2022, the Bank did not pay a dividend to the Company and since the first quarter of 2022, the Company has paid a quarterly common stock dividend of $0.07 per share. The amount and timing of all future dividend payments by the Company, if any, is subject to discretion of the Company’s board of directors and will depend on the Company’s earnings, capital position, financial condition and other factors, including new regulatory capital requirements, as they become known to the Company.
Regulatory Capital Levels:
Actual and required capital levels at September 30, 2022, and December 31, 2021 are presented below (dollars in thousands):
Minimum to be
well
capitalized under
Minimum for
prompt
capital
corrective action
Actual
adequacy purposes
provisions1
Ratio
SmartFinancial:
Total Capital (to Risk Weighted Assets)
412,647
11.44
288,445
8.00
Tier 1 Capital (to Risk Weighted Assets)
347,884
9.65
216,334
6.00
Common Equity Tier 1 Capital (to Risk Weighted Assets)
162,250
4.50
Tier 1 Capital (to Average Assets)2
7.40
188,070
4.00
SmartBank:
411,529
11.41
288,523
360,653
10.00
388,760
10.78
216,392
162,294
234,425
6.50
8.27
188,071
235,089
5.00
386,627
12.55
246,483
325,345
10.56
184,862
138,647
Tier 1 Capital (to Average Assets)
7.45
174,578
378,055
12.29
246,053
307,566
358,703
11.66
184,539
138,405
199,918
8.23
174,384
217,980
1The prompt corrective action provisions are applicable at the Bank level only.
2Average assets for the above calculations were based on the most recent quarter.
Note 14. Other Comprehensive Income (Loss)
The changes in each component of accumulated other comprehensive income (loss), net of tax, were as follows (in thousands):
Available-for-
Transferred to
Municipal
Cash Flow
Sale
Held-to-Maturity
Security Hedges
Hedges
Beginning balance, June 30, 2022
(23,526)
(804)
(318)
Other comprehensive income (loss)
(14,942)
(16,190)
Reclassification of amounts included in net income
Net other comprehensive income (loss) during period
Ending balance, September 30, 2022
(38,468)
(773)
Beginning balance, June 30, 2021
2,051
287
210
Net other comprehensive income during period
Ending balance, September 30, 2021
2,228
Beginning balance, December 31, 2021
665
753
(38,493)
(1,490)
(42,302)
52
(1,438)
Beginning balance, December 31, 2020
2,968
(785)
(707)
409
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
While we offer a wide range of commercial banking services, we focus on making loans secured primarily by commercial real estate and other types of secured and unsecured commercial loans to small and medium-sized businesses in a number of industries, as well as loans to individuals for a variety of purposes. Our principal sources of funds for loans and investing in securities are deposits and, to a lesser extent, borrowings. We offer a broad range of deposit products, including checking (“NOW”), savings, money market accounts and time deposits. We actively pursue business relationships by utilizing the business contacts of our senior management, other bank officers and our directors, thereby capitalizing on our knowledge of our local market areas.
Forward-Looking Statement
The Company may from time to time make written or oral statements, including statements contained in this report and information incorporated by reference herein (including, without limitation, certain statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2), that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements, including statements regarding the effects of the COVID-19 (and the variants thereof) pandemic on the Company’s business and financial results and conditions, are based on assumptions and estimates and are not guarantees of future performance. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify some of the forward-looking statements by the use of forward-looking words (and their derivatives), such as “may,” “will,” “could,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “continue,” “potential,” “plan,” “forecast,” and the like, the negatives of such expressions, or the use of the future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of a current condition. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, financial condition, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to:
These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in SmartFinancial’s most recent annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, in each case filed with or furnished to the Securities and Exchange Commission (the “SEC”) and available on the SEC’s website (www.sec.gov). Undue reliance should not be placed on forward-looking statements. The Company disclaims any obligation to update or revise any forward-looking statements contained in this release, which speak only as of the date hereof, whether as a result of new information, future events, or otherwise.
Economic Conditions
The economic conditions and growth prospects for our markets, even against the headwinds of inflation and recessionary concerns, continue to reflect a solid and positive overall outlook with economic activity close to pre-pandemic levels. Increasing interest rates and rising building costs have caused some slowing of the highly robust single family housing market, however, there continues to be a shortage of housing in several Tennessee markets. Worker shortages especially in the restaurant, hospitality and retail industries combined with supply chain disruptions impacting numerous industries and inflationary conditions has had some impact on the level of economic growth. Ongoing higher inflation levels and higher interest rates could have a negative impact on both our consumer and commercial borrowers.
Critical Accounting Estimates
Our Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the industries in which we operate. The most significant accounting policies we follow are presented in Note 1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of the Consolidated Financial Statements. These factors include among other things, whether the policy requires management to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. The accounting policies which we believe to be most critical in preparing our Consolidated Financial Statements are presented in the section titled “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2021.
Executive Summary
The following is a summary of the Company’s financial highlights and significant events during the third quarter and first nine months of 2022:
Selected Financial Information
The following is a summary of certain financial information for the three and nine month periods ended September 30, 2022 and 2021 and as of September 30, 2022 and December 31, 2021 (dollars in thousands, except per share data):
Change
Income Statement:
Interest income
8,986
19,066
Interest expense
2,660
2,716
6,326
16,350
(175)
2,019
6,501
14,331
Noninterest income
3,447
Noninterest expense
3,921
15,304
Income before income taxes
2,521
2,474
578
590
1,884
Per Share Data:
Basic income per common share
0.07
(0.06)
Diluted income per common share
Performance Ratios:
Return on average assets
0.95
0.97
(0.02)
0.85
1.04
(0.18)
Return on average shareholders' equity
10.77
9.70
1.07
9.46
10.05
(0.59)
Balance Sheet:
402,302
258,471
Analysis of Results of Operations
Third quarter of 2022 compared to 2021
Net income was $11.5 million, or $0.68 per diluted common share, for the third quarter of 2022, compared to $9.6 million, or $0.61 per diluted common share, for the third quarter of 2021. For the three months ended September 30, 2022, when compared to the comparable period in 2021, the increase in net income of $1.9 million was due to an increase in net interest income after provision for loan and lease losses of $6.5 million, offset by increases in noninterest expense of $3.9 million and income tax expense of $578 thousand. The tax equivalent net interest margin was 3.29% for the third quarter of 2022, compared to 3.35% for the third quarter of 2021. Noninterest income to average assets was 0.52% for the third quarter of 2022, decreasing from 0.64% for the third quarter of 2021. Noninterest expense to average assets decreased to 2.25% in the third quarter of 2022, from 2.35% in the third quarter of 2021.
First nine months of 2022 compared to 2021
Net income totaled $30.0 million, or $1.78 per diluted share, for the first nine months ended 2022, compared to $28.1 million, or $1.84 per diluted share, for the first nine months of 2021. The increase in net income for this period was primarily from the increase of $14.3 million in net interest income after provision for loan and lease losses and $3.4 million in noninterest income, offset by increases of $15.3 million in noninterest expense. The tax equivalent net interest margin was 3.10% for the first nine months of 2022 compared to 3.37% for the first nine months of 2021. Noninterest income to average assets was 0.59% for the first nine months of 2022, decreasing from 0.63% for the first nine months of 2021.
Noninterest expense to average assets decreased to 2.24% in the first nine months of 2022, from 2.34% in the first nine months of 2021.
Net Interest Income and Yield Analysis
Net interest income, taxable equivalent, increased to $36.9 million for the third quarter of 2022, up from $30.5 million for the third quarter of 2021. Net interest income was positively impacted by the increase in balances of loans and leases, securities, and the increase in yield/rate on federal funds sold and other earning assets. Average interest-earning assets increased from $3.61 billion for the third quarter of 2021, to $4.45 billion for the third quarter of 2022, primarily from the Company’s continued organic loan and lease growth, the acquisition of SCB, which was completed September 1, 2021, and the increase in our securities, this was partially offset by a decrease in our overall liquidity position. Over this period, average loan and lease balances increased by $500.5 million, average securities increased $547.0 million, average interest-bearing deposits increased by $579.4 million and average noninterest-bearing deposits increased $315.0 million. Average federal funds sold and other interest earning assets decreased by $215.0 million and average borrowings decreased $67.0 million. The tax equivalent net interest margin decreased to 3.29% for the third quarter of 2022, compared to 3.35% for the third quarter of 2021. The yield on earning assets increased from 3.67% for the third quarter of 2021, to 3.79% for the third quarter of 2022, primarily due the deployment of excess cash and cash equivalents into loans and leases and the increase in rates by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The cost of average interest-bearing deposits increased from 0.34% for the third quarter of 2021, to 0.62% for the third quarter of 2022, primarily due to the increase in rates by the Federal Reserve.
The following tables summarizes the major components of net interest income and the related yields and costs for the periods presented (dollars in thousands):
Yield/
Loans and leases, including fees1
3,037,092
4.59
2,536,591
4.95
Taxable securities
720,114
1.73
187,032
1.77
Tax-exempt securities2
101,559
732
2.86
87,621
477
2.16
587,755
2.34
802,712
0.23
Total interest-earning assets
4,446,520
42,468
3.79
3,613,956
33,457
3.67
Noninterest-earning assets
362,869
323,067
4,809,389
3,937,023
Liabilities and Shareholders' Equity:
966,437
1,956
0.80
763,613
414
0.21
1,632,510
2,298
0.56
1,233,533
854
0.27
501,919
612
0.48
524,327
885
0.67
Total interest-bearing deposits
3,100,866
2,521,473
0.34
13,141
2.93
80,188
0.60
41,980
5.91
40,211
6.47
Total interest-bearing liabilities
3,155,987
0.70
2,641,872
2,928
0.44
Noninterest-bearing deposits
1,192,813
877,831
35,224
24,522
4,384,024
3,544,225
Shareholders' equity
425,365
392,798
Total liabilities and shareholders’ equity
Net interest income, taxable equivalent
36,879
30,529
Interest rate spread
3.23
Tax equivalent net interest margin
3.29
3.35
Percentage of average interest-earning assets to average interest-bearing liabilities
140.89
136.80
Percentage of average equity to average assets
8.84
9.98
1Loans and leases include PPP loans with an average balance of $22.0 million and $128.4 million for the three months ended September 30, 2022, and 2021, respectively. Loan and lease fees included in loan and lease income was $660 thousand million and $3.5 million for the three months ended September 30, 2022, and 2021, respectively. Loan and lease fee income for the three months ended September 30, 2022, and 2021, includes $166 thousand and $2.9 million accretion of loan fees on PPP loans, respectively.
2Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 21.0%. The taxable-equivalent adjustment was $171 thousand for the three months ended September 30, 2022, and $146 thousand for the three months ended September 30, 2021.
Net interest income, taxable equivalent, increased to $100.4 million for the first nine months of 2022, up from $84.0 million for the first nine months of 2021. Net interest income was positively impacted, compared to the prior year, primarily by the increase in balances of loans and leases, securities and federal funds sold and other earning assets. Average interest-earning assets increased from $3.33 billion for the first nine months of 2021, to $4.33 billion for the first nine months of 2022, primarily because of the Company’s continued organic loan and lease growth, the acquisition of Fountain, which was completed on May 3, 2021, the acquisition of SCB, which was completed September 1, 2021, and the increase in our securities and overall liquidity position. Over this period, average loan and lease balances increased by $384.9 million, average securities increased $534.5 million, average federal funds sold and other interest earning assets increased by $78.4 million, average interest-bearing deposits increased by $728.2 million, average noninterest-bearing deposits increased $328.9 million and average borrowings decreased $43.2 million. The tax equivalent net interest margin decreased to 3.10% for the first nine months of 2022, compared to 3.37% for the first nine months of 2021. The yield on earning assets decreased from 3.73% for the first nine months of 2021, to 3.46% for the first nine months of 2022, primarily due to a reduction in PPP fees and loan discount accretion. The cost of average interest-bearing deposits increased from 0.39% for the first nine months of 2021 to 0.41% for the first nine months of 2022, primarily due to the increase in rates by the Federal Reserve.
50
2,880,444
4.47
2,495,567
4.72
Taxable Securities
683,926
1.65
163,005
2.03
102,872
1,873
2.43
89,244
1,339
2.01
Federal funds and other earning assets
663,400
1.09
584,970
0.25
4,330,642
112,025
3.46
3,332,786
92,900
3.73
373,081
295,074
4,703,723
3,627,860
952,523
3,137
698,148
0.19
1,572,287
4,282
0.36
1,112,342
2,580
0.31
531,419
1,965
0.49
517,566
3,179
0.82
3,056,229
0.41
2,328,056
0.39
Borrowings3
37,933
1.31
81,177
0.59
41,959
5.98
39,650
6.15
3,136,121
0.50
2,448,883
1,111,854
782,960
31,412
21,553
4,279,387
3,253,396
424,336
374,464
100,393
83,984
2.96
3.24
3.10
3.37
138.09
136.09
9.02
10.32
1Loans and leases include PPP loans with an average balance of $36.6 million and $235.0 million for the nine months ended September 30, 2022 and 2021, respectively. Loan and lease fees included in loan and lease income was $3.6 million and $9.0 million for the nine months ended September 30, 2022 and 2021, respectively. Loan lease fee income for the nine months ended September 30, 2022, and 2021, includes $1.9 million and $7.4 million accretion of loan fees on PPP loans, respectively.
2Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 21.0%. The taxable-equivalent adjustment was $504 thousand for the nine months ended September 30, 2022, and $445 thousand for the nine months ended September 30, 2021.
Noninterest Income
The following table summarizes noninterest income by category (in thousands):
1,098
(824)
(1,763)
1,640
(405)
278
1,268
(581)
1,654
Noninterest income decreased by $59 thousand, or 0.9%, during the third quarter of 2022 compared to the same period in 2021. This quarterly change in total noninterest income primarily resulted from the following:
Noninterest income increased by $3.4 million, or 20.1%, during the first nine months of 2022 compared to the same period in 2021. This change in total noninterest income primarily resulted from the following:
Noninterest Expense
The following table summarizes noninterest expense by category (in thousands):
2,723
10,370
631
1,850
180
756
416
543
509
322
(377)
(332)
483
Noninterest expense increased by $3.9 million, or 16.8%, in the third quarter of 2022 as compared to the same period in 2021. The quarterly increase in total noninterest expense primarily resulted from the following:
Noninterest expense increased by $15.3 million, or 24.1%, in the first nine months of 2022 as compared to the same period in 2021. The change in total noninterest expense primarily resulted from the following:
Taxes
In the third quarter of 2022 income tax expense totaled $3.2 million compared to $2.6 million in the second quarter of 2021. The effective tax rate was approximately 21.8% in the second quarter of 2022 compared to 22.0% third quarter of 2021.
In the first nine months of 2022 income tax expense totaled $8.4 million compared to $7.8 million in the first nine months of 2021. The effective tax rate was approximately 21.8% for first nine months of 2022 compared to 21.6% for the first nine months of 2021.
The Inflation Reduction Act (“IRA”) was signed into law in August 2022, with most provisions effective beginning in the 2023 tax year, including an alternative corporate minimum tax if certain thresholds are met, a non-deductible excise tax on share repurchase, and transferability of certain federal tax credits. We do not expect the provisions of the IRA to have a material impact on our consolidated financial statements in the near future.
Loan and Lease Portfolio
The Company had total net loans and leases outstanding, including organic and acquired loans and leases, of approximately $3.08 billion at September 30, 2022, compared to $2.67 billion at December 31, 2021. Loans secured by real estate, consisting of commercial and residential property, are the principal component of our loan and lease portfolio.
Organic Loans and Leases
Our organic net loans and leases, which excludes loans and leases purchased through acquisitions, increased by $517.2 million, or 23.3%, from December 31, 2021, to $2.74 billion at September 30, 2022.
Acquired Loans and Leases
Net purchased non-credit impaired loans and leases of $304.6 million at September 30, 2022 decreased by $103.9 million from December 31, 2021. Since December 31, 2021, our net purchased credit impaired (“PCI”) loans and leases, decreased by $10.9 million to $30.2 million at September 30, 2022. The decrease in purchased non-credit impaired loans and leases and PCI loans and leases is related to maturities, paydowns and payoffs.
The following tables summarize the composition of our loan and lease portfolio for the periods presented (dollars in thousands):
Purchased
% of
Non-Credit
Credit
Organic
Impaired
Commercial real estate-mortgage
1,356,822
164,081
49.6
Consumer real estate-mortgage
463,773
89,940
18.1
392,955
10,495
13.1
489,347
22,410
16.6
44,069
19,257
2.1
15,092
0.5
Total gross loans and leases receivable, net of deferred fees
2,762,058
306,657
100.0
Allowance for loan and leases losses
(20,583)
(2,019)
Total loans and leases, net
2,741,475
304,638
1,157,702
205,579
51.4
346,322
119,117
17.7
258,196
17,308
10.3
449,909
35,599
18,067
32,471
2.0
10,536
1,244
0.4
2,240,732
411,318
Allowance for loan and lease losses
(16,441)
(2,732)
2,224,291
408,586
54
Loan and Lease Portfolio Maturities
The following table sets forth the maturity distribution of our loans and leases at September 30, 2022, including the interest rate sensitivity for loans and leases maturing after one year (in thousands):
Rate Structure for Loans and Leases
Maturing Over One Year
One Year
One through
Five through
Over Fifteen
Fixed
Floating
or Less
Five Years
Fifteen Years
Years
92,689
683,726
744,300
16,336
930,384
513,978
38,039
206,697
201,698
115,974
255,741
268,628
126,582
178,407
75,525
24,493
165,462
112,963
109,257
292,161
105,306
7,556
325,480
79,543
62,282
7,985
7,081
453
6,890
697
377,068
1,430,354
1,127,282
164,412
1,746,239
975,809
Nonaccrual, Past Due, and Restructured Loans and Leases
Nonperforming loans and leases as a percentage of total gross loans and leases, net of deferred fees, was 0.11% as of September 30, 2022, and 0.12% December 31, 2021, respectively. Total nonperforming assets as a percentage of total assets was 0.10% as of September 30, 2022, and 0.11% as of December 31, 2021, respectively. Acquired PCI loans and leases that are included in loan pools are reclassified at acquisition to accrual status and thus are not included as nonperforming assets.
The following table is a summary of our loans and leases that were past due at least 30 days but less than 89 days and 90 days or more past due for the periods presented (dollars in thousands):
Accruing Loans
30-89 Days
90 Days or More
Total Accruing
Past Due
Past Due Loans
Percentage of
Loans in
Category
0.01
0.03
0.22
163
202
1.30
1,005
0.00
1,025
1,310
1,355
0.28
0.87
0.16
1.03
2,931
0.11
2,995
The following table is a summary of our nonaccrual loans and leases for the periods presented (dollars in thousands):
Nonaccrual Loans
0.02
0.06
0.37
0.45
0.04
0.09
0.12
Allowance for loans and leases to nonaccrual loans
673.84%
619.46%
Allocation of the Allowance for Loan and Lease Losses
We maintain the allowance at a level that we deem appropriate to adequately cover the probable losses inherent in the loan and lease portfolio. Our provision for loan and lease losses for the nine months ended September 30, 2022, is $3.2 million compared to $1.2 million in the same period of 2021, an increase of $2.0 million. As of September 30, 2022, and December 31, 2021, our allowance for loan and lease losses was $22.8 million and $19.4 million, respectively, which we deemed to be adequate at each of the respective dates. Our allowance for loan and lease loss as a percentage of total loans and leases was 0.73% at September 30, 2022 and 0.72% at December 31, 2021, respectively.
Our purchased loans and leases were recorded at fair value upon acquisition. The fair value adjustments on the performing purchased loans and leases will be accreted into income over the life of the loans and leases. A provision for loan and lease losses is recorded for any deterioration in these loans and leases subsequent to the acquisition. As of September 30, 2022, the outstanding principal balance on PCI loan and leases was $44.5 million and the carrying value was $30.2 million, for a net difference of $14.1 million in discounts. At September 30, 2022, there was an allowance on PCI loans and leases of $167 thousand.
The following table sets forth, based on management's best estimate, the allocation of the allowance for credit losses on loans and leases to categories of loans and leases and loan and lease balances by category and the percentage of loans and leases in each category to total loans and leases and allowance for credit losses as a percentage of total loans and leases within each loan and lease category for each period presented (dollars in thousands):
Percentage of Loans
Ratio of Allowance
Amount of
in Each Category
Allocated to Loans in
Allowance Allocated
to Total Loans
Each Category
0.71
0.78
0.75
1.60
0.88
0.73
0.72
0.77
1.05
56
The allocation by category is determined based on the loans and leases individually assigned risk rating, if applicable, and environmental factors applicable to each category of loan and lease. For impaired loans and leases, those loans and leases are reviewed for a specific allowance allocation. Specific valuation allowances related to impaired, non PCI loans and leases were approximately $395 thousand at September 30, 2022, compared to $561 thousand at December 31, 2021.
Analysis of the Allowance for Loan and Lease Losses
The following is a summary of changes in the allowance for loan and lease losses for the periods presented including the ratio of the allowance for loan and lease losses to total loans and leases as of the end of each period (dollars in thousands):
Ratio of Net (charge-offs)
Provision for
Net (charge-offs)
Recoveries to
Credit Losses
Recoveries
Average Loans
1,531,028
546,286
383,488
(32)
497,378
(0.01)
63,831
0.05
(147)
15,081
(0.97)
(143)
1,143,094
448,983
300,308
(38)
605,105
(63)
27,149
(0.23)
(99)
11,952
(0.83)
(164)
1,471,905
528
504,007
0.10
350,872
(78)
479,392
84
60,836
0.14
13,432
(2.61)
187
1,163,262
(26)
444,553
299,494
541,834
34,912
(170)
11,512
(1.48)
(262)
We assess the adequacy of the allowance at the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon our evaluation of the loan and lease portfolio, past loan and lease loss experience, known and inherent risks in the portfolio, the views of the Bank’s regulators, adverse situations that may affect borrowers’ ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan and lease portfolio, economic conditions, industry and peer bank loan and lease quality indications and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans and leases that may be susceptible to significant change.
Securities Portfolio
Our available-for-sale securities portfolio is carried at fair market value and our held-to-maturity securities portfolio is carried at amortized cost, and consists primarily of Federal agency bonds, mortgage-backed securities, state and municipal securities and other debt securities. Our securities portfolio increased from $559.4 million at December 31, 2021, to $806.8 million at September 30, 2022, primarily as a result of strategically deploying a portion of the Bank’s cash position. New purchases were focused on U.S. Treasuries to provide cash flow and liquidity. Our securities to asset ratio has increased from 12.1% at December 31, 2021, to 16.8% at September 30, 2022. Over the past nine months the bank has increased its securities portfolio to strategically invest its excess liquidity.
The following table presents the contractual maturity of the Company’s securities by contractual maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis) at September 30, 2022 (dollars in thousands). The composition and maturity/repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.
1 or Less
1 to 5
5 to 10
Over 10
Yield (1)
198,158
43,860
1.29
U.S. Government agencies
3.42
State and political subdivisions
3.80
1,828
7,038
2.60
46,286
4.09
3.87
990
2.95
29,477
500
4.54
173
1.24
11,149
2.02
78,389
1.68
151,820
2.17
2.00
Total securities
443
2.80
213,775
1.39
158,764
2.15
198,606
2.62
1.47
34,013
1.83
16,825
1.92
1.86
4,298
2.20
49,637
2.13
2.14
27,085
2.12
43,204
1.90
93,547
2.09
1.74
(1)Based on amortized cost, taxable equivalent basis
Deposits are the primary source of funds for the Company’s lending and investing activities. The Company provides a range of deposit services to businesses and individuals, including noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money market accounts, IRAs and CDs. These accounts generally earn interest at rates the Company establishes based on market factors and the anticipated amount and timing of funding needs. The establishment or continuity of a core deposit relationship can be a factor in loan pricing decisions. While the Company’s primary focus is on establishing customer relationships to attract core deposits, at times, the Company uses brokered deposits and other wholesale deposits to supplement its funding sources. As of September 30, 2022, brokered deposits represented approximately 0.98% of total deposits.
The following tables summarize the average balances outstanding and average interest rates for each major category of deposits for the three and nine month periods ending September 30, 2022 and 2021, respectively (dollars in thousands):
September 30, 2021
27.8
25.8
22.5
38.0
36.3
11.7
15.4
Total average deposits
4,293,679
3,399,304
26.7
25.2
22.9
22.4
37.7
35.8
12.7
4,168,083
0.30
3,111,016
0.29
The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of interest-bearing deposits for the three months ended September 30, 2022, and 2021, was 0.62% and 0.34%, respectively. The increase cost was primarily attributable to the increases in rates by the Federal Reserve. The average cost of interest-bearing deposits for the nine months ended September 30, 2022, and 2021, was 0.41% and 0.39%, respectively. The increase cost was primarily attributable to the increases in rates by the Federal Reserve.
Total deposits as of September 30, 2022, were $4.28 billion, which was an increase of $258.5 million from December 31, 2021. This increase was primarily from organic deposit growth. As of September 30, 2022, the Company had outstanding time deposits under $250,000 with balances of $329.8 million and time deposits over $250,000 with balances of $138.2 million.
The following table summarizes the maturities of time deposits $250,000 or more (in thousands).
Three months or less
41,538
Three to six months
32,254
Six to twelve months
44,249
More than twelve months
20,120
138,161
The Company uses short-term borrowings and long-term debt to provide both funding and, to a lesser extent, regulatory capital using debt at the Company level which can be downstreamed as Tier 1 capital to the Bank. Borrowings totaled $18.4 million at September 30, 2022, and consisted of short-term borrowings of $12.5 million, and $5.9 million of securities sold under repurchase agreements. Long-term debt totaled $42.0 million at September 30, 2022, and $41.9 million at December 31, 2021, and consisted entirely of subordinated debt. For more information regarding our borrowings, see "Part I - Item 1. Consolidated Financial Statements - Note 7 – Borrowings, Line of Credit and Subordinated Debt."
Capital Resources
The Company uses leverage analysis to examine the potential of the institution to increase assets and liabilities using the current capital base. The key measurements included in this analysis are the Bank’s Common Equity Tier 1 capital, Tier 1 capital, leverage and total capital ratios. At September 30, 2022 and December 31, 2021, our capital ratios, including our Bank’s capital ratios, exceeded regulatory minimum capital requirements. From time to time we may be required to support the capital needs of our bank subsidiary. We believe we have various capital raising techniques available to us to provide for the capital needs of our bank, if necessary. For more information regarding our capital, leverage and total capital ratios, see “Part I - Item 1. Consolidated Financial Statements - Note 13 - Regulatory Matters.”
Liquidity and Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing and depository needs of its customers. At September 30, 2022, we had $885.9 million of pre-approved but unused lines of credit and $16.1 million of standby letters of credit. These commitments generally have fixed expiration dates and many will expire without being drawn upon. The total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank has the ability to liquidate Federal funds sold or securities available-for-sale, or on a short-term basis to borrow and purchase Federal funds from other financial institutions. For more information regarding our off-balance sheet arrangements, see “Part I - Item 1. Consolidated Financial Statements - Note 9 – Commitments and Contingent Liabilities.”
Market Risk and Liquidity Risk Management
The Bank’s Asset Liability Management Committee (“ALCO”), oversees market risk management and establishes risk measures, limits on policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. A variety of measures are used to provide for a comprehensive overview of the Company’s magnitude of interest rate risk, the distribution of risk, the level of risk over time and the exposure to changes in certain interest rate relationships. We utilize an independent third party earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12-24 months. The model measures the impact on net interest income relative to a flat-rate case scenario of hypothetical fluctuations in interest rates over the next 12-24 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate, caps and floors, is also included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered. In addition, third parties will join the meetings of ALCO to provide feedback regarding future balance sheet structure, earnings and liquidity strategies. ALCO continuously monitors and manages the balance between interest rate-sensitive assets and liabilities. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, management may lengthen or shorten the duration of assets or liabilities.
Interest Rate Sensitivity
Interest rate sensitivity refers to the responsiveness of interest-earning assets and interest-bearing liabilities to changes in market interest rates. In the normal course of business, we are exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates the interest rate risk so that we can meet customer demands for various types of loans and leases and deposits. ALCO determines the most appropriate amounts of on-balance sheet and off-balance sheet items. The primary measurements we use to help us manage interest rate sensitivity are an earnings simulation model and an economic value of equity model. These measurements are used in conjunction with competitive pricing analysis and are further described below.
Earnings Simulation Model We believe interest rate risk is effectively measured by our earnings simulation modeling. Earning assets, interest-bearing liabilities and off-balance sheet financial instruments are combined with simulated forecasts of interest rates for the next 12 months. To limit interest rate risk, we have guidelines for our earnings at risk which seek to limit the variance of net interest income in instantaneous changes to interest rates. We also periodically monitor simulations based on various rate scenarios such as non-parallel shifts in market interest rates over time. For changes up or down in rates from our static interest rate forecast over the next 12 months, limits in the decline in net interest income are as follows:
Estimated % Change in Net Interest Income Over 12 Months
Instantaneous, Parallel Change in Prevailing Interest Rates Equal to:
100 basis points increase
1.10%
200 basis points increase
2.15%
100 basis points decrease
(1.61)%
60
Economic Value of Equity Our economic value of equity model measures the extent that estimated economic values of our assets, liabilities and off-balance sheet items will change as a result of interest rate changes. Economic values are determined by discounting expected cash flows from assets, liabilities and off-balance sheet items, which establishes a base case economic value of equity.
To help monitor our related risk, we’ve established the following policy limits regarding simulated changes in our economic value of equity:
Current Estimated Instantaneous Rate Change
0.90%
0.71%
(2.49)%
Liquidity Risk Management
The purpose of liquidity risk management is to ensure that there are sufficient cash flows to satisfy loan and lease demand, deposit withdrawals, and our other needs. Traditional sources of liquidity for a bank include asset maturities and growth in core deposits. A bank may achieve its desired liquidity objectives from the management of its assets and liabilities and by internally generated funding through its operations. Funds invested in marketable instruments that can be readily sold and the continuous maturing of other earning assets are sources of liquidity from an asset perspective. The liability base provides sources of liquidity through attraction of increased deposits and borrowing funds from various other institutions.
Changes in interest rates also affect our liquidity position. We currently price deposits in response to market rates and intend to continue this policy. If deposits are not priced in response to market rates, a loss of deposits could occur which would negatively affect our liquidity position.
Scheduled loan and lease payments are a relatively stable source of funds, but loan and lease payoffs and deposit flows fluctuate significantly, being influenced by interest rates, general economic conditions and competition. Additionally, debt securities are subject to prepayment and call provisions that could accelerate their payoff prior to stated maturity. We attempt to price our deposit products to meet our asset/liability objectives consistent with local market conditions. Our ALCO is responsible for monitoring our ongoing liquidity needs. Our regulators also monitor our liquidity and capital resources on a periodic basis.
The Company has $443 thousand in securities that mature throughout the next 12 months. The Company also anticipates $31.2 million of principal payments from mortgage-backed securities over the same period. The Company also has unused borrowing capacity in the amount of $548.5 million available with the Federal Reserve, FHLB, several correspondent banks and a line of credit. With these sources of funds, the Company currently anticipates adequate liquidity to meet the expected obligations of its customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information presented in the Market Risk and Liquidity Risk Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of this report is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including SmartFinancial’s Chief Executive Officer and Chief Financial Officer, SmartFinancial has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of June 30, 2022 (the “Evaluation Date”). Based on such evaluation, SmartFinancial’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, SmartFinancial’s disclosure controls and procedures were effective to ensure that information required to be disclosed by SmartFinancial in the reports that it files or submits under the Exchange Act is (i) accumulated and communicated to SmartFinancial’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decision regarding the required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There were no changes in SmartFinancial’s internal control over financial reporting during SmartFinancial’s fiscal quarter ended September 30, 2022, that have materially affected, or are reasonably likely to materially affect, SmartFinancial’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
SmartFinancial, Inc. and its wholly owned subsidiary, SmartBank, are periodically involved as a plaintiff or a defendant in various legal actions in the ordinary course of business. While the outcome of these matters is not currently determinable, management does not expect the disposition of any of these matters to have a material adverse impact on the Company’s financial condition, financial statements or results of operations.
Item 1A. Risk Factors.
In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I--Item 1A--Risk Factors” in our Form 10-K for the year ended December 31, 2021. These factors could materially and adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report. Please be aware that these risks may change over time and other risks may prove to be important in the future. In addition, these risks may be heightened by the continued disruption and uncertainty resulting from COVID-19. There have been no material changes from the risk factors described in our Form 10-K for the year ended December 31, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On November 20, 2018, the Company announced that its board of directors had authorized a stock repurchase plan pursuant to which the Company may purchase up to $10.0 million in shares of the Company’s outstanding common stock. Stock repurchases under the plan will be made from time to time in the open market, at the discretion of the management of the Company, and in accordance with applicable legal requirements. The stock repurchase plan does not obligate the Company to repurchase any dollar amount or number of shares, and the program may be extended, modified, amended, suspended, or discontinued at any time. As of September 30, 2022, we have purchased $5.5 million of the authorized $10.0 million and may purchase up to an additional $4.5 million in the Company’s outstanding common stock.
The following table summarizes the Company’s repurchase activity during the three months ended September 30, 2022.
Maximum
Number (or
Approximate
Dollar Value) of
Shares That May
Total Number of Shares
Yet Be Purchased
Total Number of
Purchased as Part of
Under the Plans
Average Price Paid
Publicly Announced
or Programs (in
Period
Repurchased
Per Share
Plans or Programs
thousands)
July 1, 2022 to July 31, 2022
4,484
August 1, 2022 to August 31, 2022
September 1, 2022 to September 30, 2022
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not Applicable.
Item 5. Other Information.
Item 6. Exhibits
ExhibitNo.
Asset Purchase Agreement, dated as of September 1, 2022, by Sunbelt Group, LLC, A. Mark Slater., and Rains Agency Inc.
Incorporated by reference to Exhibit 2.1 to Form 8-K filed September 6, 2022
3.1
Second Amended and Restated Charter of SmartFinancial, Inc.
Incorporated by reference to Exhibit 3.3 to Form 8-K filed September 2, 2015
3.2
Second Amended and Restated Bylaws of SmartFinancial, Inc.
Incorporated by reference to Exhibit 3.1 to Form 8-K filed October 26, 2015
31.1
Certification pursuant to Rule 13a -14(a)/15d-14(a)
Filed herewith.
31.2
32.1
Certification pursuant to 18 USC Section 1350 -Sarbanes-Oxley Act of 2002
Furnished herewith.
32.2
101
Interactive Data Files (formatted as Inline XBRL)
Cover Page Interactive Data File (Formatted as Inline XBRL and contained in Exhibit 101)
Filed herewith
* Certain schedules and similar attachments have been omitted pursuant to Item 601(a)(5) of Regulation S-K. The registrant will furnish a copy of any omitted schedule to the Securities and Exchange Commission upon request.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SmartFinancial, Inc.
Date:
November 9, 2022
/s/ William Y. Carroll, Jr.
William Y. Carroll, Jr.
President and Chief Executive Officer
(principal executive officer)
/s/ Ronald J. Gorczynski
Ronald J. Gorczynski
Executive Vice President and Chief Financial Officer
(principal financial officer and accounting officer)