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 June 30, 2023
☐
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 August 04, 2023, there were 17,004,092 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 June 30, 2023 and December 31, 2022
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2023 and 2022
4
Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2023 and 2022
5
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2023 and 2022
6
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2023 and 2022
7
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
46
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
63
Item 4.
Controls and Procedures
PART II – OTHER INFORMATION
64
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
65
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
66
2
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SMARTFINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except for share data)
(Unaudited)
June 30,
December 31,
2023
2022*
ASSETS:
Cash and due from banks
$
37,532
44,265
Interest-bearing deposits with banks
198,756
206,849
Federal funds sold
2,610
15,310
Total cash and cash equivalents
238,898
266,424
Securities available-for-sale, at fair value
540,308
483,893
Securities held-to-maturity, at amortized cost
283,564
285,949
Other investments
14,396
15,530
Loans held for sale
986
1,752
Loans and leases
3,337,790
3,253,627
Less: Allowance for credit losses
(32,747)
(23,334)
Loans and leases, net
3,305,043
3,230,293
Premises and equipment, net
92,351
92,511
Other real estate owned
1,708
1,436
Goodwill and other intangibles, net
108,439
109,772
Bank owned life insurance
82,419
81,470
Other assets
77,688
68,468
Total assets
4,745,800
4,637,498
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Noninterest-bearing demand
1,003,432
1,072,449
Interest-bearing demand
938,758
965,911
Money market and savings
1,720,202
1,583,481
Time deposits
537,192
455,259
Total deposits
4,199,584
4,077,100
Borrowings
15,496
41,860
Subordinated debt
42,057
42,015
Other liabilities
43,816
44,071
Total liabilities
4,300,953
4,205,046
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; 17,004,092 and 16,900,805 shares issued and outstanding, respectively
17,004
16,901
Additional paid-in capital
295,296
294,330
Retained earnings
167,564
156,545
Accumulated other comprehensive income (loss)
(35,017)
(35,324)
Total shareholders' equity
444,847
432,452
Total liabilities and shareholders' equity
* Derived from audited financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share data)
Three Months Ended
Six Months Ended
2022
Interest income:
Loans and leases, including fees
45,446
31,530
90,173
61,172
Securities:
Taxable
4,335
2,908
7,986
5,327
Tax-exempt
357
441
709
809
Federal funds sold and other earning assets
1,956
1,430
6,405
1,916
Total interest income
52,094
36,309
105,273
69,224
Interest expense:
Deposits
19,554
2,504
35,900
4,518
339
117
564
274
626
1,252
Total interest expense
20,519
3,247
37,716
6,044
Net interest income
31,575
33,062
67,557
63,180
Provision for credit losses
113
1,250
663
2,256
Net interest income after provision for credit losses
31,462
31,812
66,894
60,924
Noninterest income:
Service charges on deposit accounts
1,657
1,446
3,102
2,765
Mortgage banking
332
471
504
1,305
Investment services
1,300
1,065
2,305
2,135
Insurance commissions
1,139
598
2,398
1,499
Interchange and debit card transaction fees, net
1,347
1,467
2,730
2,751
Other
1,355
2,182
3,016
3,885
Total noninterest income
7,130
7,229
14,055
14,340
Noninterest expense:
Salaries and employee benefits
15,947
15,673
32,689
30,719
Occupancy and equipment
3,318
2,793
6,526
5,852
FDIC insurance
875
676
1,416
1,317
Other real estate and loan related expense
636
1,013
1,365
Advertising and marketing
305
327
660
697
Data processing and technology
2,235
1,728
4,398
3,314
Professional services
764
745
1,572
1,987
Amortization of intangibles
675
633
1,334
1,270
Merger related and restructuring expenses
81
520
2,850
2,634
5,331
4,602
Total noninterest expense
27,410
25,926
54,939
51,643
Income before income tax expense
11,182
13,115
26,010
23,621
Income tax expense
2,346
2,900
5,674
5,146
Net income
8,836
10,215
20,336
18,475
Earnings per common share:
Basic
0.53
0.61
1.21
1.11
Diluted
0.52
1.20
1.10
Weighted average common shares outstanding:
16,806,389
16,734,930
16,798,939
16,726,696
16,898,091
16,867,774
16,897,444
16,863,299
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
Other comprehensive income (loss):
Investment securities:
Unrealized holding gains (losses) on securities available-for-sale
(7,624)
(11,404)
652
(31,752)
Tax effect
1,970
2,945
(168)
8,201
Reclassification of unrealized gains (losses) on securities transferred from available-for-sale to held-to-maturity
(2,009)
519
Amortization of unrealized gains (losses) on investment securities transferred from available-for-sale to held-to-maturity
38
78
27
(10)
(9)
(20)
(6)
Unrealized gains (losses) on securities available-for-sale, net of tax
(5,626)
(8,430)
542
(25,020)
Fair value hedging activities:
Unrealized gains (losses) on fair value municipal security hedges
(892)
(1,443)
230
372
Unrealized gains (losses) on fair value municipal security hedge instruments arising during the period, net of tax
(662)
(1,071)
Cash flow hedging activities:
Unrealized gains (losses) on cash flow hedges
(1,039)
(317)
268
82
Unrealized gains (losses) on cash flow hedge instruments arising during the period, net of tax
(771)
(235)
Total other comprehensive income (loss)
(6,397)
(9,092)
307
(26,091)
Comprehensive income (loss)
2,439
1,123
20,643
(7,616)
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY – (Unaudited)
For the Three and Six Months Ended June 30, 2023 and 2022
Accumulated
Common Stock
Additional
Retained
Comprehensive
Shares
Amount
Paid-in Capital
Earnings
Income (Loss)
Total
Balance, December 31, 2021
16,802,990
16,803
292,937
118,247
1,443
429,430
Other comprehensive loss
Common stock issued pursuant to:
Stock options exercised
31,400
31
232
263
Restricted stock
64,015
(64)
Stock compensation expense
710
Common stock dividend ($0.14 per share)
(2,360)
Balance, June 30, 2022
16,898,405
16,898
293,815
134,362
(24,648)
420,427
Balance, December 31, 2022
16,900,805
Cumulative effect adjustment for adoption of ASU 2016-13, net of tax
(6,606)
Balance, January 1, 2023, adjusted
149,939
425,846
Other comprehensive income
15,705
15
150
165
Restricted stock, net of forfeitures
87,582
88
(88)
904
Common stock dividend ($0.16 per share)
(2,711)
Balance, June 30, 2023
17,004,092
Balance, March 31, 2022
16,893,282
16,893
293,376
125,329
(15,556)
420,042
3,850
42
1,273
1
(1)
398
Common stock dividend ($0.07 per share)
(1,182)
Balance, March 31, 2023
294,930
160,085
(28,620)
443,399
366
Common stock dividends ($0.08 per share)
(1,357)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
5,506
4,918
Accretion of fair value purchase accounting adjustments, net
(552)
Amortization of intangible assets
Deferred income tax expense
1,739
328
Increase in cash surrender value of bank owned life insurance
(949)
(918)
Net losses from sale and write-downs of other real estate owned
59
Net gains from mortgage banking
(504)
(1,305)
Origination of loans held for sale
(18,990)
(42,712)
Proceeds from sales of loans held for sale
20,259
47,413
Net (gain) loss from sale/disposal of fixed assets
(253)
Net change in:
Accrued interest receivable
(1,393)
(1,597)
Accrued interest payable
(224)
(5,516)
(13,351)
(3,426)
13,890
Net cash provided by operating activities
21,329
28,407
Cash flows from investing activities:
Available-for-sale:
Proceeds from maturities, calls and paydowns
20,491
21,247
Purchases
(78,096)
(266,872)
Held-to-maturity:
1,293
634
(50,575)
Proceeds from sales of other investments
2,053
Purchases of other investments
(919)
(75)
Net increase in loans and leases
(84,897)
(299,793)
Proceeds from sale of fixed assets
623
1,278
Purchases of premises and equipment
(3,059)
(7,358)
Proceeds from sale of other real estate owned
108
Net cash used by investing activities
(142,511)
(601,406)
Cash flows from financing activities:
Net increase in deposits
122,566
260,000
Net increase (decrease) in securities sold under agreements to repurchase
221
(36)
Proceeds from borrowings
26,000
Repayment of borrowings
(52,585)
(75,000)
Cash dividends paid
Issuance of common stock, net of restricted shares withheld for taxes
Net cash provided by financing activities
93,656
182,867
Net change in cash and cash equivalents
(27,526)
(390,132)
Cash and cash equivalents, beginning of period
1,045,077
Cash and cash equivalents, end of period
654,945
Supplemental disclosures of cash flow information:
Cash paid during the period for interest
36,417
6,267
Net cash paid during the period for income taxes
8,577
3,640
Noncash investing and financing activities:
Recognition of operating lease assets in exchange for lease liabilities
1,751
53
Acquisition of real estate through foreclosure
272
Transfer of securities from available-for-sale to held-to-maturity
162,378
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 credit losses, the valuation of foreclosed assets and deferred taxes, 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, 2022.
Allowance for Credit Losses (“ACL”):
As described below under Recently Issued and Adopted Accounting Pronouncements, the Company adopted ASU 2016-13 effective January 1, 2023, which requires the estimation of an allowance for credit losses in accordance with the Current Expected Credit Losses (“CECL”) methodology. This standard applies to all financial assets measured at amortized cost and off-balance sheet credit exposures, including loans, investment securities and unfunded commitments. We applied the standard’s provisions using the modified retrospective method as a cumulative-effect adjustment to retained earnings as of January 1, 2023. With this transition method, we did not have to restate comparative prior periods presented in the financial statements related to Topic 326, but will present comparative prior periods disclosures using the previous accounting guidance for the allowance for loan losses. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard.
In connection with the adoption of ASU 2016-13, the Company revised certain accounting policies and implemented certain accounting policy elections. The revised accounting policies are described below:
ACL - Held-to-Maturity (“HTM”) Securities - The Company measures expected credit losses on HTM securities on a collective basis by major security type with each type sharing similar risk characteristics. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The Company has made the election to exclude accrued interest receivable on HTM securities from the estimate of credit losses and report accrued interest separately on the consolidated balance sheets. See Note 4 - Securities, for additional information related to the Company’s allowance for credit losses on HTM securities.
ACL - Available-for-Sale (“AFS”) Securities - For AFS securities in an unrealized loss position, the Company first evaluates whether it intends to sell, or whether it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of these criteria regarding intent or requirement to sell is met, the AFS security amortized cost basis is written down to fair value through income. If the criteria is not met, the Company is required to assess whether the decline in fair value has resulted from credit losses or noncredit-related factors. If the assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists, and an allowance for credit loss is recorded through income as a component of provision for credit loss expense. If the assessment indicates that a credit loss does not exist, the Company records the decline in fair value through other comprehensive income, net of related income tax effects. The Company has made the election to exclude accrued interest receivable on AFS securities from the estimate of credit losses and report accrued interest separately on the consolidated balance sheets. Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an AFS security is confirmed or when either of the criteria regarding intent or requirement to sell is met. See Note 4 - Securities, for additional information related to the Company’s allowance for credit losses on AFS securities.
ACL – Loans and Leases – The ACL reflects management’s estimate of expected losses that will result from the inability of our clients to make required loan and lease payments. Loans and leases deemed to be uncollectible are charged against the ACL, while recoveries of previously charged-off amounts are credited to the ACL. Management uses systematic methodologies to determine its ACL for loans and leases held for investment and certain off-balance-sheet exposures. The ACL is a valuation account that is subtracted from the amortized cost basis to present the net amount expected to be collected on the loan and lease portfolio. Management considers the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan and lease portfolio. The ACL recorded on the balance sheet reflects management’s best estimate of expected credit losses. The Company’s ACL is calculated using collectively assessed and individually assessed loans and leases.
The ACL is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments. The Company segmented the loan and lease portfolio by call code and risk rating. The loan portfolio reserve estimate is calculated using a non-discounted cash flow method for probability of default and loss given default values. This method utilizes the Company’s data along with peer data that is regressed against the national unemployment rate. The lease portfolio’s reserve estimate is based on the open pool methodology which is a simplified process of capturing losses by quarter over the life of a lease divided by the balance of all leases originated.
Management considers forward-looking information in estimating expected credit losses. The Company uses an average of Fannie Mae and Federal Open Market Committee projections of the national unemployment rate to determine the best estimate of expected credit losses. For the contractual term that extends beyond the reasonable and supportable forecast period, the Company reverts to the long term mean of historical factors using a straight-line approach. The Company uses an eight-quarter forecast and a four-quarter reversion period.
Management considers the need to qualitatively adjust expected credit losses for information not already captured in the loss estimation. The qualitative factors considered by management include: (1) effectiveness of the Company’s loan and lease policies and procedures; (2) the experience, ability and depth of lending management and other relevant staff; and (3) the quality of external and internal loan review and internal controls.
Loans that do not share risk characteristics are evaluated on an individual basis. The Company maintains a net book balance threshold of $500,000 for individually evaluated loans unless further analysis in the future suggests a change is needed to this threshold based on the credit environment at that time. For collateral dependent financial assets where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral,
9
expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the present value of expected cash flows from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The allowance for credit losses may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset. If the loan is not collateral dependent, the measurement of loss is based on the difference between the expected and contractual future cash flows of the loan.
Management measures expected credit losses over the contractual term of a loan. When determining the contractual term, the Company considers expected prepayments but is precluded from considering expected extensions, renewals, or modifications, unless the Company reasonably expects it will execute a loan modification (“LM”) with a borrower. In the event of a reasonably expected LM, the Company factors the reasonably-expected LM into the current expected credit losses estimate.
Purchased credit-deteriorated, otherwise referred to herein as (“PCD”), assets are defined as acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by the Company’s assessment. The Company records acquired PCD loans by adding the expected credit losses (i.e. allowance for credit losses) to the purchase price of the financial assets rather than recording through the provision for credit losses in the income statement. The expected credit loss, as of the acquisition day, of a PCD loan is added to the allowance for credit losses. The non-credit discount or premium is the difference between the unpaid principal balance and the amortized cost basis as of the acquisition date. Subsequent to the acquisition date, the change in the ACL on PCD loans is recognized through the provision for credit losses. The non-credit discount or premium is accreted or amortized, respectively, into interest income over the remaining life of the PCD loan on a level-yield basis. In accordance with the transition requirements within the standard, the Company’s purchased credit-impaired loans (“PCI”) were treated as PCD loans.
The Company follows its nonaccrual policy by reversing contractual interest income in the income statement when the Company places a loan on nonaccrual status. Therefore, Management excludes the accrued interest receivable balance from the amortized cost basis in measuring expected credit losses on the portfolio and does not record an allowance for credit losses on accrued interest receivable. As of June 30, 2023, and December 31, 2022, the accrued interest receivables for loans recorded in other assets were $10.5 million and $9.8 million, respectively.
ACL – Off- Balance Sheet Credit Exposures – The Company has a variety of assets that have a component that qualifies as an off-balance sheet exposure. These primarily include undrawn portions of revolving lines of credit and standby letters of credit. The expected losses associated with these exposures within the unfunded portion of the expected credit loss will be recorded as a liability on the balance sheet with an offsetting income statement expense. Management has determined that all of the Company’s off-balance-sheet credit exposures are not unconditionally cancellable. As of June 30, 2023, the liability recorded for expected credit losses on unfunded commitments in Other Liabilities was $2.8 million. The current adjustment to the ACL for unfunded commitments is recognized through the provision for credit losses in the Consolidated Statement of Income.
Recently Issued and Adopted Accounting Pronouncements:
In June 2016, the FASB issued Accounting Standards Update 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (Topic 326) (“ASU 2016-13”), and has issued subsequent amendments thereto, which introduces the current expected credit losses (“CECL”) methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets, including loans and held-to-maturity debt securities, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The new model requires institutions to calculate and estimated losses that are expected to be incurred through the financial asset's contractual life through a provision for credit losses, including loans obtained as a result of any acquisition not deemed to be PCD. ASU 2016-13 also requires the allowance for credit losses for PCD loans to be determined in a manner similar to that of other financial assets measured
10
at amortized cost; however, the initial allowance determined at acquisition is added to the purchase price rather than recorded as provision expense. In accordance with ASU 2016-13, the disclosure of credit quality indicators related to the amortized cost of financing receivables is further disaggregated by year of origination (or vintage). The Company adopted ASU 2016-13 and all subsequent amendments thereto effective January 1, 2023, using the modified retrospective method for all financial assets measured at amortized cost and off balance sheet credit exposures. Amounts for periods beginning on or after January 1, 2023, are presented under ASU 2016-13 and all prior period information is presented in accordance with previously applicable GAAP. At January 1, 2023, the Company recognized a cumulative adjustment to retained earnings of $6.6 million, net of tax, attributable to an increase in the allowance for credit losses (“ACL”) of $8.7 million, an increase in the allowance for off balance sheet credit exposures of $3.0 million, and an increase in deferred tax assets of $2.3 million. Included in the $8.7 million increase in the allowance for credit losses is $2.9 million that was recognized on PCD loans previously classified as purchased credit impaired (“PCI”) with a corresponding adjustment to the gross carrying amount of the loans. The Company adopted ASU 2016-13 using the prospective transition approach for PCD loans, which did not require re-evaluation of whether loans previously classified as PCI loans met the criteria of PCD assets at the date of adoption. The remaining noncredit discount will be accreted into interest income over the life of the individual loans beginning January 1, 2023.
The following table illustrates the impact of ASU 2016-13 (in thousands):
December 31, 2022
Adoption impact of ASU 2016-13
Impact of PCD Gross Up
January 1, 2023
Allowance for credit losses:
Commercial real estate
10,821
879
2,652
14,352
Consumer real estate
4,028
1,952
166
6,146
Construction and land development
3,059
2,145
25
5,229
Commercial and industrial
3,997
1,451
5,475
Leases
(683)
28
638
Consumer and other
136
13
-
149
Total allowance for credit losses
23,334
5,757
2,898
31,989
Unfunded lending commitments(1)
3,029
(1) The unfunded lending commitments is recorded within other liabilities on the Consolidated Statements of Financial Condition. The related expense for unfunded lending commitments is recorded within provision for credit losses on the Consolidated Statements of Income.
In March 2020, the FASB issued Accounting Standards Update 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, and has issued subsequent amendments thereto, 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 the London Inter-bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. 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. In December 2022, the FASB issued an update to Accounting Standards Update 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting with Accounting Standards Update 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848, which updated the effective date to be March 12, 2020, through December 31, 2024. The Company has 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. The Company has begun negotiating loans using its preferred replacement index, the Secured Overnight Financing Rate ("SOFR"). For the Company’s currently outstanding LIBOR-based loans, the timing and manner in which each customer's contract transitions to SOFR will vary on a case-by-case basis. The Company completed all loan transitions by June 30, 2023.
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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 result 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 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. The Company adopted ASU 2022-02 when it adopted ASU 2016-13 in January 2023. The adoption 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, 2022, 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 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.
In March 2023, the FASB issued ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. ASU 2023-02 permits reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met. ASU 2023-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2023. The Company is assessing ASU 2023-02 and its impact on its accounting and disclosures.
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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).
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)
17
Total assets acquired
349
1,935
2,284
Liabilities:
Payables and other liabilities
364
Total liabilities assumed
Excess of liabilities acquired over assets assumed
(15)
Aggregate fair value adjustments
Total identifiable net assets
1,920
Consideration transferred:
Purchase price
6,500
Total fair value of consideration transferred
Goodwill
4,580
(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.
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 six months ended June 30, 2023, and June 30, 2022, 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
91,702
132,844
98,505
136,603
Average common shares outstanding - diluted
Diluted earnings per common share
Note 4. Securities
Available-for-Sale Securities (“AFS”), which include any security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value. Realized gains and losses, based on specifically identified amortized cost of the individual security, are included in other income. Unrealized gains and losses are recorded, net of related income tax effects, in accumulated other comprehensive income (loss). Premiums and discounts are amortized and accreted, respectively, to interest income using the constant effective yield method over the estimated life of the security. Prepayments are anticipated for mortgage-backed and Small Business Administration (“SBA”) securities. Premiums on callable securities are amortized to their earliest call date.
Held-to-Maturity Securities (“HTM”), which include any security for which the Company has both the positive intent and ability to hold until maturity, are carried at historical cost adjusted for amortization of premiums and accretion of discounts. Premiums and discounts are amortized and accreted, respectively, to interest income using the constant effective yield method over the security’s estimated life. Prepayments are anticipated for mortgage-backed and SBA securities. Premiums on callable securities are amortized to their earliest call date.
14
The amortized cost, gross unrealized gains and losses and fair value of securities AFS and HTM are summarized as follows (in thousands):
June 30, 2023
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
U.S. Treasury
240,489
(16,638)
223,851
U.S. Government-sponsored enterprises (GSEs)
59,207
1,597
(62)
60,742
Municipal securities
18,974
58
(568)
18,464
Other debt securities
34,435
(4,019)
30,416
Mortgage-backed securities (GSEs)
231,873
(25,038)
206,835
584,978
1,655
(46,325)
150,186
(4,252)
145,934
49,944
(7,625)
42,319
53,204
(6,984)
46,220
30,230
(4,199)
26,031
(23,060)
260,504
241,506
(17,853)
223,653
1,593
(18)
1,575
19,210
(616)
18,611
32,959
(2,408)
30,551
233,948
(24,451)
209,503
529,216
23
(45,346)
150,295
(5,613)
144,682
50,539
(8,037)
42,502
53,694
(7,550)
46,144
31,421
(4,136)
27,285
(25,336)
260,613
At June 30, 2023 and December 31, 2022, securities with a carrying value totaling approximately $453.0 million and $304.8 million, respectively, were pledged to secure public funds and securities sold under agreements to repurchase.
The amortized cost and estimated fair value of securities at June 30, 2023 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
110,826
108,173
Due from one year to five years
112,113
102,201
Due from five years to ten years
119,881
113,140
Due after ten years
10,285
9,959
353,105
333,473
Mortgage-backed securities
145,933
39,007
33,724
64,141
54,816
253,334
234,473
The following tables present the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities AFS and HTM have been in a continuous unrealized loss position (in thousands):
Less than 12 Months
12 Months or Greater
Number
of
Securities
3,909
(82)
219,940
(16,556)
19
223,849
20
17,637
(59)
250
(3)
17,887
5,160
(138)
8,535
(430)
13,695
22
5,000
(492)
25,416
(3,527)
24
36,279
(1,272)
170,557
(23,766)
89
206,836
114
67,985
(2,043)
41
424,698
(44,282)
492,683
190
42,318
46,222
35
57
16
134,414
(7,610)
89,239
(10,243)
1,266
(14)
309
(4)
13,146
25,044
(1,866)
(542)
30,550
26
111,598
(8,968)
86
96,285
(15,483)
207,883
285,468
(19,074)
191,339
(26,272)
47
476,807
183
144,683
13,048
(2,503)
29,451
(5,534)
42,499
40,770
(6,387)
5,375
(1,163)
46,145
198,501
(14,503)
62,111
(10,833)
260,612
For any securities classified as available-for-sale that are in an unrealized loss position at the balance sheet date, the Company assesses whether it intends to sell the security, or more likely than not will be required to sell the security before recovery of its amortized cost basis which would require a write-down to fair value through net income. Because the Company currently does not intend to sell those available-for-sale securities that have an unrealized loss at June 30, 2023, and it is not likely that they we will be required to sell the securities before recovery of their amortized cost bases, which may be maturity, the Company has determined that no write-down is necessary. In addition, the Company evaluates whether any portion of the decline in fair value of available-for-sale securities is the result of credit deterioration, which would require the recognition of an allowance for credit losses. The unrealized losses associated with available-for-sale securities at June 30, 2023, are driven by changes in interest rates and are not due to the credit quality of the securities, and accordingly, no allowance for credit losses is considered necessary related to available-for-sale securities at June 30, 2023. Management evaluates the financial performance of the issuers on a quarterly basis to determine if it is probable that the issuers can make all contractual principal and interest payments.
The unrealized losses in the Company’s held-to-maturity portfolio were caused by changes in the interest rate environment. The Company has a zero-loss expectation for its U.S. treasury securities in addition to U.S. Government-sponsored enterprises (GSEs) and mortgage-backed securities (GSEs), and accordingly, no allowance for credit losses is estimated for these securities. The held-to-maturity state and municipal securities are general obligation bonds which have a very low historical default rate due to issuers generally having unlimited taxing authority to service the debt. All debt securities in an unrealized loss position as of June 30, 2023, continue to perform as scheduled and we do not believe there is a credit loss or a provision for credit losses is necessary.
The Company utilizes bond credit ratings assigned by third party ratings agencies to monitor the credit quality of debt securities held-to-maturity. At June 30, 2023, all debt securities classified as held-to-maturity were rated AAA or higher by the ratings agencies. Updated credit ratings are obtained as they become available from the ratings agencies.
Allowance for Credit Losses
The Company adopted ASU 2016-13 on January 1, 2023, and based on the analysis of the underlying risk characteristics of its AFS and HTM portfolios, including credit ratings and other qualitative factors, there was no provision for credit
losses related to AFS or HTM securities recorded during the three and six months ended June 30, 2023, because ACL was deemed immaterial.
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 June 30, 2023, 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
9,808
9,783
Federal Home Loan Bank stock
4,238
5,397
First National Bankers Bank stock
350
Note 5. Loans and Leases and Allowance for Credit Losses
Portfolio Segmentation:
Major categories of loans and leases are summarized as follows (in thousands):
1,641,757
1,627,761
624,828
587,977
394,742
402,501
594,427
551,867
66,401
67,427
15,635
16,094
Total loans and leases
The loan and lease portfolio is disaggregated into segments. 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
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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.
The Bank occasionally enters into loan participation agreements with other banks in the ordinary course of business to diversify credit risk. For certain sold participation loans, the Bank has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their share of the loan without permission from the Bank. GAAP requires the participated portion of these loans to be recorded as secured borrowings. The participated portions of these loans are included in the Commercial Real Estate totals above with a corresponding liability reflected in other borrowings. At June 30, 2023 and December 31, 2022, the balance of such loans totaled $0 and $24.6 million, respectively.
The following tables detail the changes in the allowance for credit losses by loan and lease classification (in thousands):
Three Months Ended June 30, 2023
Consumer
Construction
Commercial
Real
and Land
and
Real Estate
Estate
Development
Industrial
and Other
Beginning balance
14,528
6,411
5,219
5,359
637
125
32,279
Charged-off loans and leases
(35)
(113)
(207)
Recoveries of charge-offs
85
140
255
Provision charged to expense (1)
(215)
333
202
95
420
Ending balance
14,314
6,748
5,446
5,504
586
32,747
Three Months Ended June 30, 2022
10,405
3,388
2,120
3,501
548
116
20,078
(23)
(120)
(143)
547
126
72
753
Provision charged to expense
193
(100)
784
32
276
10,600
3,835
2,904
3,659
807
133
21,938
Six Months Ended June 30, 2023
Impact of adopting ASU 2016-13
PCD gross up
(208)
(68)
(246)
(522)
105
168
310
(41)
593
192
132
970
Six Months Ended June 30, 2022
9,781
3,454
1,882
3,781
330
124
19,352
(33)
(188)
(108)
(302)
(631)
554
143
163
98
961
816
(140)
1,022
(77)
422
213
The following tables detail the allowance for credit losses and recorded investment in loans by loan classification and by impairment evaluation method as of December 31, 2022, as determined in accordance with ASC 310 prior to the adoption of ASU 2016-13 (in thousands):
December 31, 2022:
Performing loans and leases
10,815
3,913
2,674
22,828
Impaired loans and leases
385
23,213
PCI loans and leases
115
121
1,611,815
578,342
400,114
549,974
66,459
16,091
3,222,795
1,283
858
2,141
579,625
400,972
3,224,936
15,946
8,352
1,529
1,893
968
28,691
We maintain the allowance for credit losses at a level that we deem appropriate to adequately cover the expected credit loss in the loan and lease portfolio. Our provision for loan and lease losses for the three and six months ended June 30, 2023, is $420 thousand and $970 thousand, respectively, and $1.3 million and $2.3 million, during the three and six months ended June 30, 2022, respectively. As of June 30, 2023, and December 31, 2022, our allowance for credit losses was $32.7 million and $23.3 million, respectively, which we deemed to be adequate at each of the respective dates. Our allowance for credit losses as a percentage of total loans and leases was 0.98% at June 30, 2023, and 0.72% at December 31, 2022.
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
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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 credit 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 credit loss methodology on an ongoing basis. There were no changes to these subsequent to adoption ASU 2016-13 on January 1, 2023.
The following tables outline the amount of each loan and lease classification and the amount categorized into each risk rating based on year of origination (in thousands):
Loans Amortized Cost Basis by Origination Year
Revolving
Loans
Converted
2021
2020
2019
Prior
to Term
Pass
108,210
544,700
468,647
184,539
141,585
127,216
16,152
8,246
1,599,295
Watch
743
25,253
3,114
2,574
3,888
269
35,841
Special mention
1,629
312
1,941
Substandard
993
3,164
469
4,680
Doubtful
Total commercial real estate
109,946
569,954
474,925
187,166
147,102
127,954
16,464
YTD gross charge-offs
64,050
186,718
102,568
57,022
36,105
60,153
109,600
2,996
619,212
172
321
303
1,285
769
2,922
55
200
950
1,474
2,639
Total consumer real estate
64,422
187,740
102,889
57,325
62,967
110,384
81,326
199,971
57,062
5,286
7,581
31,428
1,673
388,907
2,632
1,960
76
4,781
620
396
1,054
Total construction and land development
83,958
200,084
59,060
5,200
8,053
100,693
186,281
75,120
36,064
12,554
28,479
147,625
5,354
592,170
77
646
222
134
100
1,887
219
346
Total commercial and industrial
100,989
186,928
75,342
36,324
12,639
28,579
148,248
5,378
(66)
(50)
(58)
(34)
14,316
32,866
11,883
5,605
1,280
451
Total leases
(56)
(12)
4,522
3,436
1,221
843
154
5,078
15,551
68
69
Total consumer and other
3,504
844
169
(51)
(39)
Total loans
373,117
1,153,972
716,501
288,653
196,964
224,099
309,883
18,347
3,281,536
3,624
26,084
5,617
3,011
3,988
1,730
1,392
2,020
1,412
1,020
3,202
800
2,339
8,788
378,153
1,181,076
725,320
292,464
202,581
228,223
311,602
18,371
Total YTD gross charge-offs
(210)
(101)
(97)
(32)
(73)
The following tables outline the amount of each loan and lease classification and the amount categorized into each risk rating as of December 31, 2022, prior to the adoption of ASU 2016-13 (in thousands):
Non PCI Loans and Leases:
1,579,387
576,428
399,846
545,210
16,057
3,183,387
29,810
1,496
224
4,523
36,072
2,539
61
2,635
79
1,666
902
180
2,842
PCI Loans and Leases:
11,924
6,927
22,769
1,439
188
54
2,572
1,183
429
4,184
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):
90 Days
30-59 Days
60-89 Days
or More
Loans Not
Past Due
1,641,171
334
1,563
1,897
622,931
478
394,264
1,531
257
1,788
592,639
266
66,135
234
15,401
3,376
1,873
5,249
3,332,541
1,627,707
594
587,383
185
203
551,664
1,024
84
1,251
66,176
103
107
15,987
106
2,209
3,251,418
The table below presents the amortized cost basis of loans on nonaccrual status and loans past due 90 or more days and still accruing interest at June 30, 2023 and December 31, 2022. Also presented is the balance of loans on nonaccrual status at June 30, 2023 for which there was no related allowance for credit losses recorded (in thousands):
Nonaccrual
Loans Past Due
With No Allowance
Over 90 Days
for Credit Losses
Still Accruing
759
1,833
949
1,665
920
94
70
3,722
2,808
The following table presents the amortized cost basis of collateral dependent loans, which are individually evaluated to determine expected credit losses (in thousands):
3,871
1,330
1,411
6,612
Impaired Loans and Leases:
The following table presents impaired loans at December 31, 2022, as determined under ASC 310 prior to the adoption of ASU 2016-13. 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. Presented are the recorded investment, unpaid principal balance and related allowance of impaired loans at December 31, 2022, by loan classification (in thousands):
Unpaid
Recorded
Principal
Related
Investment
Balance
Allowance
Impaired loans and leases without a valuation allowance:
1,282
Impaired loans and leases with a valuation allowance:
PCI loans and leases:
500
580
684
1,184
1,226
Total impaired loans and leases
3,325
3,366
506
The following table details the average recorded investment and the amount of interest income recognized on a cash basis for the three and six months ended June 30, 2022, respectively, of impaired loans by loan classification as determined under ASC 310 prior to the adoption of ASU 2016-13 (in thousands):
Average
Interest
Income
Recognized
152
1,957
2,109
538
855
1,396
4,363
101
1,907
2,008
572
87
286
977
885
878
1,766
4,751
83
Loan Modifications to Borrowers Experiencing Financial Difficulty:
The Company adopted ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”) effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty.
The table below shows loans and leases made to borrowers experiencing financial difficulty that were modified during the three and six months ended June 30, 2023 (dollars in thousands):
Payment Delay
Total Class
Payment
Term
and Term
of Financing
Three months ended June 30, 2023
Delay
Extension
Receivable
413
0.03
%
153
0.04
479
670
0.02
Six months ended June 30, 2023
The following table summarizes the financial impacts of loan modifications made to borrowers experiencing financial difficulty during the three and six months ended June 30, 2023 (dollars in thousands):
Weighted-Average
Total Payment
(in months)
30
No loan modifications made to borrowers experiencing financial difficulty, defaulted during the three and six months ended June 30, 2023.
The table below shows an age analysis of loans and leases made to borrowers experiencing financial difficulty that were modified on or after January 1, 2023, that date the Company adopted ASU 2022-02 (in thousands):
30-89 Days
Current
632
As of December 31, 2022, prior to the adoption ASU 2022-02, management had approximately $101 thousand that meet the criteria of trouble debt restructured (“TDR”), none of which were on nonaccrual.
There were three loans for $586 that were modified as a TDR during the six months ended June 30, 2022.
Foreclosure Proceedings and Balances:
As of June 30, 2023, there were two residential real estate properties totaling $314 thousand secured by real estate included in other real estate owned and there were no residential real estate loan in the process of foreclosure.
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. Considering the recent economic conditions, the Company performed a Step 1 goodwill impairment test (which compares the fair value of a reporting unit with its carrying amount, including goodwill) at June 30, 2023, the results indicated that there was no impairment. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.
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.
29
The carrying amount of goodwill and other intangible assets as of the dates indicated is summarized below (in thousands):
Goodwill:
Balance, beginning of period
96,145
91,565
Acquisition of Sunbelt
Balance, end of the period
Core Deposit
Customer Relationships
Tradename
Amortized other intangible assets:
Intangibles
June 30, 2023:
Beginning balance January 1, 2023, gross
17,470
5,670
23,203
Less: accumulated amortization
(8,897)
(1,949)
(63)
(10,909)
Balance, June 30, 2023, other intangible assets, net
8,573
3,721
12,294
Beginning balance January 1, 2022, gross
21,255
Balance, December 31, 2022, other intangible assets, gross
(8,021)
(1,519)
(9,576)
Balance, December 31, 2022, other intangible assets, net
9,449
4,151
13,627
The aggregate amortization expense for other intangible assets for the three and six months ended June 30, 2023, was $675 thousand and $1.3 million, respectively, and for the three and six months ended June 30, 2022, was $633 thousand and $1.3 million, respectively.
As of June 30, 2023, the estimated aggregate amortization expense for future periods for intangibles is as follows (in thousands):
Remainder of 2023
1,290
2024
2,425
2025
2026
2,086
2027
1,904
Thereafter
2,333
Note 7. Borrowings, Line of Credit and Subordinated Debt
Borrowings:
At June 30, 2023, total borrowings were $15.5 million compared to $41.9 million at December 31, 2022. Borrowings consist of the following (dollars in thousands):
Securities sold under customer repurchase agreements
4,996
4,775
Loan participation agreements(1)
24,585
Other borrowings
10,500
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 $9.1 million and $9.2 million at June 30, 2023 and December 31, 2022, respectively. The average balance during the six month period June 30, 2023, and 2022 was $4.7 million and $5.1 million, respectively. The maximum month-end outstanding balance for the six month period ended June 30, 2023, and 2022 was $5.0 million and $5.5 million, respectively.
Other Borrowings:
The Company has a Loan and Security Agreement and revolving line of credit for an aggregate amount of $35 million. The maturity of the line of credit is February 1, 2025. At June 30, 2023, $10.5 million was outstanding under the line of credit, and $24.5 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 March 31, 2023 and December 31, 2022. Unamortized debt issuance cost was $443 thousand and $485 thousand at June 30, 2023 and December 31, 2022, 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, with the sunset of LIBOR, reset quarterly to an annual floating rate equal to three-month CME Term SOFR, plus 281.161 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 $443 thousand at June 30, 2023, and will be amortized through the Notes’ maturity date. Amortization expense totaled $21 thousand and $42 thousand for the three and six months ended June 30, 2023, and 2022, 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. In relation to the three-month LIBOR rate being no longer available in the future, the Company anticipates using the three-month term SOFR rate in future repricing. 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 six month periods ending June 30, 2023, was $443 thousand and $909 thousand, respectively. The Company’s contribution to the Plan for the three and six months ended June 30, 2022, was $453 thousand and $847 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 June 30, 2023, the Company had one active equity incentive plan available for future grants, the 2015 Stock Incentive Plan, which has 1,676,663 Rights available for future grants or awards.
The Company’s 2015 Stock Incentive Plan has 11,840 Rights issued. In addition, the Company has 4,500 Rights issued from the Cornerstone Non-Qualified Plan Options, which 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, 2022
32,045
12.04
Granted
Exercised
(15,705)
10.47
Forfeited
Outstanding at June 30, 2023
16,340
13.55
Information pertaining to stock options outstanding at June 30, 2023, is as follows:
Options Outstanding
Options Exercisable
Weighted-
Remaining
Exercise
Contractual
Prices
Outstanding
Life
9.60
4,500
0.67 years
15.05
11,840
2.25 years
Outstanding, end of period
1.82 years
The Company did not recognize any stock option-based compensation expense during the three and six months ended June 30, 2023 and 2022, 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.
No stock options were exercised during the three months ended June 30, 2023. Stock options of 15,705 shares were exercised during the six month period ended June 30, 2023. Stock options of 3,850 and 31,400 shares were exercised during the three and six month periods ended June 30, 2022, respectively. The income tax benefit recognized for the exercise of options during the six months ended June 30, 2023, was a benefit of $65 thousand, respectively, and for the three and six months ended June 30, 2022, was a benefit of $8 thousand and a benefit of $84 thousand, respectively.
No stock options were exercised during the three months ended June 30, 2023. The intrinsic value of options exercised during the six months ended June 30, 2023, was $242 thousand, and $50 thousand and $555 thousand, during the three and six months ended June 30, 2022, respectively. The aggregate intrinsic value of total options outstanding and exercisable options at June 30, 2023, was $130 thousand. Cash received from options exercised under all share-based payment arrangements for the six months ended June 30, 2023, was $165 thousand.
Restricted Stock Awards:
A summary of the activity of the Company’s unvested restricted stock awards for the period ended June 30, 2023, is presented below:
Grant-Date
Fair Value
Balance at December 31, 2022
129,836
19.61
89,582
26.23
Vested
(20,770)
24.83
Forfeited/expired
(2,000)
17.56
Balance at June 30, 2023
196,648
22.10
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 six months ended June 30, 2023, was $366 thousand and $904 thousand, respectively, and was $398 thousand and $710 thousand, during the three and six months ended June 30, 2022, respectively. As of June 30, 2023, there was $2.2 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 2.18 years. The grant-date fair value of restricted stock awards vested was $516 thousand for the six months ended June 30, 2023.
Stock Appreciation Rights (“SARs”):
A summary of the status of SARs plans is presented in the following table:
Exercisable Price
36,000
18.25
(4,000)
15.19
32,000
18.63
33
Information pertaining to SARs outstanding at June 30, 2023, is as follows:
SARs Outstanding
SARs Exercisable
Weighted- Average
12,000
0.50 years
20.70
20,000
1.51 years
1.13 years
SARs compensation expense of ($28) thousand and ($123) thousand was recognized for the three and six months ended June 30, 2023, respectively, and ($17) thousand and ($43) thousand for the three and six months ended June 30, 2022. The credit adjustment for the three and six month periods ended June 30, 2023, and June 30, 2022, respectively, 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
770,898
911,998
Standby letters of credit
16,252
6,897
At June 30, 2023, and December 31, 2022, the allowance for these off-balance sheet commitments was $2.8 million and $85 thousand, respectively. With the adoption of ASU 2016-13, effective January 1, 2023, there was an increase in the allowance of $3.0 million on these off-balance sheet commitments. The expense related to the allowance for off-balance sheet commitments during the three and six months ended June 30, 2023, was ($380) thousand and ($307) thousand, respectively, and was $0 thousand and $15 thousand, during the three and six months ended June 30, 2022, respectively.
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.
34
Collateral held varies and is required in instances which the Company deems necessary. At June 30, 2023 and December 31, 2022, 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 and interest rate swap agreements 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
11,111
Total assets at fair value
551,419
12,710
11,834
495,727
13,110
During the three months ending June 30, 2023, there were no transfers between Level 1 and Level 2 in the fair value hierarchy.
36
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
3,211
Collateral dependent loans(1)
1,536
915
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
37
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
3,306,029
3,161,489
Noninterest-bearing demand deposits
Interest-bearing demand deposits
Money market and savings deposits
536,452
39,457
3,232,045
3,143,921
451,899
40,439
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.
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.
During the fourth quarter of 2022 the Company dissolved this hedging relationship. The effects of the Company’s fair value hedge relationships reported in interest income in 2022 on tax-exempt available-for-sale securities on the consolidated income statement were as follows (in thousands):
Interest income on tax-exempt securities
387
780
Effects of fair value hedge relationships
(190)
(444)
Reported interest income on tax-exempt securities
197
336
Gain (loss) on fair value hedging relationship
Interest rate swap agreements – securities:
Hedged items
1,662
(3,511)
Derivative designated as hedging instruments
(1,662)
3,511
Carry amount of hedged assets – securities available-for-sale
37,977
39
Derivatives Designated as Cash Flow Hedges:
The Company enters into interest rate derivative contracts on assets and liabilities that are designated as qualifying cash flow hedges. The Company hedges the exposure to variability in expected future cash flows attributable to changes in contractual specified interest rates. 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 offsetting cash flows attributable to the hedged risk. 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 accumulated other comprehensive income (“AOCI”) is recognized in earnings immediately. The cash flow hedges are recorded at fair value in other assets and 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 or liability affects earnings and are presented in the same income statement line item as the earnings effect of the hedged asset or liability, as future interest payments are made on the underlying assets. At June 30, 2023, the Company estimates that in the next 12 months an additional $744 thousand will be reclassified as a decrease in interest income and $130 thousand will be reclassified as a decrease in interest expense.
At June 30, 2023 and December 31, 2022, cash flow hedges are as follows (in thousands):
Balance Sheet
Notional
Location
Cash flow hedges:
25,000
Liabilities
100,000
(1,780)
(1,304)
The following table presents the effect of fair value and cash flow hedge accounting on AOCI (in thousands):
Derivatives in cash flow hedging relationships:
Amount of Gain (Loss) Recognized on OCI on Derivative
Amount of Gain or (Loss) Recognized from OCI Included
Location of Gain or (Loss) Recognized from AOCI into Income
Amount of Gain or (Loss) Reclassified from AOCI into Income
Amount of Gain or (Loss) Reclassified from AOCI into Income Included Component
Interest rate swaps – Assets
(1,152)
Interest income
(96)
Interest rate swaps – Liabilities
Interest expense
(8)
Three months ended June 30, 2022
(1,733)
(103)
Six months ended June 30, 2022
40
The following table presents the effect of fair value and cash flow hedge accounting on the income statement (in thousands):
52,190
105,376
Effects of cash flow hedge relationships
Reported total interest income
20,527
37,724
Reported total interest expense
Non-hedged derivatives:
The Company provides 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 are recognized as other noninterest income in the current period.
At June 30, 2023 and December 31, 2022, 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:
271,305
10,998
216,656
(10,998)
(11,834)
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
158
876
497
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 June 30, 2023, collateral totaling $600 thousand and $1.4 million at December 31, 2022, 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
10,368
9,314
Operating lease liabilities
10,570
9,457
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 June 30, 2023, the weighted average remaining lease term was 9.40 years and the weighted average discount rate was 2.85%.
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).
Lease costs:
Operating lease costs
405
403
817
Variable lease costs
50
439
428
866
867
Other information:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
370
382
749
778
Future minimum payments for operating leases with initial or remaining terms of one year or more as of June 30, 2023, were as follows (in thousands):
Amounts
612
1,415
1,359
1,291
1,107
6,476
Total future minimum lease payments
12,260
Amounts representing interest
(1,690)
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 June 30, 2023, the Company and the Bank exceeded the minimum regulatory requirements and exceeded the threshold for the “well capitalized” regulatory classification.
In December 2018, the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation (“FDIC”) (collectively, the “agencies”) issued a final rule revising regulatory capital rules in anticipation of the adoption of ASU 2016-13 that provided an option to phase in over a three year period on a straight line basis the day-one impact of the adoption on earnings and tier one capital. The Company adopted ASU 2016-13 on January 1, 2023, and has chosen the three year phase in option.
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 six months ended June 30, 2023, the Bank paid $5 million in dividends to the Company, and since the first quarter of 2023, the Company has paid a quarterly common stock dividend of $0.08 per share. The amount and timing
43
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 June 30, 2023, and December 31, 2022 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)
447,086
11.94
299,513
8.00
Tier 1 Capital (to Risk Weighted Assets)
378,773
10.12
224,634
6.00
Common Equity Tier 1 Capital (to Risk Weighted Assets)
168,476
4.50
Tier 1 Capital (to Average Assets)2
8.24
183,761
4.00
SmartBank:
447,469
11.97
298,998
373,748
10.00
421,213
11.27
224,249
168,187
242,936
6.50
9.18
183,585
229,481
5.00
425,957
11.40
298,966
360,608
9.65
224,224
168,168
Tier 1 Capital (to Average Assets)
7.95
181,387
426,947
11.44
298,476
373,094
403,613
10.82
223,857
167,892
242,511
8.90
181,383
226,729
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.
44
Note 14. Other Comprehensive Income (Loss)
The changes in each component of accumulated other comprehensive income (loss), presented net of tax, were as follows (in thousands):
Available-for-
Transferred to
Municipal
Cash Flow
Sale
Held-to-Maturity
Security Hedges
Hedges
Beginning balance, March 31, 2023
(27,478)
(712)
Other comprehensive income (loss)
(5,654)
(6,425)
Reclassification of amounts included in net income
Net other comprehensive income (loss) during period
Ending balance, June 30, 2023
(33,132)
(684)
(1,201)
Beginning balance, March 31, 2022
(15,067)
(833)
344
(8,459)
(9,121)
Ending balance, June 30, 2022
(23,526)
(804)
(318)
Beginning balance, December 31, 2022
(33,616)
(742)
(966)
484
249
Beginning balance, December 31, 2021
665
(23,551)
(1,490)
(26,112)
(1,469)
45
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 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.
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, 2022. 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, 2022. On January 1, 2023, we adopted FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326) (“ASU 2016-13”) which significantly changes our methodology for determining our Allowance for Credit Losses (“ACL”) and ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, See Note 1. Recently Issued and Adopted Accounting Pronouncements in the Notes to our Consolidated Financial Statements in this Form 10-Q for further information related to these changes. There have been no other significant changes in the Company’s application of critical accounting policies since December 31, 2022.
Executive Summary
The following is a summary of the Company’s financial highlights and significant events during the second quarter and first six months of 2023:
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Selected Financial Information
The following is a summary of certain financial information for the three and six month periods ended June 30, 2023 and 2022 and as of June 30, 2023 and December 31, 2022 (dollars in thousands, except per share data):
Change
Income Statement:
15,785
36,049
17,272
31,672
(1,487)
4,377
(1,137)
(1,593)
(350)
5,970
Noninterest income
(99)
(285)
Noninterest expense
1,484
3,296
Income before income taxes
(1,933)
2,389
(554)
528
(1,379)
1,861
Per Share Data:
Basic income per common share
(0.08)
0.10
Diluted income per common share
(0.09)
Performance Ratios:
Return on average assets
0.75
0.87
(0.12)
0.80
0.07
Return on average shareholders' equity
7.98
9.76
(1.78)
9.36
8.79
0.57
Balance Sheet:
74,750
122,484
Analysis of Results of Operations
Second quarter of 2023 compared to 2022
Net income was $8.8 million, or $0.52 per diluted common share, for the second quarter of 2023, compared to $10.2 million, or $0.61 per diluted common share, for the second quarter of 2022. For the three months ended June 30, 2023, when compared to the comparable period in 2022, the decrease in net income of $1.4 million was primarily driven by a decline in net interest income and provision in credit losses, offset by an increase in noninterest expense. The tax equivalent net interest margin was 2.93% for the second quarter of 2023, compared to 3.08% for the second quarter of 2022. Noninterest income to average assets was 0.61% for the second quarter of 2023, decreasing from 0.62% for the second quarter of 2022. Noninterest expense to average assets increased to 2.34% in the second quarter of 2023, from 2.21% in the second quarter of 2022.
First six months of 2023 compared to 2022
Net income totaled $20.3 million, or $1.20 per diluted common share, for the six months ended 2023, compared to $18.5 million, or $1.10 per diluted common share, for the six months ended 2022. The increase in net income for this period was primarily from the increase of $6.0 million in net interest income after provision for credit losses, offset by increases of $3.3 million in noninterest expense and $528 thousand in income tax expense. The tax equivalent net interest margin was 3.12% for the first six months of 2023, compared to 3.00% for the first six months of 2022. Noninterest income to average assets was 0.60% for the first six months of 2023, decreasing from 0.62% for the first six months of 2022.
49
Noninterest expense to average assets increased to 2.34% in the first six months of 2023, from 2.24% in the first six months of 2022.
Net Interest Income and Yield Analysis
Net interest income, taxable equivalent, decreased to $31.7 million for the second quarter of 2023, down from $33.2 million for the second quarter of 2022. Net interest income was positively impacted by the increase in balances of loans and leases, securities, and the increase in yield/rate on these interest-earning assets, offset by the increase in the cost of interest-bearing liabilities. Average interest-earning assets increased from $4.32 billion for the second quarter of 2022, to $4.34 billion for the second quarter of 2023, primarily from the Company’s continued organic loan and lease growth and the increase in our securities, which was offset by a decrease in our overall liquidity position. Over this period, average loan and lease balances increased by $435.8 million, average securities increased $16.4 million and average interest-bearing deposits increased by $131.3 million. Average federal funds sold and other interest earning assets decreased by $433.4 million, average borrowings decreased $6.7 million and noninterest-bearing deposits decreased by $161.3 million. The tax equivalent net interest margin decreased to 2.93% for the second quarter of 2023, compared to 3.08% for the second quarter of 2022. The yield on earning assets increased from 3.39% for the second quarter of 2022, to 4.82% for the second quarter of 2023, primarily due the deployment of excess cash and cash equivalents into loans and leases and the increase in rates by the Federal Reserve. The cost of average interest-bearing deposits increased from 0.33% for the second quarter of 2022, to 2.46% for the second quarter of 2023, primarily due to the increase in rates by the Federal Reserve and increased pricing competition.
The following tables summarizes the major components of net interest income and the related yields and costs for the periods presented (dollars in thousands):
Three Months Ended June 30,
Yield/
Loans and leases, including fees1
3,308,595
5.51
2,872,748
4.40
Taxable securities
770,275
2.26
717,507
1.63
Tax-exempt securities2
65,265
452
2.78
101,585
609
2.40
195,266
4.02
628,677
0.91
Total interest-earning assets
4,339,401
52,189
4.82
4,320,517
36,477
3.39
Noninterest-earning assets
355,701
374,776
4,695,102
4,695,293
Liabilities and Shareholders' Equity:
950,227
4,892
2.06
968,806
734
0.30
1,737,303
11,785
2.72
1,559,963
1,126
0.29
504,350
2,877
2.29
531,783
644
0.49
Total interest-bearing deposits
3,191,880
2.46
3,060,552
0.33
Borrowings3
24,845
5.47
31,510
1.49
42,044
5.97
41,959
5.98
Total interest-bearing liabilities
3,258,769
2.53
3,134,021
0.42
Noninterest-bearing deposits
951,381
1,112,643
40,669
28,903
4,250,819
4,275,567
Shareholders' equity
444,283
419,726
Total liabilities and shareholders’ equity
Net interest income, taxable equivalent
31,670
33,230
Interest rate spread
2.30
2.97
Tax equivalent net interest margin
2.93
3.08
Percentage of average interest-earning assets to average interest-bearing liabilities
133.16
137.86
Percentage of average equity to average assets
9.46
8.94
1Loans and leases include PPP loans with an average balance of $2.9 million and $34.3 million for the three months ended June 30, 2023, and 2022, respectively. Loan and lease fees included in loan and lease income was $1.0 million and $1.4 million for the three months ended June 30, 2023, and 2022, respectively. Loan and lease fee income for the three months ended June 30, 2023, and 2022, includes $10 thousand and $710 thousand 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 $95 thousand for the three months ended June 30, 2023, and $168 thousand for the three months ended June 30, 2022.
Net interest income, taxable equivalent, increased to $67.7 million for the first six months of 2023, up from $63.5 million for the first six months of 2022. Net interest income was positively impacted, compared to the prior year, primarily by the increase in balances of loans and leases, securities, and the increase in yield/rate on these interest-earning assets, offset by the increase in the cost of interest-bearing liabilities. Average interest-earning assets increased from $4.27 billion for the first six months of 2022, to $4.38 billion for the first six months of 2023, primarily because of the Company’s continued organic loan and lease growth and the increase in our securities, this was offset by a decrease in our overall liquidity position. Over this period, average loan and lease balances increased by $482.8 million, average securities increased $43.4 million and average interest-bearing deposits increased by $179.3 million. Average federal funds sold and other interest earning assets decreased by $415.6 million, average borrowings decreased $29.7 million and noninterest-bearing deposits decreased by $87.4 million. The tax equivalent net interest margin increased to 3.12% for the first six months of 2023, compared to 3.00% for the first six months of 2022. The yield on earning assets increased from 3.28% for the first six months of 2022, to 4.85% for the first six months of 2023, primarily due the deployment of excess cash and cash equivalents into loans and leases and the increase in rates by the Federal Reserve. The cost of average interest-bearing
51
deposits increased from 0.30% for the first six months of 2022 to 2.25% for the first six months of 2023, primarily due to the increase in rates by the Federal Reserve and increased pricing competition.
3,283,662
5.54
2,800,821
747,037
2.16
665,532
1.61
Taxable Securities
65,405
897
2.77
103,540
1,142
2.22
286,254
4.51
701,850
0.55
Federal funds and other earning assets
4,382,358
105,461
4.85
4,271,743
69,557
3.28
357,837
378,271
4,740,195
4,650,014
947,196
9,119
1.94
945,450
1,181
0.25
1,778,650
22,168
2.51
1,541,678
1,985
0.26
486,952
4,613
1.91
546,413
1,352
0.50
3,212,798
2.25
3,033,541
20,874
5.45
50,533
1.09
42,033
6.01
41,949
6.02
3,275,705
2.32
3,126,023
0.39
983,348
1,070,703
42,777
29,475
4,301,830
4,226,201
438,365
423,813
67,745
63,513
2.89
3.12
3.00
133.78
136.65
9.25
9.11
1Loans and leases include PPP loans with an average balance of $3.0 million and $44.1 million for the six months ended June 30, 2023 and 2022, respectively. Loan and lease fees included in loan and lease income was $3.9 million and $2.9 million for the six months ended June 30, 2023 and 2022, respectively. Loan lease fee income for the six months ended June 30, 2023, and 2022, includes $18 thousand and $1.8 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 $188 thousand for the six months ended June 30, 2023, and $333 thousand for the six months ended June 30, 2022.
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Noninterest Income
The following table summarizes noninterest income by category (in thousands):
211
337
(139)
(801)
235
170
541
899
(21)
(827)
(869)
Noninterest income decreased by $99 thousand, or 1.4%, during the second quarter of 2023 compared to the same period in 2022. This quarterly change in total noninterest income primarily resulted from the following:
Noninterest income decreased by $285 thousand, or 2.0%, during the first six months of 2023 compared to the same period in 2022. This change in total noninterest income primarily resulted from the following:
Noninterest Expense
The following table summarizes noninterest expense by category (in thousands):
525
674
199
99
(195)
(352)
(22)
(37)
507
1,084
(415)
(81)
(520)
216
729
Noninterest expense increased by $1.5 million, or 5.7%, in the second quarter of 2023 as compared to the same period in 2022. The quarterly increase in total noninterest expense primarily resulted from the following:
Noninterest expense increased by $3.3 million, or 6.4%, in the first six months of 2023 as compared to the same period in 2022. The change in total noninterest expense primarily resulted from the following:
Taxes
In the second quarter of 2023 income tax expense totaled $2.3 million compared to $2.9 million in the second quarter of 2022. The effective tax rate was approximately 21.0% in the second quarter of 2023 compared to 22.1% in the second quarter of 2022.
In the first six months of 2023 income tax expense totaled $5.7 million compared to $5.1 million in the first six months of 2022. The effective tax rate was approximately 21.8% for first six months of 2023 and 2022, respectively.
Loan and Lease Portfolio
The Company had total net loans and leases outstanding of approximately $3.31 billion at June 30, 2023, compared to $3.23 billion at December 31, 2022. Loans secured by real estate, consisting of commercial and residential property, are the principal component of our loan and lease portfolio.
The following tables summarize the composition of our loan and lease portfolio for the periods presented (dollars in thousands):
% of
49.2
50.0
18.7
18.1
11.8
12.4
17.8
17.0
2.0
2.1
0.5
100.0
Loan and Lease Portfolio Maturities
The following table sets forth the maturity distribution of our loans and leases at June 30, 2023, 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
Rate
Commercial real estate-mortgage
63,604
885,960
683,556
8,637
975,187
602,966
Consumer real estate-mortgage
32,758
218,317
202,338
171,415
282,633
309,437
126,333
176,139
60,766
31,504
145,767
122,642
135,617
365,239
87,240
6,331
365,844
92,966
2,170
64,231
7,168
7,977
7,666
801
367,650
1,717,863
1,034,341
217,936
1,841,328
1,128,812
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 June 30, 2023, and 0.09% December 31, 2022, respectively. Total nonperforming assets as a percentage of total assets was 0.12% as of June 30, 2023, and 0.10% as of December 31, 2022, respectively.
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
90 Days or More
Total Accruing
Past Due Loans
Percentage of
Loans in
Category
0.12
0.40
1.50
0.16
1,108
1.64
0.21
1.86
0.66
2,066
0.06
The following table is a summary of our nonaccrual loans and leases for the periods presented (dollars in thousands):
Nonaccrual Loans
0.05
0.28
0.23
0.14
0.45
0.09
0.11
Allowance for credit losses to nonaccrual loans
879.82%
830.98%
Allocation of the Allowance for Credit Losses
We maintain the allowance at a level that we deem appropriate to adequately cover change in the loan and lease portfolio. Our provision for credit losses for loans and leases for the six months ended June 30, 2023, is $970 thousand compared to $2.3 million in the same period of 2022, a decrease of $1.3 million. As of June 30, 2023, and December 31, 2022, our allowance for credit losses was $32.7 million and $23.3 million, respectively, which we deemed to be adequate at each of the respective dates. The increase was primarily the result of the implementation ASU 2016-13, which resulted in an increase of $8.7 million to the allowance for credit losses. See Note 1. Recently Issued and Adopted Accounting Pronouncements in the Notes to our Consolidated Financial Statements in this Form 10-Q for further information related to this change. Our allowance for credit loss as a percentage of total loans and leases was 0.98% at June 30 2023 and 0.72% at December 31, 2022, respectively.
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
56
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
1.08
1.38
0.93
0.88
0.95
0.98
0.69
0.76
0.72
1.92
0.85
The allocation by category is determined based on the loans and leases individually assigned call code and risk rating. Specific valuation allowances was $2.8 million at June 30, 2023, and $385 thousand at December 31, 2022. Prior to the adoption of ASU 2016-13 on January 1, 2023, impaired loans and leases were reviewed for a specific allowance allocation.
Analysis of the Allowance for Credit Losses
The following is a summary of changes in the allowance for credit losses for the periods presented including the ratio of the allowance for credit 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
1,638,053
615,364
390,357
0.01
582,580
67,027
15,214
0.18
1,489,463
506,144
335,956
467,425
(17)
60,933
(0.03)
(48)
12,827
(0.37)
610
1,625,710
610,726
387,415
578,190
(0.02)
66,522
(0.10)
(78)
15,099
(0.52)
(212)
(0.01)
1,451,916
0.00
521
483,227
327,488
(45)
466,289
59,397
(204)
12,504
(1.63)
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 $769.8 million at December 31, 2022, to $823.9 million at June 30, 2023, primarily as a result of strategically deploying a portion of the Bank’s cash position. New purchases were focused on floating rate or short-term government agency backed securities. Our securities to asset ratio has increased from 16.7% at December 31, 2022, to 17.4% at June 30, 2023.
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 June 30, 2023 (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.
Over Ten
Ten Years
Yield (1)
100,427
1.34
107,049
1.28
33,013
1.31
U.S. Government agencies
10,000
5.50
1,534
3.93
47,673
6.51
6.27
State and political subdivisions
400
4.37
2,536
6,253
9,785
3.80
3.33
3.65
32,942
4.48
11,153
2.07
86,706
2.57
134,014
2.45
2.48
Total securities
110,827
1.73
123,265
1.43
206,587
3.59
144,299
2.55
2.52
1.47
34,749
1.82
15,195
4,258
2.20
48,946
2.13
2.14
4,860
25,370
2.11
43,867
1.89
89,511
2.09
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 June 30, 2023, brokered deposits represented approximately 0.93% 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 six month periods ending June 30, 2023 and 2022, respectively (dollars in thousands):
June 30, 2022
23.0
26.7
22.9
23.2
41.9
37.4
12.2
12.7
Total average deposits
4,143,261
4,173,195
0.24
23.4
26.1
22.6
42.4
37.6
11.6
13.3
4,196,146
4,104,244
0.22
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 June 30, 2023, and 2022, was 2.46% and 0.33%, respectively. The increase cost was primarily attributable to the increases in rates and increased pricing competition. The average cost of interest-bearing deposits for the six months ended June 30, 2023, and 2022, was 2.25% and 0.30%, respectively. The increase cost was primarily attributable to the increases in rates and increased pricing competition.
Total deposits as of June 30, 2023, were $4.20 billion, which was an increase of $122.5 million from December 31, 2022. This increase was primarily from organic deposit growth. As of June 30, 2023, the Company had outstanding time deposits under $250,000 with balances of $328.8 million and time deposits over $250,000 with balances of $208.4 million.
The following table summarizes the maturities of time deposits $250,000 or more (in thousands).
Three months or less
17,851
Three to six months
41,576
Six to twelve months
109,435
More than twelve months
39,559
208,421
The Company's estimated uninsured deposits totaled $1.7 billion at June 30, 2023, compared to $1.6 billion at December 31, 2022, representing 40.7% and 40.4% of total deposits at June 30, 2023, and December 31, 2022, respectively. These estimates were derived using the same methodologies and assumptions used for the Bank's regulatory reporting.
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 $15.5 million at June 30, 2023, and consisted of short-term borrowings of $10.5 million, and $5.0 million of securities sold under repurchase agreements. Long-term debt totaled $42.1 million at June 30, 2023, and $42.0 million at December 31, 2022, 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 June 30, 2023 and December 31, 2022, 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 June 30, 2023, we had $770.9 million of pre-approved but unused lines of credit and $16.3 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.”
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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
(2.70)%
200 basis points increase
(5.52)%
100 basis points decrease
2.83%
200 basis points decrease
4.71%
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
(1.14)%
(3.40)%
1.10%
0.23%
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 $261.0 million in securities that mature throughout the next 12 months. The Company also has unused borrowing capacity in the amount of $1.1 billion available with the Federal Reserve, Federal Home Loan Bank, 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.
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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, 2023 (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 June 30, 2023, 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, 2022 and under “Part II – Item 1A — Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023. 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.
There are no material changes during the period covered by this Report to the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2022 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023.
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 June 30, 2023, 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 June 30, 2023.
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)
April 1, 2023 to April 30, 2023
4,484
May 1, 2023 to May 31, 2023
June 1, 2023 to June 30, 2023
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
Interactive Data Files (formatted as Inline XBRL)
104
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:
August 9, 2023
/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)
67