SMARTFINANCIAL INC. - Annual Report: 2016 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________
FORM 10-K
_________________________________________________________
ý | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2016
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For transition period from __________ to __________
Commission File Number: 001-37391
_________________________________________________________
SMARTFINANCIAL, INC.
(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 | |
(Registrant’s telephone number, including area code) | |
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value
Indicate by check mark if Registrant is a well known seasoned issuer, as defined in Rule 405 of the of the Securities Act.
Yes ¨ No ý
Indicate by check mark if Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes ¨ No ý
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 and 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 ý No ¨
Indicate by check whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company x |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No ý
As of June 30, 2016, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was approximately $74.6 million. As of March 21, 2017, there were 8,207,091 shares outstanding of the registrant’s common stock, $1.00 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2017, are incorporated by reference in Part III of this Form 10-K.
TABLE OF CONTENTS
Item No. | Page No. | |
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FORWARD-LOOKING STATEMENTS
SmartFinancial, Inc. (“SmartFinancial”) may from time to time make written or oral statements, including statements contained in this report (including, without limitation, certain statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7), that constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). 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, 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:
• | weakness or a decline in the U.S. economy, in particular in Tennessee, and other markets in which we operate; |
• | the possibility that our asset quality would decline or that we experience greater loan losses than anticipated; |
• | the impact of liquidity needs on our results of operations and financial condition; |
• | competition from financial institutions and other financial service providers; |
• | the impact of negative developments in the financial industry and U.S. and global capital and credit markets; |
• | the impact of recently enacted and future legislation and regulation on our business; |
• | negative changes in the real estate markets in which we operate and have our primary lending activities, which may result in an unanticipated decline in real estate values in our market area; |
• | risks associated with our growth strategy, including a failure to implement our growth plans or an inability to manage our growth effectively; |
• | claims and litigation arising from our business activities and from the companies we acquire, which may relate to contractual issues, environmental laws, fiduciary responsibility, and other matters; |
• | cyber attacks, computer viruses or other malware that may breach the security of our websites or other systems we operate or rely upon for services to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage our systems and negatively impact our operations and our reputation in the market; |
• | results of examinations by our primary regulators, the Tennessee Department of Financial Institutions (the “TDFI”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for credit losses, write-down assets, require us to reimburse customers, change the way we do business, or limit or eliminate certain other banking activities; |
• | government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve; |
• | our inability to pay dividends at current levels, or at all, because of inadequate future earnings, regulatory restrictions or limitations, and changes in the composition of qualifying regulatory capital and minimum capital requirements (including those resulting from the U.S. implementation of Basel III requirements); |
• | the relatively greater credit risk of commercial real estate loans and construction and land development loans in our loan portfolio; |
• | unanticipated credit deterioration in our loan portfolio or higher than expected loan losses within one or more segments of our loan portfolio; |
• | unexpected significant declines in the loan portfolio due to the lack of economic expansion, increased competition, large prepayments, changes in regulatory lending guidance or other factors; |
• | unanticipated loan delinquencies, loss of collateral, decreased service revenues, and other potential negative effects on our business caused by severe weather or other external events; |
• | changes in expected income tax expense or tax rates, including changes resulting from revisions in tax laws, regulations and case law; |
• | our ability to retain the services of key personnel; |
• | the impact of Tennessee’s anti-takeover statutes and certain of our charter provisions on potential acquisitions of us; and |
• | our ability to use the net proceeds of this offering as currently contemplated. |
For a more detailed discussion of some of the risk factors, see the section entitled “Risk Factors” below. We do not intend to update any factors, except as required by SEC rules, or to publicly announce revisions to any of our forward-looking statements. Any forward-looking statement speaks only as of the date that such statement was made. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.
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PART I
ITEM 1. BUSINESS
OVERVIEW
SmartFinancial, Inc. (“SmartFinancial” the “Company”), formerly “Cornerstone Bancshares, Inc.,” was incorporated on September 19, 1983, under the laws of the State of Tennessee. SmartFinancial is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. On August 31, 2015, Cornerstone Bancshares, Inc. merged with SmartFinancial, Inc. (“Legacy SmartFinancial”), with Cornerstone Bancshares, Inc. surviving the merger and changing its name to “SmartFinancial, Inc.” Following the merger, the Company operated two wholly-owned subsidiaries: SmartBank and Cornerstone Community Bank, both Tennessee banking corporations (the “Banks”). On February 26, 2016, the company merged Cornerstone Community Bank with and into SmartBank, with SmartBank surviving the merger. As of the date of this annual report, SmartBank (the “Bank”) is our only subsidiary Bank.
SmartFinancial
The primary activity of SmartFinancial currently is, and is expected to remain for the foreseeable future, the ownership and operation of SmartBank. As a bank holding company, SmartFinancial intends to facilitate SmartBank’s ability to serve its customers’ requirements for financial services. The holding company structure also provides flexibility for expansion through the possible acquisition of other financial institutions and the provision of additional banking-related services, as well as certain non-banking services, which a traditional commercial bank may not provide under present laws.
The Merger
On August 31, 2015, we completed our merger with Legacy SmartFinancial valued at approximately $28.4 million. Legacy SmartFinancial was merged with and into Cornerstone Bancshares, with Cornerstone Bancshares continuing on as the surviving corporation, changing its name to SmartFinancial, Inc. and relocating the headquarters to Knoxville, Tennessee. The merger was treated as a reverse merger for accounting purposes. Following the merger, SmartBank and Cornerstone Community Bank continued to operate separately until February 26, 2016, when the two banks were merged together. In connection with the merger, Cornerstone Bancshares Inc. sold $15 million of common stock at $3.75 per share in a stock offering to accredited investors, and used the proceeds to redeem the Company’s Series A Cumulative Preferred Stock. As part of the merger, Cornerstone effected a 1-for-4 reverse stock split after which the Legacy SmartFinancial shareholders were issued 1.05 shares of Cornerstone common stock for each share of Legacy SmartFinancial common stock owned. All of Cornerstone’s outstanding stock options vested upon consummation of the merger. The merger gave us a material market presence in the Chattanooga, Tennessee-Georgia MSA and surrounding counties. Following the merger, SmartFinancial listed its common stock on the NASDAQ exchange under the symbol “SMBK.”
SBLF Preferred Stock
On August 31, 2015, and in connection with the merger, the Company entered into an Assignment and Assumption Agreement (the “Assignment Agreement”) with Legacy SmartFinancial, pursuant to which Legacy SmartFinancial assigned to the Company, and the Company assumed, all of Legacy SmartFinancial’s rights, responsibilities, and obligations under that certain Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of August 4, 2011, by and between The United States Secretary of the Treasury (“Treasury”) and Legacy SmartFinancial. The Securities Purchase Agreement was entered into by Legacy SmartFinancial in connection with its participation in Treasury’s Small Business Lending Fund Program.
Under the terms of the Securities Purchase Agreement, Legacy SmartFinancial sold 12,000 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series A (“Legacy SmartFinancial SBLF Stock”), to Treasury for a purchase price of $12 million. Each share of Legacy SmartFinancial SBLF Stock was converted into one share of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (the “SBLF Preferred Stock”). More details about the SBLF Preferred Stock can be found in Note 16 in the “Notes to Consolidated Financial Statements.”
SmartBank
SmartBank is a Tennessee-chartered commercial bank established in 2007 which has its principal executive offices in Pigeon Forge, Tennessee. The principal business of the Bank consists of attracting deposits from the general public and investing those funds, together with funds generated from operations and from principal and interest payments on loans, primarily in commercial loans, commercial and residential real estate loans, consumer loans and residential and commercial construction loans. Funds not
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invested in the loan portfolio are invested by the Bank primarily in obligations of the U.S. Government, U.S. Government agencies, and various states and their political subdivisions. In addition to deposits, sources of funds for the Bank’s loans and other investments include amortization and prepayment of loans, sales of loans or participations in loans, sales of its investment securities and borrowings from other financial institutions. The principal sources of income for the Bank are interest and fees collected on loans, fees collected on deposit accounts and interest and dividends collected on other investments. The principal expenses of the Bank are interest paid on deposits, employee compensation and benefits, office expenses and other overhead expenses. At December 31, 2016, SmartBank had twelve full-service branches located in East Tennessee and the Florida Panhandle, two loan production offices, one mortgage loan production office, and two service centers.
Employees
As of December 31, 2016, SmartFinancial had 222 full-time equivalent employees and SmartBank had 219 full-time equivalent employees. The employees are not represented by a collective bargaining unit. SmartFinancial believes that its relationship with its employees is good.
Merger and Acquisition Strategy
Our strategic plan involves growing a high performing community bank through organic loan and deposit growth as well as disciplined merger and acquisition activity. We are continually evaluating business combination opportunities and may conduct due diligence activities in connection with these opportunities. As a result, business combination discussions and, in some cases, negotiations, may take place, and transactions involving cash, debt or equity securities could be expected. Any future business combinations or series of business combinations that we might undertake may be material in terms of assets acquired, liabilities assumed, or equity issued.
Competition
The three Tennessee markets in which we currently operate are very competitive. The Knoxville MSA banking market consists of 48 financial institutions with over $16.2 billion in deposits in the market as of June 30, 2016, up from $15.1 billion at June 30, 2015. As of June 30, 2016, approximately 47.6 percent of this deposit base was controlled by three large, multi-state banks headquartered outside of Knoxville: First Horizon, SunTrust, and Regions Financial. At June 30, 2016, SmartBank had approximately 0.4 percent of the deposit market share in the Knoxville MSA.
The Chattanooga MSA banking market consists of 27 financial institutions with over $9.3 billion in deposits in the market as of June 30, 2016, up from $9.0 billion at June 30, 2015. As of June 30, 2016, approximately 55.5 percent of this deposit base was controlled by three large, multi-state banks headquartered outside of Chattanooga: First Horizon, SunTrust, and Regions Financial. At June 30, 2016, SmartBank had approximately 3.4 percent of the deposit market share in the Chattanooga MSA.
The Sevier County banking market, which is not in a MSA, is comprised of 10 financial institutions with over $2.2 billion in deposits in the market as of June 30, 2016, up from $2.1 billion at June 30, 2015. As of June 30, 2016, approximately 78.8 percent of this deposit base was controlled by four local community banks which are headquartered in the county. At June 30, 2016, SmartBank had approximately 19.4 percent of the deposit market share in Sevier County.
The two Florida markets in which we currently operate branches are very competitive. The Pensacola-Ferry Pass-Brent MSA banking market consists of 18 financial institutions with over $5.4 billion in deposits in the market as of June 30, 2016, up from $5.1 billion at June 30, 2015. As of June 30, 2016, approximately 65.8 percent of this deposit base was controlled by five large, multi-state banks headquartered outside of Pensacola: Regions, Bank of America, Wells Fargo, Synovus Financial, and Hancock Holding Co. At June 30, 2016, SmartBank had approximately 0.3 percent of the deposit market share in the Pensacola MSA.
The Crestview-Fort Walton Beach-Destin MSA banking market is comprised of 25 financial institutions with over $4.8 billion in deposits in the market as of June 30, 2016, up from $4.6 billion at June 30, 2015. As of June 30, 2016, approximately 43.1 percent of this deposit base was controlled by four large, multi-state banks headquartered outside of Pensacola: Regions, Synovus Financial, Bank of America, and Wells Fargo. At June 30, 2016, SmartBank had approximately 1.3 percent of the deposit market share in the Crestview MSA.
The Bank competes for deposits principally by offering depositors a variety of deposit programs with competitive interest rates, quality service and convenient locations and hours. The Bank focuses its resources in seeking out and attracting small business relationships and taking advantage of the Bank’s ability to provide flexible service that meets the needs of this customer class. Management feels this market niche is the most promising business area for the future growth of the Bank.
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SUPERVISON AND REGULATION
General
The U.S. banking industry is highly regulated under federal and state law. The following is a general summary of the material aspects of certain statutes and regulations applicable to SmartFinancial and SmartBank. This supervisory framework could materially impact the conduct and profitability of our activities. A change in applicable laws and regulations, or in the manner such laws or regulations are interpreted by regulatory agencies or courts, may have a material effect on our business, operations and earnings.
SmartFinancial is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, or the BHC Act. As a result, we are subject to supervision, regulation, and examination by the Federal Reserve, and we are required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require pursuant to the BHC Act. SmartFinancial is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require pursuant to the BHC Act and other applicable regulations. The Federal Reserve may also make examinations of SmartFinancial and its subsidiary. We are also under the jurisdiction of the SEC for matters relating to the offering and sale of our securities and are subject to the SEC’s rules and regulations relating to periodic reporting, reporting to shareholders, proxy solicitations, and insider-trading regulations.
SmartBank is a Tennessee-chartered commercial bank and is a member of the Federal Reserve System. As a Tennessee bank, SmartBank is subject to supervision, regulation and examination by the TDFI. As a member of the Federal Reserve System, SmartBank is also subject to supervision, regulation and examination by the Federal Reserve. In addition, SmartBank’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund of the FDIC, and SmartBank is subject to regulation by the FDIC as the insurer of its deposits.
The bank and bank holding company regulatory scheme has two primary goals: to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. This comprehensive system of supervision and regulation is intended primarily for the protection of the FDIC’s Deposit Insurance Fund, bank depositors and the public, rather than our shareholders or creditors. To this end, federal and state banking laws and regulations control, among other things, the types of activities in which we and SmartBank may engage, permissible investments that we and SmartBank may make, the level of reserves that SmartBank must maintain against deposits, minimum equity capital levels, the nature and amount of collateral required for loans, maximum interest rates that can be charged, the manner and amount of the dividends that may be paid, and corporate activities regarding mergers, acquisitions and the establishment and closing of branch offices. In addition, federal and state laws impose substantial requirements on SmartBank in the areas of consumer protection and detection and reporting of potential or suspected money laundering and terrorist financing.
The description below summarizes certain elements of the bank regulatory framework applicable to us and SmartBank. This summary is not, however, intended to describe all laws, regulations and policies applicable to us and SmartBank, and you should refer to the full text of the statutes, regulations, and corresponding guidance for more information. These statutes and regulations are subject to change, and additional statutes, regulations, and corresponding guidance may be adopted. Proposals to change the laws and regulations governing the banking industry are frequently raised at both the state and federal level. We are unable to predict these future changes or the effects, if any, that these changes could have on our business, revenues, and financial results.
Regulation of SmartFinancial
As a regulated bank holding company, we are subject to various laws and regulations that affect our business. These laws and regulations, among other matters, prescribe minimum capital requirements, limit transactions with affiliates, impose limitations on the business activities in which we can engage, restrict our ability to pay dividends to our shareholders, restrict the ability of institutions to guarantee our debt and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles, among other things.
Permitted activities
Under the BHC Act, a bank holding company that is not a financial holding company, as discussed below, is generally permitted to engage in, or acquire direct or indirect control of more than five percent of any class of the voting shares of any company that is not a bank or bank holding company and that is engaged in, the following activities (in each case, subject to certain conditions and restrictions and prior approval of the Federal Reserve):
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• | banking or managing or controlling banks; |
• | furnishing services to or performing services for its subsidiaries; and |
• | any activity that the Federal Reserve determines by regulation or order to be so closely related to banking as to be a proper incident to the business of banking, including, for example factoring accounts receivable, making, acquiring, brokering or servicing loans and usual related activities, leasing personal or real property, operating a nonbank depository institution, such as a savings association, performing trust company functions, conducting financial and investment advisory activities, underwriting and dealing in government obligations and money market instruments, performing selected insurance underwriting activities, issuing and selling money orders and similar consumer-type payment instruments, and engaging in certain community development activities. |
While the Federal Reserve has found these activities in the past acceptable for other bank holding companies, the Federal Reserve may not allow us to conduct any or all of these activities, which are reviewed by the Federal Reserve on a case by case basis upon application by a bank holding company.
Acquisitions subject to prior regulatory approval
The BHC Act requires the prior approval of the Federal Reserve for a bank holding company to acquire substantially all the assets of a bank or to acquire direct or indirect ownership or control of more than 5 percent of any class of the voting shares of any bank, bank holding company, savings and loan holding company or savings association, or to increase any such non-majority ownership or control of any bank, bank holding company, savings and loan holding company or savings association, or to merge or consolidate with any bank holding company.
Under the BHC Act, a bank holding company that is located in Tennessee and is “well capitalized” and “well managed”, as such terms are defined under the BHC Act and implementing regulations, may purchase a bank located outside of Tennessee. Conversely, a well-capitalized and well-managed bank holding company located outside of Tennessee may purchase a bank located inside Tennessee. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in concentrations of deposits exceeding limits specified by statute.
Federal and state laws, including the BHC Act and the Change in Bank Control Act, impose additional prior notice or approval requirements and ongoing regulatory requirements on any investor that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank holding company. “Control” of a depository institution is a facts and circumstances analysis, but generally an investor is deemed to control a depository institution or other company if the investor owns or controls 25 percent or more of any class of voting securities. Ownership or control of 10 percent or more of any class of voting securities, where either the depository institution or company is a public company, as we are, or no other person will own or control a greater percentage of that class of voting securities after the acquisition, is also presumed to result in the investor controlling the depository institution or other company, although this is subject to rebuttal.
The BHC Act was substantially amended through the Financial Services Modernization Act of 1999, commonly referred to as the Gramm-Leach Bliley Act, or the GLBA. The GLBA eliminated long-standing barriers to affiliations among banks, securities firms, insurance companies and other financial services providers. A bank holding company whose subsidiary deposit institutions are “well capitalized” and “well managed” may elect to become a “financial holding company” and thereby engage without prior Federal Reserve approval in certain banking and non-banking activities that are deemed to be financial in nature or incidental to financial activity. These “financial in nature” activities include securities underwriting, dealing and market making; organizing, sponsoring and managing mutual funds; insurance underwriting and agency; merchant banking activities; and other activities that the Federal Reserve has determined to be closely related to banking. No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve. We have not elected to become a financial holding company.
A dominant theme of the GLBA is functional regulation of financial services, with the primary regulator of a company or its subsidiaries being the agency which traditionally regulates the activity in which the aompany or its subsidiaries wish to engage. For example, the SEC will regulate bank holding company securities transactions, and the various banking regulators will oversee banking activities.
Bank holding company obligations to bank subsidiaries
Under current law and Federal Reserve policy, a bank holding company is expected to act as a source of financial and managerial strength to its depository institution subsidiaries and to maintain resources adequate to support such subsidiaries, which could
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require us to commit resources to support SmartBank in situations where additional investments may not otherwise be warranted. As a result of these obligations, a bank holding company may be required to contribute additional capital to its subsidiaries.
Bank holding company dividends
The Federal Reserve’s policy regarding dividends is that a bank holding company should not declare or pay a cash dividend which would impose undue pressure on the capital of any bank subsidiary or would be funded only through borrowing or other arrangements that might adversely affect a bank holding company’s financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer, or significantly reduce the bank holding company’s dividends if:
• | its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; |
• | its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or |
• | it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. |
Should an insured member bank controlled by a bank holding company be “significantly undercapitalized” under the applicable federal bank capital ratios, or if the bank subsidiary is “undercapitalized” and has failed to submit an acceptable capital restoration plan or has materially failed to implement such a plan, the Federal Reserve may require prior approval for any capital distribution by the bank holding company. For more information, see “Capitalization levels and prompt corrective action” below.
In addition, since our legal entity is separate and distinct from SmartBank and does not conduct stand-alone operations, our ability to pay dividends depends on the ability of SmartBank to pay dividends to us, which is also subject to regulatory restrictions as described below in “Bank dividends.”
Under Tennessee law, we are not permitted to pay cash dividends if, after giving effect to such payment, we would not be able to pay our debts as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus any amounts needed to satisfy any preferential rights if we were dissolving.
Dodd-Frank Act
On July 21, 2010, the President signed into law the Dodd-Frank Act. The Dodd-Frank Act has imposed new restrictions on and expanded regulatory oversight for financial institutions, including depository institutions like SmartBank. Although the Dodd-Frank Act is primarily aimed at the activities of investment banks and large commercial banks, many of the provisions of the legislation impact operations of community banks like SmartBank. In addition to the Volcker Rule, which is discussed in more detail below, the following aspects of the Dodd-Frank Act are related to our operations:
• | Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated, subject to various grandfathering and transition rules. |
• | The deposit insurance assessment base calculation now equals the depository institution’s average consolidated total assets minus its average tangible equity during the assessment period. Previously, the deposit insurance assessment was calculated based on the insured deposits held by the institution. |
• | The ceiling on the size of the Deposit Insurance Fund was removed and the minimum designated reserve ratio of the Deposit Insurance Fund increased 20 basis points to 1.35 percent of estimated annual insured deposits or assessment base. The FDIC also was directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion. |
• | Bank holding companies and banks must be “well capitalized” and “well managed” in order to acquire banks located outside of their home state, which codified long-standing Federal Reserve policy. Any bank holding company electing to be treated as a financial holding company must be and remain “well capitalized” and “well managed.” |
• | Capital requirements for insured depository institutions are now countercyclical, such that capital requirements increase in times of economic expansion and decrease in times of economic contraction. |
• | The Federal Reserve established interchange transaction fees for electronic debit transactions under a restrictive “reasonable and proportional cost” per transaction standard. |
• | The “opt in” provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1997 have been eliminated, which allows state banks to establish de novo branches in states other than the bank’s home state if the law of such other state would permit a bank chartered in that state to open a branch at that location. |
• | The Durbin Amendment limits interchange fees payable on debit card transactions for financial institutions with more than $10 billion in assets. While the Durbin Amendment does not directly apply to SmartBank, competitive |
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market forces related to the reduction mandated by the Durbin Amendment may result in a decrease in revenue from interchange fees for smaller financial institutions.
• | The prohibition on the payment of interest on demand deposit accounts was repealed effective one year after enactment, thereby permitting depository institutions to pay interest on business checking and other accounts. |
• | A new federal agency was created, the Consumer Financial Protection Bureau, or CFPB, which has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB is also responsible for examining large financial institutions (i.e., those with more than $10 billion in assets) and enforcing compliance with federal consumer financial protection. |
• | The regulation of consumer protections regarding mortgage originations, addressing loan originator compensation, minimum repayment standards including restrictions on variable-rate lending by requiring the ability to repay be determined based on the maximum rate that will apply during the first five years of a variable-rate loan term, prepayment consideration, and new disclosures, has been expanded. |
The foregoing provisions may have the consequence of increasing our expenses, decreasing our revenues and changing the activities in which we choose to engage. The environment in which banking organizations will now operate, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, changes in fiscal policy and steps to eliminate government support for banking organizations, may have long-term effects on the profitability of banking organizations that cannot now be foreseen. The ultimate effect of the Dodd-Frank Act and its implementing regulations on the financial services industry in general, and on us in particular, is uncertain at this time.
The Volcker Rule
On December 10, 2013, the Federal Reserve and the other federal banking regulators as well as the SEC each adopted a final rule implementing Section 619 of the Dodd-Frank Act, commonly referred to as the “Volcker Rule.” Generally speaking, the final rule prohibits a bank and its affiliates from engaging in proprietary trading and from sponsoring certain “covered funds” or from acquiring or retaining any ownership interest in such covered funds. Most private equity, venture capital, and hedge funds are considered “covered funds” as are bank trust preferred collateralized debt obligations. The final rule required banking entities to divest disallowed securities by July 21, 2015, subject to extension upon application. The Volcker Rule did not impact any of our activities nor do we hold any securities that we were required to sell under the rule, but it does limit the scope of permissible activities in which we might engage in the future.
U.S. Basel III capital rules
The U.S. Basel III capital rules, effective January 1, 2015, apply to all national and state banks and savings associations and most bank holding companies, which we collectively refer to herein as “covered banking organizations.” The requirements in the U.S. Basel III capital rules started to phase in on January 1, 2015, for many covered banking organizations, including SmartFinancial and SmartBank. The requirements in the U.S. Basel III capital rules will be fully phased in by January 1, 2019.
The U.S. Basel III capital rules impose higher risk-based capital and leverage requirements than those previously in place. Specifically, the rules impose the following minimum capital requirements:
• | a new common equity Tier 1 risk-based capital ratio of 4.5 percent; |
• | a Tier 1 risk-based capital ratio of 6 percent (increased from the then-current 4 percent requirement); |
• | a total risk-based capital ratio of 8 percent (unchanged from the then-current requirements); |
• | a leverage ratio of 4 percent; and |
• | a new supplementary leverage ratio of 3 percent applicable to advanced approaches banking organizations, resulting in a leverage ratio requirement of 7 percent for such institutions. |
Under the U.S. Basel III capital rules, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, or CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as non-cumulative perpetual preferred stock.
The rules permit bank holding companies with less than $15.0 billion in total consolidated assets, such as us, to continue to include trust-preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in CET1 capital, subject to certain restrictions. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment.
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In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a capital conservation buffer on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital, and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5 percent of risk-weighted assets.
The U.S. Basel III capital standards require certain deductions from or adjustments to capital. As a result, deductions from CET1 capital will be required for goodwill (net of associated deferred tax liabilities); intangible assets such as non-mortgage servicing assets and purchased credit card relationships (net of associated deferred tax liabilities); deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities); any gain on sale in connection with a securitization exposure; any defined benefit pension fund net asset (net of any associated deferred tax liabilities) held by a bank holding company (this provision does not apply to a bank or savings association); the aggregate amount of outstanding equity investments (including retained earnings) in financial subsidiaries; and identified losses. Other deductions will be necessary from different levels of capital. The U.S. Basel III capital rules also increase the risk weight for certain assets, meaning that more capital must be held against such assets. For example, commercial real estate loans that do not meet certain underwriting requirements must be risk-weighted at 150 percent rather than the 100 percent that was the case prior to these rules becoming effective.
Additionally, the U.S. Basel III capital standards provide for the deduction of three categories of assets: (i) deferred tax assets arising from temporary differences that cannot be realized through net operating loss carrybacks (net of related valuation allowances and of deferred tax liabilities), (ii) mortgage servicing assets (net of associated deferred tax liabilities) and (iii) investments in more than 10 percent of the issued and outstanding common stock of unconsolidated financial institutions (net of associated deferred tax liabilities). The amount in each category that exceeds 10 percent of CET1 capital must be deducted from CET1 capital. The remaining, non-deducted amounts are then aggregated, and the amount by which this total amount exceeds 15 percent of CET1 capital must be deducted from CET1 capital. Amounts of minority investments in consolidated subsidiaries that exceed certain limits and investments in unconsolidated financial institutions may also have to be deducted from the category of capital to which such instruments belong.
Accumulated other comprehensive income, or AOCI, is presumptively included in CET1 capital and often would operate to reduce this category of capital. The U.S. Basel III capital rules provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We elected to opt out. The rules also have the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, mortgage servicing rights not includable in CET1 capital, equity exposures, and claims on securities firms, which are used in the denominator of the three risk-based capital ratios.
When fully phased in on January 1, 2019, the U.S. Basel III capital rules will require us and SmartBank to maintain (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.5 percent, plus the 2.5 percent capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7 percent, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus the capital conservation buffer, effectively resulting in a minimum Tier 1 capital ratio of 8.5 percent, (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0 percent, plus the capital conservation buffer, effectively resulting in a minimum total capital ratio of 10.5 percent and (iv) a minimum leverage ratio of 4 percent, calculated as the ratio of Tier 1 capital to average assets. Management believes that we and SmartBank would meet all capital adequacy requirements under the U.S. Basel III capital rules on a fully phased-in basis if such requirements were currently effective.
The U.S. Basel III capital rules also make important changes to the “prompt corrective action” framework discussed below in “Regulation of SmartBank-Capitalization levels and prompt corrective action.”
Anti-tying restrictions.
Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other nonbanking services offered by a bank holding company or its affiliates.
Executive compensation and corporate governance
The Dodd-Frank Act requires public companies to include, at least once every three years, a separate non-binding “say on pay” vote in their proxy statement by which shareholders may vote on the compensation of the public company’s named executive officers. In addition, if such public companies are involved in a merger, acquisition, or consolidation, or if they propose to sell or
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dispose of all or substantially all of their assets, shareholders have a right to an advisory vote on any golden parachute arrangements in connection with such transaction (frequently referred to as “say-on-golden parachute” vote). Other provisions of the act may impact our corporate governance. For instance, the act requires the SEC to adopt rules prohibiting the listing of any equity security of a company that does not have an independent compensation committee; and requiring all exchange-traded companies to adopt clawback policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements.
Regulation of SmartBank
As a Tennessee-chartered commercial bank, SmartBank is subject to supervision, regulation, and examination by the TDFI, and, as a member of the Federal Reserve System, SmartBank is also subject to supervision, regulation, and examination by the Federal Reserve. Federal and state law and regulation affect virtually all of SmartBank’s activities including capital requirements, the ability to pay dividends, mergers and acquisitions, limitations on the amount that can be loaned to a single borrower and related interests, permissible investments, and geographic and new product expansion, among other things. SmartBank must submit an application to, and receive the approval of, the TDFI and Federal Reserve before opening a new branch office or merging with another financial institution. The Commissioner of the TDFI and the Federal Reserve have the authority to enforce laws and regulations by ordering SmartBank or a director, officer, or employee of SmartBank to cease and desist from violating a law or regulation or from engaging in unsafe or unsound banking practices and by imposing other sanctions including civil money penalties.
Tennessee law contains limitations on the interest rates that may be charged on various types of loans and restrictions on the nature and amount of loans that may be granted and on the type of investments which may be made. The operations of banks are also affected by various consumer laws and regulations, including those relating to equal credit opportunity and regulation of consumer lending practices. SmartBank’s deposits are insured by the FDIC under the Federal Deposit Insurance Act.
State banks are subject to regulation by the TDFI with regard to capital requirements and the payment of dividends. Tennessee has adopted the provisions of the Federal Reserve’s Regulation O with respect to restrictions on loans and other extensions of credit to bank “insiders.” Further, under Tennessee law, state banks are prohibited from lending to any one person, firm, or corporation amounts more than 15 percent of the bank’s equity capital accounts, except (i) in the case of certain loans secured by negotiable title documents covering readily marketable nonperishable staples, or (ii) with the prior approval of the bank’s board of directors or finance committee (however titled), the bank may make a loan to any person, firm or corporation of up to 25 percent of its equity capital accounts.
Various state and federal consumer laws and regulations also affect the operations of SmartBank, including state usury laws, consumer credit and equal credit opportunity laws, and fair credit reporting. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, generally prohibits insured state chartered institutions from conducting activities as principal that are not permitted for national banks.
Capitalization levels and prompt corrective action
Federal law and regulations establish a capital-based regulatory scheme designed to promote early intervention for troubled banks and require the FDIC to choose the least expensive resolution of bank failures. The capital-based regulatory framework contains five categories of regulatory capital requirements, including “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To qualify as a “well capitalized” institution for these purposes, a bank must have a leverage ratio of no less than 5 percent, a Tier 1 capital ratio of no less than 6 percent, and a total risk-based capital ratio of no less than 10 percent, and a bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.
Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the Federal Deposit Insurance Act, or FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. Bank holding companies controlling financial institutions can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; (iv) requiring the institution to change and improve its management; (iv) prohibiting the
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acceptance of deposits from correspondent banks; (v) requiring prior Federal Reserve approval for any capital distribution by a bank holding company controlling the institution; and (vi) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Notably, the thresholds for each of the five categories for regulatory capital requirements were revised pursuant to the U.S. Basel III capital rules. See the discussion under the heading “U.S. Basel III capital rules” above. Under these rules, which started to phase in on January 1, 2015, a well-capitalized insured depository institution is one (i) having a total risk-based capital ratio of 10 percent or greater, (ii) having a Tier 1 risk-based capital ratio of 8 percent or greater, (iii) having a CET1 capital ratio of 6.5 percent or greater, (iv) having a leverage capital ratio of 5 percent or greater and (v) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. A state member bank is considered “adequately capitalized” if it has a leverage ratio of at least 4 percent, a CET1 capital ratio of 4.5 percent or better, a Tier 1 risk-based capital ratio of at least 6.0 percent, a total risk-based capital ratio of at least 8.0 percent and does not meet the definition of a well-capitalized bank.
It should be noted that the minimum ratios referred to above in this section are merely guidelines, and the bank regulators possess the discretionary authority to require higher capital ratios.
Bank reserves
The Federal Reserve requires all depository institutions, even if not members of the Federal Reserve System, to maintain reserves against some transaction accounts (primarily negotiable order of withdrawal (NOW) and Super NOW checking accounts). The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. An institution may borrow from the Federal Reserve Bank “discount window” as a secondary source of funds, provided that the institution meets the Federal Reserve Bank’s credit standards.
Bank dividends
The Federal Reserve prohibits any distribution that would result in the bank being “undercapitalized” (<4 percent leverage ratio, <4.5 percent CET1 capital ratio, <6 percent Tier 1 risk-based capital ratio, or <8 percent total risk-based capital ratio). Tennessee law places restrictions on the declaration of dividends by state chartered banks to their shareholders, including, but not limited to, that the board of directors of a Tennessee-chartered bank may only make a dividend from the surplus profits arising from the business of the bank, and may not declare dividends in any calendar year that exceeds the total of its retained net income of that year combined with its retained net income of the preceding two years without the prior approval of the commissioner of the TDFI. Tennessee laws regulating banks require certain charges against and transfers from an institution’s undivided profits account before undivided profits can be made available for the payment of dividends. Furthermore, the TDFI also has authority to prohibit the payment of dividends by a Tennessee bank when it determines such payment to be an unsafe and unsound banking practice.
Insurance of accounts and other assessments
SmartBank pays deposit insurance assessments to the Deposit Insurance Fund, which is determined through a risk-based assessment system. SmartBank’s deposit accounts are currently insured by the Deposit Insurance Fund, generally up to a maximum of $250,000 per separately insured depositor. SmartBank pays assessments to the FDIC for such deposit insurance. Under the current assessment system, the FDIC assigns an institution to a risk category based on the institution’s most recent supervisory and capital evaluations, which are designed to measure risk. Under the FDIA, the FDIC may terminate a bank’s deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, agreement or condition imposed by the FDIC.
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, or FICO, a federal government corporation established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the FICO bonds mature in 2017 through 2019.
Restrictions on transactions with affiliates
SmartBank is also subject to federal laws that restrict certain transactions between it and its nonbank affiliates. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank, including in the case of SmartBank, SmartFinancial. Under sections 23A and 23B of the Federal Reserve Act, or FRA, and the Federal Reserve’s Regulation W, covered transactions by SmartBank with a single nonbank affiliate are generally limited to 10 percent of SmartBank’s capital and surplus and 20 percent of capital and surplus for all covered transactions with all nonbank affiliates. The definition of “covered
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transactions” includes transactions like a loan by a bank to an affiliate, an investment by a bank in an affiliate, or a purchase by a bank of assets from an affiliate. A loan by a bank to a nonbank affiliate must be secured by collateral valued at 100 percent to 130 percent of the loan amount, depending on the type of collateral and certain low quality assets and any securities of an affiliate may not serve as collateral.
All such transactions must generally be consistent with safe and sound banking practices and must be on terms that are no less favorable to the bank than those that would be available from nonaffiliated third parties. Moreover, state banking laws impose restrictions on affiliate transactions similar to those imposed by federal law. Federal Reserve policies also forbid the payment by bank subsidiaries of management fees which are unreasonable in amount or exceed the fair market value of the services rendered or, if no market exists, actual costs plus a reasonable profit.
Loans to insiders
Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10 percent of any class of voting securities of a bank, or to any related interest of those persons, including any company controlled by that person, are subject to Sections 22(g) and 22(h) of the FRA and their corresponding regulations, which is referred to as Regulation O. Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Regulation O prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15 percent of an institution’s unimpaired capital and surplus plus an additional 10 percent of unimpaired capital and surplus in the case of loans that are fully secured by certain readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the bank’s unimpaired capital and unimpaired surplus. Section 22(g) identifies limited circumstances in which the bank is permitted to extend credit to executive officers.
Community Reinvestment Act
The Community Reinvestment Act, or CRA, and its corresponding regulations are intended to encourage banks to help meet the credit needs of their service areas, including low and moderate-income neighborhoods, consistent with safe and sound operations. These regulations provide for regulatory assessment of a bank’s record in meeting the credit needs of its service area. Federal banking agencies are required to make public a rating of a bank’s performance under the CRA. The federal banking agencies consider a bank’s CRA rating when a bank submits an application to establish banking centers, merge, or acquire the assets and assume the liabilities of another bank. In the case of a bank holding company, the CRA performance record of all banks involved in the merger or acquisition are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other financial holding company. An unsatisfactory record can substantially delay, block or impose conditions on the transaction. SmartBank received a satisfactory rating on its most recent CRA assessment.
Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or Riegle-Neal Act, provides that adequately capitalized and managed bank holding companies are permitted to acquire banks in any state. Previously, under the Riegle-Neal Act, a bank’s ability to branch into a particular state was largely dependent upon whether the state “opted in” to de novo interstate branching. Many states did not “opt-in,” which resulted in branching restrictions in those states. The Dodd-Frank Act amended the Riegle-Neal legal framework for interstate branching to permit national banks and state banks to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state. Under current Tennessee law, our bank may open branch offices throughout Tennessee with the prior approval of the TDFI. All branching remains subject to applicable regulatory approval and adherence to applicable legal requirements.
Bank Secrecy Act
The Currency and Foreign Transactions Reporting Act of 1970, better known as the Bank Secrecy Act, or BSA, requires all United States financial institutions to assist United States government agencies to detect and prevent money laundering. Specifically, BSA requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding a daily aggregate amount of $10,000, and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities.
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Anti-money laundering and economic sanctions
The USA PATRIOT Act provides the federal government with additional powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. By way of amendments to the BSA, the USA PATRIOT Act imposed new requirements that obligate financial institutions, such as banks, to take certain steps to control the risks associated with money laundering and terrorist financing.
Among other requirements, the USA PATRIOT Act and implementing regulations require banks to establish anti-money laundering programs that include, at a minimum:
• | internal policies, procedures and controls designed to implement and maintain the bank's compliance with all of the requirements of the USA PATRIOT Act, the BSA and related laws and regulations; |
• | systems and procedures for monitoring and reporting of suspicious transactions and activities; |
• | designated compliance officer; |
• | employee training; |
• | an independent audit function to test the anti-money laundering program; |
• | procedures to verify the identity of each customer upon the opening of accounts; and |
• | heightened due diligence policies, procedures and controls applicable to certain foreign accounts and relationships. |
Additionally, the USA PATRIOT Act requires each financial institution to develop a customer identification program, or CIP, as part of the bank's anti-money laundering program. The key components of the CIP are identification, verification, government list comparison, notice and record retention. The purpose of the CIP is to enable the financial institution to determine the true identity and anticipated account activity of each customer. To make this determination, among other things, the financial institution must collect certain information from customers at the time they enter into the customer relationship with the financial institution. This information must be verified within a reasonable time through documentary and non-documentary methods. Furthermore, all customers must be screened against any CIP-related government lists of known or suspected terrorists. Financial institutions are also required to comply with various reporting and recordkeeping requirements. The Federal Reserve and the FDIC consider an applicant's effectiveness in combating money laundering, among other factors, in connection with an application to approve a bank merger or acquisition of control of a bank or bank holding company.
Likewise, the Treasury's Office of Foreign Assets Control, or OFAC, is responsible for helping to ensure that United States entities do not engage in transactions with the subjects of U.S. sanctions, as defined by various Executive Orders and Acts of Congress. Currently, OFAC administers and enforces comprehensive U.S. economic sanctions programs against certain specified countries/regions. In addition to the country/region-wide sanctions programs, OFAC also administers complete embargoes against individuals and entities identified on OFAC's list of Specially Designated Nationals and Blocked Persons, or SDN List. The SDN List includes over 7,000 parties that are located in many jurisdictions throughout the world, including in the United States and Europe. SmartBank is responsible for determining whether any potential and/or existing customers appear on the SDN List or are owned or controlled by a person on the SDN List. If any customer appears on the SDN List or is owned or controlled by a person or entity on the SDN List, such customer's account must be placed on hold and a blocking or rejection report, as appropriate and if required, must be filed within 10 business days with OFAC. In addition, if a customer is a citizen of, has provided an address in, or is organized under the laws of any country or region for which OFAC maintains a comprehensive sanctions program, the Bank must take certain actions with respect to such customers as dictated under the relevant OFAC sanctions program. SmartBank must maintain compliance with OFAC by implementing appropriate policies and procedures and by establishing a recordkeeping system that is reasonably appropriate to administer the Bank's compliance program. SmartBank has adopted policies, procedures and controls to comply with the BSA, the USA PATRIOT Act and OFAC regulations.
Privacy and data security
Under the GLBA, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The GLBA also directed federal regulators, including the FDIC, to prescribe standards for the security of consumer information. SmartBank is subject to such standards, as well as standards for notifying customers in the event of a security breach.
Consumer laws and regulations
SmartBank is also subject to other federal and state consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, or TILA, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Check Clearing for the 21st Century Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Equal Credit Opportunity Act,
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the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair and Accurate Transactions Act, the Servicemembers Civil Relief Act, the Military Lending Act, the Mortgage Disclosure Improvement Act, and the Real Estate Settlement Procedures Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with consumers when offering consumer financial products and services.
Rulemaking authority for these and other consumer financial protection laws transferred from the prudential regulators to the CFPB on July 21, 2011. In some cases, regulators such as the Federal Trade Commission, the U.S. Department of Housing and Urban Development, and the U.S. Department of Justice also retain certain rulemaking or enforcement authority. The CFPB also has broad authority to prohibit unfair, deceptive and abusive acts and practices, or UDAAP, and to investigate and penalize financial institutions that violate this prohibition. While the statutory language of the Dodd-Frank Act sets forth the standards for acts and practices that violate the prohibition on UDAAP, certain aspects of these standards are untested, and thus it is currently not possible to predict how the CFPB will exercise this authority. In addition, consumer compliance examination authority remains with the prudential regulators for smaller depository institutions ($10 billion or less in total assets). The possibility of changes in the authority of the CFPB going forward after President-elect Trump is sworn into office is uncertain, and we cannot ascertain the impact, if any, changes to the CFPB may have on our business, revenues, operations, or results.
The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” On January 10, 2013, the CFPB published final rules to, among other things, specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. Since then the CFPB made certain modifications to these rules. The rules extend the requirement that creditors verify and document a borrower’s “income and assets” to include all “information” that creditors rely on in determining repayment ability. The rules also provide further examples of third-party documents that may be relied on for such verification, such as government records and check-cashing or funds-transfer service receipts. The new rules were effective beginning on January 10, 2014. The rules also define “qualified mortgages,” imposing both underwriting standards-for example, a borrower’s debt-to-income ratio may not exceed 43 percent-and limits on the terms of their loans. Points and fees are subject to a relatively stringent cap, and the terms include a wide array of payments that may be made in the course of closing a loan. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.
On October 3, 2015, the CFPB implemented a final rule combining the mortgage disclosures consumers previously received under TILA and the Real Estate Settlement Procedures Act, or RESPA. For more than 30 years, the TILA and RESPA mortgage disclosures had been administered separately by, respectively, the Federal Reserve and the U.S. Department of Housing and Urban Development. The final rule requires lenders to provide applicants with the new Loan Estimate and Closing Disclosure and generally applies to most closed-end consumer mortgage loans for which the creditor or mortgage broker receives an application on or after October 3, 2015.
Volcker Rule
The Volcker Rule generally prohibits a “banking entity” (which includes any insured depository institution, such as SmartBank, or any affiliate or subsidiary of such depository institution, such as SmartFinancial) from engaging in proprietary trading and acquiring or retaining any ownership interest in, sponsoring, or engaging in certain transactions with, a “covered fund”. Both the proprietary trading and covered fund-related prohibitions are subject to a number of exemptions and exclusions. The Volcker Rule became effective by statute in July 2012, and on December 10, 2013, five federal regulators including the FDIC and the Federal Reserve jointly adopted the final regulations to implement the Volcker Rule. The final regulations contain exemptions for, among others, market making, risk-mitigating hedging, underwriting, and trading in U.S. government and agency obligations and also permit certain ownership interests in certain types of funds to be retained. They also permit the offering and sponsoring of funds under certain conditions. In addition, the final regulations impose significant compliance and reporting obligations on banking entities.
The final regulations became effective on April 1, 2014, and banking entities were required to conform their proprietary trading activities and investments in and relationships with covered funds that were in place after December 31, 2013 by July 21, 2015. For those banking entities whose investments in and relationships with covered funds were in place prior to December 31, 2013 (“legacy covered funds”), the Volcker Rule conformance period was recently extended by the Federal Reserve to July 21, 2017 for such legacy covered funds. In addition, the Federal Reserve has also indicated its intention to grant two additional one-year extensions of the conformance period to July 21, 2017, for banking entities to conform ownership interests in and sponsorship of
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activities of collateralized loan obligations, or CLOs, that are backed in part by non-loan assets and that were in place as of December 31, 2013.
FIRREA and FDICIA
Far-reaching legislation, including the Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, and the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, have impacted the business of banking for years. FIRREA primarily affected the regulation of savings institutions rather than the regulation of commercial banks and bank holding companies like SmartBank and SmartFinancial, but did include provisions affecting deposit insurance premiums, acquisitions of thrifts by banks and bank holding companies, liability of commonly controlled depository institutions, receivership and conservatorship rights and procedures and substantially increased penalties for violations of banking statutes, regulations and orders.
FDICIA resulted in extensive changes to the federal banking laws. The primary purpose of FDICIA was to authorize additional borrowings by the FDIC in order to assist in the resolution of failed and failing financial institutions. However, the law also instituted certain changes to the supervisory process and contained various provisions affecting the operations of banks and bank holding companies.
The additional supervisory powers and regulations mandated by FDICIA include a “prompt corrective action” program based upon five regulatory zones for banks, in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank’s financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank’s ratio of tangible equity to total assets reaches two percent. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital. The Federal Reserve has adopted regulations implementing the prompt corrective action provisions of the FDICIA, which place financial institutions into one of the following five categories based upon capitalization ratios as these ratios have been amended following regulations implementing the requirements of Basel III: (1) a “well capitalized” institution has a total risk-based capital ratio of at least 10 percent, a Tier 1 risk-based capital ratio of at least 8 percent, a leverage ratio of at least 5 percent and a CET1 capital ratio of at least 6.5 percent; (2) an “adequately capitalized” institution has a total risk-based ratio of at least 8 percent, a Tier 1 risk-based ratio of at least 6 percent, a leverage ratio of at least 4 percent and a CET1 capital ratio of at least 4.5 percent; (3) an “undercapitalized” institution has a total risk-based capital ratio of under 8 percent, a Tier 1 risk-based capital ratio of under 6 percent, a leverage ratio of under 4 percent or a CET1 capital ratio of less than 4.5 percent; (4) a “significantly undercapitalized” institution has a total risk-based capital ratio of under 6 percent, a Tier 1 risk-based ratio of under 4 percent, a leverage ratio of under 3 percent or a CET1 capital ratio of less than 3 percent; and (5) a “critically undercapitalized” institution has a ratio of tangible equity to total assets of 2 percent or less. Institutions in any of the three undercapitalized categories would generally be prohibited from declaring dividends or making capital distributions. The regulations also establish procedures for “downgrading” an institution to a lower capital category based on supervisory factors other than capital.
Various other sections of the FDICIA impose substantial audit and reporting requirements and increase the role of independent accountants and outside directors. Set forth below is a list containing certain other significant provisions of the FDICIA:
• | annual on-site examinations by regulators (except for smaller, well-capitalized banks with high management ratings, which must be examined every 18 months); |
• | mandated annual independent audits by independent public accountants and an independent audit committee of outside directors for institutions with more than $500,000,000 in assets; |
• | uniform disclosure requirements for interest rates and terms of deposit accounts; |
• | a requirement that the FDIC establish a risk-based deposit insurance assessment system; |
• | authorization for the FDIC to impose one or more special assessments on its insured banks to recapitalize the bank insurance fund (now called the Deposit Insurance Fund); |
• | a requirement that each institution submit to its primary regulators an annual report on its financial condition and management, which report will be available to the public; |
• | a ban on the acceptance of brokered deposits except by well capitalized institutions and by adequately capitalized institutions with the permission of the FDIC, and the regulation of the brokered deposit market by the FDIC; |
• | restrictions on the activities engaged in by state banks and their subsidiaries as principal, including insurance underwriting, to the same activities permissible for national banks and their subsidiaries unless the state bank is well capitalized and a determination is made by the FDIC that the activities do not pose a significant risk to the insurance fund; |
• | a review by each regulatory agency of accounting principles applicable to reports or statements required to be filed with federal banking agencies and a mandate to devise uniform requirements for all such filings; |
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• | the institution by each regulatory agency of noncapital safety and soundness standards for each institution it regulates which cover (1) internal controls, (2) loan documentation, (3) credit underwriting, (4) interest rate exposure, (5) asset growth, (6) compensation, fees and benefits paid to employees, officers and directors, (7) operational and managerial standards, and (8) asset quality, earnings and stock valuation standards for preserving a minimum ratio of market value to book value for publicly traded shares (if feasible); |
• | uniform regulations regarding real estate lending; and |
• | a review by each regulatory agency of the risk-based capital rules to ensure they take into account adequate interest rate risk, concentration of credit risk, and the risks of non-traditional activities. |
Jumpstart Our Business Startups Act of 2012
The Jumpstart Our Business Startups Act, or JOBS Act, increased the threshold under which a bank or bank holding company may terminate registration of a security under the Securities Exchange Act of 1934, as amended, to 1,200 shareholders of record from 300. The JOBS Act also raised the threshold requiring companies to register to 2,000 shareholders from 500. Since the JOBS Act was signed, numerous banks or bank holding companies have filed to deregister their common stock.
Future legislative developments
Legislative acts that impact SmartFinancial and SmartBank are introduced in Congress and the Tennessee legislature from time to time. This legislation may change banking statutes and the environment in which we operate in substantial and unpredictable ways. Due to the outcome of the 2016 presidential election, changes to legislation surrounding taxes, consumer protection laws, regulation of financial institutions, and other topics relevant to our company will likely be considered in Congress in the coming four years. We cannot determine the ultimate effect that potential changes to legislation, if enacted, or implementing regulations and interpretations with respect thereto, would have our financial condition or results of operations.
ITEM 1A. RISK FACTORS
Investing in our common stock involves various risks which are particular to SmartFinancial, its industry, and its market area. Several risk factors regarding investing in our securities are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct our business as currently planned and our financial condition or operating results could be negatively impacted. These matters could cause the trading price of our securities to decline in future periods.
Risks Related to Our Industry
Our net interest income could be negatively affected by interest rate adjustments by the Federal Reserve Board.
As a financial institution, our earnings are dependent upon our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve Board’s policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of our assets and liabilities. As a result, an increase or decrease in market interest rates could have a material adverse effect on our net interest margin and results of operations. Actions by monetary and fiscal authorities, including the Federal Reserve Board, could have an adverse effect on our deposit levels, loan demand, business and results of operations.
The Federal Reserve Board raised interest rates by 75 basis points since December 2015 after having held interest rates at almost zero over recent years. However, the consistently low rate environment has negatively impacted our net interest margin, notwithstanding decreases in nonperforming loans and improvements in deposit mix. Any reduction in net interest income will negatively affect our business, financial condition, liquidity, results of operations, and/or cash flows.
Changes in the level of interest rates also may negatively affect our ability to originate loans, the value of our assets, and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized costs of the investments, we will incur losses.
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The primary tool that management uses to measure short-term interest rate risk is a net interest income simulation model prepared by an independent third party provider. As of December 31, 2016, SmartFinancial is considered to be in an asset-sensitive position, meaning income is generally expected to increase with an increase in short-term interest rates and, conversely, to decrease with a decrease in short-term interest rates. Based on the results of this simulation model, which assumed a static environment with no contemplated asset growth or changes in our balance sheet management strategies, if short-term interest rates immediately increased by 200 basis points, we could expect net income to increase by approximately $2.2 million over a 12-month period. This result is primarily due to the floating rate securities and loans which we anticipate would reprice at a quicker rate than our interest bearing liabilities. The actual amount of any increase or decrease may be higher or lower than predicted by our simulation model.
The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.
In July 2013, the federal banking agencies published new regulatory capital rules based on the international standards, known as Basel III, that had been developed by the Basel Committee on Banking Supervision. The new rules raised the risk-based capital requirements and revised the methods for calculating risk-weighted assets, usually resulting in higher risk weights. The new rules became effective on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019.
The Basel III-based rules increase capital requirements and include two new capital measurements that will affect us, a risk-based common equity Tier 1 ratio and a capital conservation buffer. As an example, the Tier 1 capital ratio minimum requirement of 4 percent on January 1, 2015 will increase to 8.5 percent by 2019. SmartFinancial has approximately $100.7 million of Tier 1 capital. Under the previous standard, we could have grown SmartBank's total asset size to approximately $2.5 billion with our current capital but will be limited to $1.2 billion in assets under the new Basel III standards to be phased in by 2019. In 2016,93 percent of our average assets were earning assets and over 90 percent of our revenue was generated from net interest income. Therefore, a future reduction of potential earning assets by approximately 53 percent could drastically reduce our future income. More details about the new capital requirements can be found in Note 13 in the “Notes to Consolidated Financial Statements.”
We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions or breaches of security could have an adverse effect on our financial condition and results of operations.
Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify these systems as circumstances warrant, the security of our computer systems, software and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. We outsource many of our major systems, such as data processing, loan servicing and deposit processing systems. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
In addition, we provide our customers the ability to bank remotely, including over the Internet or through their mobile device. The secure transmission of confidential information is a critical element of remote and mobile banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches (including breaches of security of customer systems and networks) and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation, results of operations and ability to attract and maintain customers and businesses. In addition, a security breach could also subject us to additional regulatory scrutiny, expose us to civil litigation and possible financial liability and cause reputational damage.
Risks Related to Our Company
If our allowance for loan and lease losses and fair value adjustments with respect to acquired loans is not sufficient to cover actual loan losses, our earnings will be adversely affected.
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Our success depends significantly on the quality of our assets, particularly loans. Like other financial institutions, we are exposed to the risk that our borrowers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. As a result, we may experience significant loan losses that may have a material adverse effect on our operating results and financial condition.
We maintain an allowance for loan and lease losses with respect to our loan portfolio, in an attempt to cover loan losses inherent in our loan portfolio. In determining the size of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. We also make various assumptions and judgments about the collectability of our loan portfolio, including the diversification in our loan portfolio, the effect of changes in the economy on real estate and other collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic conditions and their probable impact on borrowers, the amount of charge-offs for the period and the amount of nonperforming loans and related collateral security.
The application of the acquisition method of accounting in our acquisitions has impacted our allowance for loan and lease losses. Under the acquisition method of accounting, all acquired loans were recorded in our consolidated financial statements at their fair values at the time of acquisition and the related allowance for loan and lease losses was eliminated because credit quality, among other factors, was considered in the determination of fair value. To the extent that our estimates of fair values are too high, we will incur losses associated with the acquired loans. The allowance, if any, associated with our purchased credit impaired loans reflects deterioration in cash flows since acquisition resulting from our quarterly re-estimation of cash flows which involves complex cash flow projections and significant judgment on timing of loan resolution.
If our analysis or assumptions prove to be incorrect, our current allowance may not be sufficient, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to the allowance for loan and lease losses would materially decrease our net income and adversely affect our general financial condition. As an example, an increase in the amount of the reserve to organic loans of 0.05 percent in 2016 would have resulted in a reduction of approximately 3 percent to pre-tax income.
In addition, federal and state regulators periodically review our allowance for loan and lease losses and may require us to increase our allowance for loan and lease losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan and lease losses or loan charge-offs required by these regulatory agencies could have a material adverse effect on our operating results and financial condition.
Our success depends significantly on economic conditions in our market areas.
Unlike larger organizations that are more geographically diversified, our branches are currently concentrated in Eastern Tennessee and the Florida Panhandle. As a result of this geographic concentration, our financial results will depend largely upon economic conditions in these market areas. If the communities in which we operate do not grow or if prevailing economic conditions, locally or nationally, deteriorate, this may have a significant impact on the amount of loans that we originate, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. A return to economic downturn conditions caused by inflation, recession, unemployment, government action, natural disasters or other factors beyond our control would likely contribute to the deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would have an adverse effect on our business. As an example, the Florida Panhandle area has been and will continue to be susceptible to major hurricanes, floods, and tropical storms. In 2016, certain of our markets in Eastern Tennessee were disrupted by wildfires which damaged homes and businesses. In addition, some portions of our target market are in areas which a substantial portion of the economy is dependent upon tourism. The tourism industry tends to be more sensitive than the economy as a whole to changes in unemployment, inflation, wage growth, and other factors which affect consumer’s financial condition and sentiment.
Our organic loan growth may be limited by regulatory constraints
During 2016 many of the regulatory agencies, including ours, increased their focus on the application of an interagency guidance issued in 2006, titled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.” The 2006 interagency guidance focuses on the risks of high levels of concentration in CRE lending at banking institutions, and specifically addresses two supervisory criteria:
• | Construction concentration criterion: Loans for construction, land, and land development (CLD or “construction”) represent 100 percent or more of a banking institution’s total risk-based capital, commonly referred to as the "100 ratio" |
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• | Total CRE concentration criterion: Total nonowner-occupied CRE loans (including CLD loans), as defined in the 2006 guidance (“total CRE”), represent 300 percent or more of the institution’s total risk-based capital, and growth in total CRE lending has increased by 50 percent or more during the previous 36 months, commonly referred to as the "300 ratio" |
The guidance states that banking institutions exceeding the concentration levels mentioned in the two supervisory criteria should have in place enhanced credit risk controls, including stress testing of CRE portfolios. The guidance also states that institutions with CRE concentration levels above those specified in the two supervisory criteria may be identified for further supervisory analysis. Under the guidance for every $1 in increased capital only $1 can be leveraged to construction lending and only $3 can be lent to total CRE lending. In comparison $1 of capital can be leveraged into about $10 other types of lending. At the end of 2016 our loan portfolio was in excess of both the 100 and 300 ratio as laid out in the guidance and as such our ability to grow those loan types could well be constrained by the amount we are also able to grow capital.
To the extent that we are unable to identify and consummate attractive acquisitions, or increase loans through organic loan growth, we may be unable to successfully implement our growth strategy, which could materially and adversely affect us.
A substantial part of our historical growth has been a result of acquisitions and we intend to continue to grow our business through strategic acquisitions of banking franchises coupled with organic loan growth. Previous availability of attractive acquisition targets may not be indicative of future acquisition opportunities, and we may be unable to identify any acquisition targets that meet our investment objectives. To the extent that we are unable to find suitable acquisition candidates, an important component of our strategy may be lost. If we are able to identify attractive acquisition opportunities, we must generally satisfy a number of conditions prior to completing any such transaction, including certain bank regulatory approvals, which have become substantially more difficult, time-consuming and unpredictable as a result of the recent financial crisis. Additionally, any future acquisitions may not produce the revenue, earnings or synergies that we anticipated. As our purchased credit impaired loan portfolio, which produces substantially higher yields than our organic and purchased non-credit impaired loan portfolios, is paid down, we expect downward pressure on our income. If we are unable to replace our purchased credit impaired loans and the related accretion with a significantly higher level of new performing loans and other earning assets due to our inability to identify attractive acquisition opportunities, a decline in loan demand, competition from other financial institutions in our markets, stagnation or continued deterioration of economic conditions, or other conditions, our financial condition and earnings may be adversely affected.
Our strategic growth plan contemplates additional acquisitions, which could expose us to additional risks.
We periodically evaluate opportunities to acquire additional financial institutions. As a result, we may engage in negotiations or discussions that, if they were to result in a transaction, could have a material effect on our operating results and financial condition, including short and long-term liquidity. Our acquisition activities could be material and could require us to use a substantial amount of common stock, cash, other liquid assets, and/or incur debt.
Our acquisition activities could involve a number of additional risks, including the risks of:
• | incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in management's attention being diverted from the operation of our existing business; |
• | using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets; |
• | incurring time and expense required to integrate the operations and personnel of the combined businesses, creating an adverse short-term effect on results of operations; and |
• | losing key employees and customers as a result of an acquisition that is poorly received. |
Our concentration in loans secured by real estate, particularly commercial real estate and construction and development, is subject to risks that could adversely affect our results of operations and financial condition.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market areas. Consequently, declines in economic conditions in these market areas may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse.
At December 31, 2016, approximately 89 percent of our loans had real estate as a primary or secondary component of collateral, with 15 percent of our loans secured by construction and development collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is
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extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Real estate values declined significantly during the recent economic crisis and may decline similarly in future periods. Although real estate prices in most of our markets have stabilized or are improving, a renewed decline in real estate values would expose us to further deterioration in the value of the collateral for all loans secured by real estate and may adversely affect our results of operations and financial condition.
Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans, particularly when there is a downturn in the business cycle. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions and a downturn in the local economy or in occupancy rates in the local economy where the property is located, each of which could increase the likelihood of default on the loan. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in the percentage of nonperforming loans. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our results of operations and financial condition, which could negatively affect our stock price.
If a commercial real estate loan did default there would be legal expenses associated with obtaining the real estate which is typically collateral for the loan. In the last several years the amount of these legal expenses has been low, compared to periods when the defaults of commercial real estate loans have been higher. Once we obtain the collateral for the commercial real estate loan it is put into foreclosed assets. Foreclosed assets generally do not produce income but do have the costs associated with the ownership of real estate, principally real estate taxes and maintenance costs. Since these assets have a cost to maintain our goal is to keep costs at a minimum by liquidating the assets as soon as possible. Generally, in spite of our best efforts and intentions, foreclosed assets are sold at a loss. Among other reasons the rate of loan defaults increase as the economy worsens and declining economic environment and political turmoil generally results in downward pressure on foreclosed asset values and increased marketing periods. In simple terms for banks like ours who have a large amount of commercial real estate loans a worsening economy will typically lead to higher loan delinquencies, followed by increases in loan defaults and greater legal expenses, leading to higher foreclosed asset levels with an increased expense to maintain the properties, ending in a sale of the foreclosed assets - most likely at a loss.
Declines in the businesses or industries of our customers could cause increased credit losses and decreased loan balances, which could adversely affect our financial results.
The small to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan, and such impairment could have an adverse effect on our business, financial condition and results of operations. A substantial focus of our marketing and business strategy is to serve small to medium-sized businesses in our market areas. As a result, a relatively high percentage of our loan portfolio consists of commercial loans to such businesses. We further anticipate an increase in the amount of loans to small to medium-sized businesses during 2017.
Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have an adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact the markets in which we operate and small to medium-sized businesses are adversely affected or our borrowers are otherwise harmed by adverse business developments, this, in turn, could have an adverse effect on our business, financial condition and results of operations.
Certain of our deposits and other funding sources may be volatile and impact our liquidity.
In addition to the traditional core deposits, such as demand deposit accounts, interest checking, money market savings and certificates of deposits less than $250,000, we utilize or in the past have utilized several noncore funding sources, such as brokered certificates of deposit, Federal Home Loan Bank (FHLB) of Cincinnati advances, federal funds purchased and other sources. We utilize these noncore funding sources to fund the ongoing operations and growth of SmartBank. The availability of these noncore funding sources is subject to broad economic conditions and to investor assessment of our financial strength and, as such, the cost of funds may fluctuate significantly and/or be restricted, thus impacting our net interest income, our immediate liquidity and/or our access to additional liquidity. We have somewhat similar risks to the extent high balance core deposits exceed the amount of deposit insurance coverage available.
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We impose certain internal limits as to the absolute level of noncore funding we will incur at any point in time. Should we exceed those limitations, we may need to modify our growth plans, liquidate certain assets, participate loans to correspondents or execute other actions to allow for us to return to an acceptable level of noncore funding within a reasonable amount of time.
We face additional risks due to our increase in mortgage banking activities that have and could negatively impact our net income and profitability.
We have established mortgage banking operations which expose us to risks that are different from our retail and commercial banking operations. During higher and rising interest rate environments, the demand for mortgage loans and the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues, which could negatively impact our earnings. While we have been experiencing historically low interest rates, the low interest rate environment likely will not continue indefinitely. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking operations also depends in large part on our ability to aggregate a high volume of loans and sell them in the secondary market at a gain. Thus, in addition to our dependence on the interest rate environment, we are dependent upon (a) the existence of an active secondary market and (b) our ability to profitably sell loans into that market. Our new mortgage banking operations incurred additional expenses over $1.8 million in 2016 and generated noninterest income of $824 thousand. Profitability of our mortgage operations will depend upon our ability to increase production and thus income while holding or reducing costs. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third-party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, we may be required to charge such shortfall to earnings.
Any expansion into new lines of business might not be successful.
As part of our ongoing strategic plan, we will continue to consider expansion into new lines of business through the acquisition of third parties, or through organic growth and development. There are substantial risks associated with such efforts, including risks that (a) revenues from such activities might not be sufficient to offset the development, compliance, and other implementation costs, (b) competing products and services and shifting market preferences might affect the profitability of such activities, and (c) our internal controls might be inadequate to manage the risks associated with new activities. Furthermore, it is possible that our unfamiliarity with new lines of business might adversely affect the success of such actions. If any such expansions into new product markets are not successful, there could be an adverse effect on our financial condition and results of operations.
We may need additional access to capital, which we may be unable to obtain on attractive terms or at all.
We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our stock price negatively affected.
We incur increased costs as a result of being a public company.
As a public company, we incur significant legal, accounting and other expenses, including costs associated with public company reporting requirements. We also incur costs associated with the Sarbanes-Oxley Act, the Dodd-Frank Act and related rules implemented or to be implemented by the SEC and the NASDAQ Stock Market. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to continue to invest resources to comply with evolving laws, regulations and standards and this continued investment may result in increased general and administrative expenses and a diversion of management's time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected. In 2016 we incurred over 350 thousand in direct external costs associated with being a public company, which does not include the increased internal costs of the personnel needed to comply with being a public company.
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Inability to retain senior management and key employees or to attract new experienced financial services professionals could impair our relationship with our customers, reduce growth and adversely affect our business.
We have assembled a senior management team which has substantial background and experience in banking and financial services. Moreover, much of our organic loan growth in 2012 through 2016 was the result of our ability to attract experienced financial services professionals who have been able to attract customers from other financial institutions. Inability to retain these key personnel or to continue to attract experienced lenders with established books of business could negatively impact our growth because of the loss of these individuals' skills and customer relationships and/or the potential difficulty of promptly replacing them.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2016, we had $6.6 million of goodwill and other intangible assets. A significant decline in our financial condition, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations. Future acquisitions could result in additional goodwill.
Risks Related to Our Stock
Our ability to declare and pay dividends is limited.
There can be no assurance of whether or when we may pay dividends on our common stock in the future. Future dividends, if any, will be declared and paid at the discretion of our board of directors and will depend on a number of factors. Our principal source of funds used to pay cash dividends on our common stock will be dividends that we receive from SmartBank. Although the Bank’s asset quality, earnings performance, liquidity and capital requirements will be taken into account before we declare or pay any future dividends on our common stock, our board of directors will also consider our liquidity and capital requirements and our board of directors could determine to declare and pay dividends without relying on dividend payments from the Bank.
Federal and state banking laws and regulations and state corporate laws restrict the amount of dividends we may declare and pay. For example, Federal Reserve Board regulations implementing the capital rules required under Basel III do not permit dividends unless capital levels exceed certain higher levels applying capital conservation buffers that began to apply on January 1, 2016 and are being phased in over three years.
Additionally, our ability to pay dividends is limited by the terms of the Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “SBLF Preferred Stock”). On August 31, 2015 we assumed all of Legacy SmartFinancial’s obligations with respect to 12,000 shares of Legacy SmartFinancial’s preferred stock issued to the Treasury in connection with the Small Business Lending Fund, and in connection with the merger, we issued 12,000 shares of SBLF Preferred Stock with a $1,000 liquidation preference per share, to the Treasury. As described below, for so long as the SBLF Preferred Stock remains outstanding, our ability to declare or pay dividends or distributions on shares of common stock is subject to restrictions.
Further, in connection with the merger, we entered into a loan agreement for a revolving line of credit of up to $8 million. Under the terms of the loan agreement, we may not pay dividends on our common stock if we do not satisfy certain financial covenants and capital ratio requirements.
Even though our common stock is currently traded on the Nasdaq Capital Market, it has less liquidity than many other stocks quoted on a national securities exchange.
The trading volume in our common stock on the Nasdaq Capital Market has been relatively low when compared with larger companies listed on the Nasdaq Capital Market or other stock exchanges. Although we have experienced increased liquidity in our stock, we cannot say with any certainty that a more active and liquid trading market for our common stock will continue to develop. Because of this, it may be more difficult for stockholders to sell a substantial number of shares for the same price at which stockholders could sell a smaller number of shares.
We cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock. We can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our future ability to raise capital through sales of our common stock.
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The market price of our common stock has fluctuated significantly, and may fluctuate in the future. These fluctuations may be unrelated to our performance. General market or industry price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.
We may issue additional shares of stock or equity derivative securities, including awards to current and future executive officers, directors and employees, which could result in the dilution of shareholders’ investment.
Our authorized capital includes 40,000,000 shares of Common Stock and 2,000,000 shares of preferred stock. As of December 31, 2016, we had 5,896,033 shares of Common Stock and 12,000 shares of preferred stock outstanding, and had reserved or otherwise set aside for issuance 717,524 shares underlying outstanding options and 2,488,013 shares that are available for future grants of stock options, restricted stock or other equity-based awards pursuant to our equity incentive plans. Subject to NASDAQ rules, our board of directors generally has the authority to issue all or part of any authorized but unissued shares of Common Stock or preferred stock for any corporate purpose. We anticipate that we will issue additional equity in connection with the acquisition of other strategic partners and that in the future we likely will seek additional equity capital as we develop our business and expand our operations, depending on the timing and magnitude of any particular future acquisition. These issuances would dilute the ownership interests of existing shareholders and may dilute the per share book value of the Common Stock. New investors also may have rights, preferences and privileges that are senior to, and that adversely affect, our then existing shareholders.
In addition, the issuance of shares under our equity compensation plans will result in dilution of our shareholders’ ownership of our Common Stock. The exercise price of stock options could also adversely affect the terms on which we can obtain additional capital. Option holders are most likely to exercise their options when the exercise price is less than the market price for our Common Stock. They may profit from any increase in the stock price without assuming the risks of ownership of the underlying shares of Common Stock by exercising their options and selling the stock immediately.
The holder of our SBLF Preferred Stock has rights that are senior to those of SmartFinancial’s common stockholders, and the terms of the SBLF Preferred Stock and our loan agreements limit our ability to pay dividends.
On August 31, 2015 we assumed all of Legacy SmartFinancial’s obligations with respect to 12,000 shares of Legacy SmartFinancial’s preferred stock issued to the Treasury in connection with the Small Business Lending Fund, and in connection with the merger, we issued 12,000 shares of SBLF Preferred Stock with a $1,000 liquidation preference per share, to the Treasury.
We are required to pay cumulative dividends on the SBLF Preferred Stock at an annual rate. The dividend rate was set at 1 percent per annum beginning in the 2013 due to attaining the target 10 percent growth rate in qualified small business loans. However, beginning in the first quarter of 2016, the dividend rate increased to 9 percent per annum. Dividends paid on our SBLF Preferred Stock will reduce the net income available to our common stockholders and our earnings per common share.
For so long as the SBLF Preferred Stock remains outstanding, our ability to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of common stock is subject to restrictions. We may not repurchase any shares of common or pay dividends on the common stock during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock. We may only declare and pay a dividend on the common stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of our Tier 1 capital would be at least 90 percent of the Signing Date Tier 1 Capital, as set forth in the Certificate of Designation relating to the SBLF Preferred Stock, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”). The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of issuance and ending on the 10th anniversary, by 10 percent for each one percent increase in small business lending that qualifies over the baseline level.
Additionally, in connection with the merger, we entered into a loan agreement for a revolving line of credit of up to $8,000,000. Under the terms of the loan agreement, we may not pay dividends on our common stock if we do not satisfy certain financial covenants and capital ratio requirements.
We are subject to Tennessee’s anti-takeover statutes and certain charter provisions that could decrease our chances of being acquired even if the acquisition is in the best interest of our shareholders.
As a Tennessee corporation, we are subject to various legislative acts that impose restrictions on and require compliance with procedures designed to protect shareholders against unfair or coercive mergers and acquisitions. These statutes may delay or prevent offers to acquire us and increase the difficulty of consummating any such offers, even if the acquisition would be in our shareholders’ best interests. Our charter also contains provisions which may make it difficult for another entity to acquire us without the approval of a majority of the disinterested directors on our board of directors. Secondly, the amount of common stock owned
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by, and other compensation arrangements with, certain of our officers and directors may make it more difficult to obtain shareholder approval of potential takeovers that they oppose. Agreements with our senior management also provide for significant payments under certain circumstances following a change in control. These compensation arrangements, together with the common stock and option ownership of our board of directors and management, could make it difficult or expensive to obtain majority support for shareholder proposals or potential acquisition proposals that the board of directors and officers oppose.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
As of December 31, 2016, the principal offices of SmartFinancial are located at 5401 Kingston Pike, #600, Knoxville, Tennessee 37919. This property is owned by SmartBank and also serves as a branch location for the Bank’s customers. In addition, the Bank operates twelve full-service branches, two loan production offices, one mortgage loan production office, and two service centers which are located at:
Owned | |
Banking Branches | 1011 Parkway, Sevierville, Tennessee 37862 |
570 East Parkway, Gatlinburg, Tennessee 37738 | |
202 Advantage Place, Knoxville, Tennessee 37922 | |
5401 Kingston Pike, #600, Knoxville, Tennessee 37919 | |
4154 Ringgold Road, East Ridge, Tennessee 37412 | |
5319 Highway 153, Hixson, Tennessee 37343 | |
2280 Gunbarrel Road, Chattanooga, Tennessee 37421 | |
8966 Old Lee Highway, Ooltewah, Tennessee 37363 | |
835 Georgia Avenue, Chattanooga, Tennessee 37402 | |
201 North Palafox Street, Pensacola, Florida 32502 | |
4405 Commons Drive East, Destin, Florida 32541 | |
Leased | |
Banking Branch | 2430 Teaster Lane, #205, Pigeon Forge, Tennessee 37863 |
Loan Production Offices | 202 West Crawford Street, Dalton, Georgia 37020 |
2411 Jenks Avenue, Panama City, Florida 32405 | |
Mortgage Loan Production Office | 243 Southwood Drive, Panama City, Florida 32405 |
Service Centers | 6413 Lee Highway, #107, Chattanooga, Tennessee 37421 |
1732 Newport Highway, Suite 1, Sevierville, Tennessee 37876 | |
ITEM 3. LEGAL PROCEEDINGS
As of the end of 2016, neither SmartFinancial nor its subsidiary was involved in any material litigation. SmartBank is periodically involved as a plaintiff or defendant in various legal actions in the ordinary course of its business. Management believes that any claims pending against SmartFinancial or its subsidiary are without merit or that the ultimate liability, if any, resulting from them will not materially affect SmartBank’s financial condition or SmartFinancial’s consolidated financial position.
ITEM 4. MINE SAFETY DICLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
On December 31, 2016, SmartFinancial had 5,896,033 shares of common stock outstanding. SmartFinancial’s common stock is listed on NASDAQ under the symbol “SMBK”.
There were approximately 576 holders of record of the common stock as of March 21, 2017. This number does not include shareholders with shares in nominee name held by the Depository Trust Company (DTC). As of March 21, 2017 there were approximately 5,612,191 shares held in nominee name by DTC. Currently we have 15 Legacy SmartFinancial stockholders and 74 legacy Cornerstone stockholders that have not transmitted their shares into SmartFinancial, Inc. shares. As the transmittal process continues SmartFinancial expects the amount of shares held in nominee name will increase.
Dividends and Dividend Restrictions
SmartFinancial paid no cash dividends on common stock in 2015 or 2016. In 2015 and 2016, SmartFinancial recognized following dividends on its SBLF Preferred Stock (including dividends recognized by Legacy SmartFinancial):
Year | Total SBLF Preferred Stock Dividends | ||
2015 | $ | 120,000 | |
2016 | $ | 1,022,000 | |
We redeemed the SBLF Preferred Stock in full on March 6, 2017. The payment of dividends is within the discretion of the board of directors, considering SmartFinancial’s expenses, the maintenance of reasonable capital and risk reserves, and appropriate capitalization requirements for state banks.
In connection with the merger with Legacy SmarFinancial, we entered into a loan agreement for a revolving line of credit Under the terms of the loan agreement, we may not pay dividends on our common stock if we do not satisfy certain financial covenants and capital ratio requirements.
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Market Prices for Our Common Stock
Table 1 presents the high and low closing prices of SmartFinancial’s common stock for the periods indicated, as reported on the Nasdaq Capital Market, or prior to December 21, 2015 the over-the-counter market. Table 1 also presents cash dividends declared on our common stock for the last two fiscal years. The prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
TABLE 1
High and Low Common Stock Price for SmartFinancial | Cash Dividends | ||||||||||
2017 Fiscal Year | Low | High | Paid Per Share | ||||||||
First Quarter (through March 21, 2017) | $ | 18.55 | $ | 22.39 | — | ||||||
2016 Fiscal Year | |||||||||||
First Quarter | $ | 14.90 | $ | 18.50 | — | ||||||
Second Quarter | $ | 15.10 | $ | 18.75 | — | ||||||
Third Quarter | $ | 15.00 | $ | 17.02 | — | ||||||
Fourth Quarter | $ | 17.04 | $ | 20.00 | — | ||||||
2015 Fiscal Year | |||||||||||
First Quarter | $ | 12.08 | $ | 14.60 | — | ||||||
Second Quarter | $ | 12.24 | $ | 15.92 | — | ||||||
Third Quarter | $ | 14.92 | $ | 17.20 | — | ||||||
Fourth Quarter | $ | 15.00 | $ | 16.25 | — | ||||||
2014 Fiscal Year | |||||||||||
First Quarter | $ | 9.20 | $ | 10.00 | — | ||||||
Second Quarter | $ | 9.40 | $ | 10.48 | — | ||||||
Third Quarter | $ | 9.84 | $ | 12.20 | — | ||||||
Fourth Quarter | $ | 11.60 | $ | 14.80 | — | ||||||
All stock prices before the fourth quarter of 2015 have been adjusted to reflect a one-for-four reverse stock split.
For information relating to compensation plans under which our equity securities are authorized for issuance, see Part III Items 11 and 12.
ITEM 6. SELECTED FINANCIAL DATA
This Item is not applicable to smaller reporting companies.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SmartFinancial, Inc. (the “Company” or “SmartFinancial”) is a bank holding company incorporated under the laws of Tennessee and headquartered in Knoxville, Tennessee. In 2016, the Company conducted its business operations primarily through its wholly-owned subsidiaries, SmartBank and Cornerstone Community Bank, Tennessee chartered community banks providing services through 15 offices in eastern Tennessee, northwest Florida, and north Georgia. On February 26, 2016, the Company merged SmartBank and Cornerstone Community Bank together, with SmartBank surviving the merger.
Mergers and Acquisitions
Merger of Legacy SmartFinancial and Cornerstone Bancshares
On June 18, 2015, the shareholders of the Legacy SmartFinancial approved a merger with Cornerstone Bancshares, Inc. (“Cornerstone”) ticker symbol “CSBQ,” the one bank holding company of Cornerstone Community Bank, which became effective August 31, 2015. Legacy SmartFinancial shareholders received 1.05 shares of Cornerstone common stock in exchange for each share of the Legacy SmartFinancial common stock. After the merger, shareholders of Legacy SmartFinancial owned approximately 56 percent of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio and new shares issued as part of a capital raise through a private placement.
While Cornerstone was the acquiring entity for legal purposes, the merger was accounted for as a reverse merger using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, Legacy SmartFinancial is considered the acquirer in the merger, and as a result the historical financial statements of the combined entity are the historical financial statements of Legacy SmartFinancial.
The assets and liabilities of Cornerstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of Legacy SmartFinancial. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill.
In periods following the merger, the financial statements of the combined entity included the results attributable to Cornerstone Community Bank beginning on the date the merger was completed. As a result of the merger Company assets increased approximately $450 million and liabilities increased approximately $421 million. The merger had a significant impact on all aspects of the Company's financial statements, and as a result, financial results after the merger may not be comparable to financial results prior to the merger.
Acquisition of Assets and Liabilities of the former Gulf South Private Bank
On October 19, 2012, SmartBank assumed all of the deposits and certain other liabilities and acquired certain assets of GulfSouth Private Bank (“GulfSouth”), headquartered in Destin, Florida from the FDIC pursuant to the terms of a Purchase and Assumption Agreement. As a result of the transaction the Company acquired approximately $141 million in assets and $136 million in liabilities.
Business Overview
The Company’s business model consists of leveraging capital into assets funded by liabilities. As a general rule capital can be leveraged approximately ten times. The primary source of revenue is interest income from earning assets, namely loans and securities. These assets are funded mainly by deposits. The Company seeks to maximize net interest income, the difference between interest received on earning assets and the amount of interest paid on liabilities. Net interest income to average assets is a key ratio that measures the profitability of the assets of the company. Noninterest income is the second source of revenue and primarily consists of customer service fees, gains on the sales of securities and loans, and other noninterest income. Noninterest income to average assets is a ratio that reflects our effectiveness in generating these other forms of revenue. The Company incurs noninterest expenses as result of the operations of the business. Primary expenses are those of employees, occupancy and equipment, professional services, and data processing. The Company seeks to minimize the amount of non-interest expense relative to the amount of total assets; non-interest expense to assets is a key ratio that measures the efficiency of the costs incurred to operate the business.
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Executive Summary
The following is a summary of the Company’s financial highlights and significant events during 2016:
• | The Company merged Cornerstone Community Bank into SmartBank in the first quarter of 2016. |
• | Earnings available to common shareholders were approximately $4.8 million, or $0.78 per diluted common share, in 2016, compared to $1.4 million, or $0.32 per diluted share, in 2015. |
• | Return on average assets was 0.57 percent for 2016, compared to 0.22 percent for 2015. |
• | Return on average equity was 5.59 percent in 2016, compared to 2.15 percent in 2015, and 3.41 percent in 2014. |
• | Non-performing assets to total assets in 2016 were 0.42 percent, an improvement from 0.79 percent in 2015. |
• | Net interest margin, fully taxable equivalent, remained above 4 percent at 4.06 percent for 2016. |
• | Efficiency ratio, fully taxable equivalent, of 75.7 percent in 2016 was down substantially from 85.0 percent in 2015. |
Analysis of Results of Operations
2016 compared to 2015
Net income was $5.8 million in 2016, which was up substantially from $1.5 million in 2015. Net income available to common shareholders was $4.8 million, or $0.78 per diluted common share, in 2016, an increase from $1.4 million, or $0.32 per diluted common share, in 2015. Net interest income to average assets of 3.77 percent in 2016 was up from 3.66 percent in 2015, with the increase as a result of a higher percentage of average earning assets to average total assets. Noninterest income to average assets of 0.41 percent was up from 0.33 percent in 2015 as a result of increases in customer service fees, higher gains on the sale of securities, gains on the sale of loans and other assets compared to losses in 2015, and higher other noninterest income. Noninterest expense to average assets decreased from 3.39 percent in 2015 to 3.20 percent in 2016 due to realized efficiencies of scale and the absences of merger and conversion related costs. The resulting pretax income to average assets was 0.95 percent in 2016 compared to 0.46 percent in 2015. Finally, in 2016 the effective tax rate was 36.70 percent, which was down substantially from 2015 when taxes were elevated due to merger and acquisition expenses which were nondeductible.
2015 compared to 2014
Net income was $1.5 million in 2015, which was down from $1.8 million in 2014. Net income available to common shareholders was $1.4 million, or $0.32 per diluted common share, in 2015, a decrease from $1.7 million, or $0.52 per diluted common share, in 2014. Net interest income to average assets of 3.66 percent in 2015 was down from 3.71 percent in 2014, with the decrease as a result of lower rates on earning assets. Noninterest income to average assets of 0.33 percent was up substantially from 0.22 percent in 2014 as a result of gains on the sale of foreclosed assets in 2015 compared to losses in 2014. Noninterest expense to average assets increased from 3.26 percent in 2014 to 3.39 percent in 2015 due to merger and conversion related costs. The resulting pretax income to average assets was 0.46 percent in 2015 compared to 0.57 percent in 2014. Finally, in 2015 taxes were elevated by $0.3 million due to merger and acquisition expenses which were nondeductible.
Net Interest Income and Yield Analysis
2016 compared to 2015
Net interest income, taxable equivalent, improved to $38.3 million in 2016 from $25.0 million in 2015. The increase in net interest income, taxable equivalent, was the result of a significant increase in earning assets primarily from the merger but also from organic business activity. Average earning assets increased from $615.3 million in 2015 to $944.6 million in 2016. Over this period, average loan balances increased by 282,537 thousand and average securities and interest bearing balances at other financial institutions increased by $54.1 million. In addition, total average interest-bearing deposits increased by $219.0 million. Net interest income to average assets of 3.77 percent in 2016 was up from 3.66 percent in 2015. Net interest margin, taxable equivalent, was 4.06 percent in 2016, compared to 4.07 percent in 2015. Net interest margin, taxable equivalent, was negatively affected by an increase in the cost of interest bearing liabilities from 0.52 percent in 2015 to 0.56 percent in 2016. In 2017 we expect net interest income to average assets and net interest margin, taxable equivalent, to experience pressure as most new assets will be lower yielding and there is the potential for pressure to increase deposit rates as short term rates increase.
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2015 compared to 2014
Net interest income improved to $25.0 million in 2015 from $18.7 million in 2014. The increase in net interest income was the result of a significant increase in earning assets primarily from the merger but also from organic business activity. Average earning assets increased from $455.5 million in 2014 to $615.3 million in 2015. Over this period, average loan balances increased by $139.4 million and average securities balances increased by $18.0 million. In addition, average interest-bearing deposits increased by $117.7 million. Net interest income to average assets of 3.66 percent 2015 was down from 3.71 percent in 2014. Net interest margin was 4.07 percent in 2015, compared to 4.12 percent in 2014. Net interest margin was negatively affected by a decline in the yield on earning assets from 4.56 percent in 2014 to 4.51 percent in 2015.
The following table summarizes the major components of net interest income and the related yields and costs for the periods presented.
2016 | 2015 | 2014 | |||||||||||||||||||||||||||||||
(Dollars in thousands) | Average | Yield/ | Average | Yield/ | Average | Yield/ | |||||||||||||||||||||||||||
Balance | Interest * | Cost* | Balance | Interest * | Cost* | Balance | Interest * | Cost* | |||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||||
Loans (1) | $ | 768,720 | $ | 39,779 | 5.17 | % | $ | 486,183 | $ | 25,739 | 5.29 | % | $ | 346,732 | $ | 18,745 | 5.42 | % | |||||||||||||||
Investment securities (2) | 167,352 | 2,609 | 1.56 | % | 113,281 | 1,877 | 1.66 | % | 95,307 | 1,919 | 2.01 | % | |||||||||||||||||||||
Federal funds and other | 8,568 | 247 | 2.88 | % | 15,853 | 161 | 1.02 | % | 13,427 | 126 | 0.94 | % | |||||||||||||||||||||
Total interest-earning assets | 944,640 | $ | 42,635 | 4.51 | % | 615,317 | $ | 27,777 | 4.51 | % | 455,466 | $ | 20,790 | 4.56 | % | ||||||||||||||||||
Non-interest-earning assets | 67,592 | 68,202 | 48,580 | ||||||||||||||||||||||||||||||
Total assets | $ | 1,012,232 | $ | 683,519 | $ | 504,046 | |||||||||||||||||||||||||||
Liabilities and Shareholders’ Equity | |||||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 150,649 | $ | 286 | 0.19 | % | $ | 117,036 | $ | 173 | 0.15 | % | $ | 83,809 | $ | 103 | 0.12 | % | |||||||||||||||
Money market and savings deposits | 258,092 | 1,172 | 0.45 | % | 161,405 | 656 | 0.41 | % | 126,303 | 462 | 0.37 | % | |||||||||||||||||||||
Time deposits | 316,046 | 2,647 | 0.84 | % | 227,317 | 1,797 | 0.79 | % | 177,921 | 1,460 | 0.82 | % | |||||||||||||||||||||
Total interest-bearing deposits | 724,787 | 4,105 | 0.57 | % | 505,758 | 2,626 | 0.52 | % | 388,033 | 2,025 | 0.52 | % | |||||||||||||||||||||
Securities sold under agreement to repurchase | 21,329 | 65 | 0.30 | % | 11,335 | 30 | 0.26 | % | 5,523 | 11 | 0.20 | % | |||||||||||||||||||||
Federal Home Loan Bank advances and other borrowings | 17,451 | 129 | 0.74 | % | 13,490 | 101 | 0.75 | % | 85 | 1 | 1.18 | % | |||||||||||||||||||||
Total interest-bearing liabilities | 763,567 | 4,299 | 0.56 | % | 530,583 | 2,757 | 0.52 | % | 393,641 | 2,037 | 0.52 | % | |||||||||||||||||||||
Net interest income, taxable equivalent | $ | 38,336 | $ | 25,020 | $ | 18,753 | |||||||||||||||||||||||||||
Noninterest-bearing deposits | 139,652 | 80,794 | 54,747 | ||||||||||||||||||||||||||||||
Other liabilities | 5,535 | 1,812 | 1,968 | ||||||||||||||||||||||||||||||
Total liabilities | 908,754 | 613,189 | 450,356 | ||||||||||||||||||||||||||||||
Shareholders’ equity | 103,478 | 70,330 | 53,690 | ||||||||||||||||||||||||||||||
Total liabilities and shareholders’ equity | $ | 1,012,232 | $ | 683,519 | $ | 504,046 | |||||||||||||||||||||||||||
Interest rate spread (3) | 3.95 | % | 3.99 | % | 4.04 | % | |||||||||||||||||||||||||||
Tax equivalent net interest margin (4) | 4.06 | % | 4.07 | % | 4.12 | % | |||||||||||||||||||||||||||
Percentage of average interest-earning assets to average interest-bearing liabilities | 123.7 | % | 116.0 | % | 115.7 | % | |||||||||||||||||||||||||||
Percentage of of average equity to average assets | 10.2 | % | 10.3 | % | 10.7 | % | |||||||||||||||||||||||||||
* Taxable equivalent basis | |||||||||||||||||||||||||||||||||
(1) | Loans include nonaccrual loans. Yields related to loans exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $16 thousand for 2016, $8 thousand for 2015 and $0 for 2014. Loan fees included in loan income was $2.6 million, $1.3 million, and $646 thousand for 2016, 2015 and 2014, respectively. |
(2) | Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $55 thousand, $16 thousand and $100 thousand for 2016, 2015 and 2014, respectively. |
(3) | Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
(4) | Net interest margin represents net interest income divided by average interest-earning assets. |
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Rate and Volume Analysis
Net interest income, taxable equivalent, increased by $13.3 million between the years ended December 31, 2016 and 2015 and by $6.3 million between the years ended December 31, 2015 and 2014. The following is an analysis of the changes in net interest income comparing the changes attributable to rates and those attributable to volumes (in thousands):
2016 Compared to 2015 Increase (decrease) due to | 2015 Compared to 2014 Increase (decrease) due to | ||||||||||||||||||||||||||
Rate | Days | Volume | Net | Rate | Volume | Net | |||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||||||||
Loans (1) | $ | (976 | ) | 70 | $ | 14,946 | $ | 14,040 | $ | (545 | ) | $ | 7,539 | $ | 6,994 | ||||||||||||
Investment securities (2) | (171 | ) | 5 | 898 | 732 | (404 | ) | 362 | (42 | ) | |||||||||||||||||
Federal funds and other | 160 | — | (74 | ) | 86 | 12 | 23 | 35 | |||||||||||||||||||
Total interest-earning assets | (987 | ) | 75 | 15,770 | 14,858 | (937 | ) | 7,924 | 6,987 | ||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||||||||
Interest-bearing demand deposits | 63 | — | 50 | 113 | 29 | 41 | 70 | ||||||||||||||||||||
Money market and savings deposits | 118 | 2 | 396 | 516 | 66 | 128 | 194 | ||||||||||||||||||||
Time deposits | 144 | 5 | 701 | 850 | (68 | ) | 405 | 337 | |||||||||||||||||||
Total interest-bearing deposits | 325 | 7 | 1,147 | 1,479 | 27 | 574 | 601 | ||||||||||||||||||||
Securities sold under agreement to repurchase | 9 | — | 26 | 35 | 7 | 12 | 19 | ||||||||||||||||||||
Federal Home Loan Bank advances and other borrowings | (2 | ) | — | 30 | 28 | (58 | ) | 158 | 100 | ||||||||||||||||||
Total interest-bearing liabilities | 332 | 7 | 1,203 | 1,542 | (24 | ) | 744 | 720 | |||||||||||||||||||
Net interest income | $ | (1,319 | ) | 68 | $ | 14,567 | $ | 13,316 | $ | (913 | ) | $ | 7,180 | $ | 6,267 | ||||||||||||
(1) | Loans include nonaccrual loans. Yields related to loans exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $16 thousand for 2016, $8 thousand for 2015 and $0 for 2014. |
(2) | Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $55 thousand, $16 thousand and $100 thousand for 2016 , 2015 and 2014, respectively. |
Changes in net interest income are attributed to either changes in average balances (volume change), changes in average rates (rate change) for earning assets and sources of funds on which interest is received or paid, or changes within the number of days in the two periods compared. Volume change is calculated as change in volume times the previous rate while rate change is change in rate times the previous volume. The change attributed to rates and volumes (change in rate times change in volume) is considered above as a change in volume.
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Non Interest Income
The following table provides a summary of non-interest income for the periods presented.
Year ended December 31, | ||||||||||||
(Dollars in thousands) | 2016 | 2015 | 2014 | |||||||||
Service charges and fees on deposit accounts | $ | 1,128 | $ | 913 | $ | 513 | ||||||
Gain on sale of securities | 199 | 52 | 116 | |||||||||
Gain (loss) on sale of loans and other assets | 948 | (112 | ) | 189 | ||||||||
Gain (loss) on sale of foreclosed assets | 191 | 266 | (625 | ) | ||||||||
Other noninterest income | 1,717 | 1,124 | 978 | |||||||||
Total non-interest income | $ | 4,183 | $ | 2,243 | $ | 1,171 | ||||||
2016 compared to 2015
Non-interest income totaled $4.2 million in 2016, which was an increase from $2.2 million in 2015. Noninterest income to average assets of 0.41 percent was up from 0.33 percent in 2015. Primary drivers of the increase were higher gains on the sale of securities, gains on the sale of loans and other assets compared to losses in 2015, and higher other noninterest income. In 2016, there were gains of $948 thousand on the sale of mortgage loans, SBA loans and other assets compared to a loss of $112 thousand in 2015 due to the loss on the sale of a bank owned property. In 2016 there were gains of $191 thousand on the sale of foreclosed assets, down from a gain of $266 thousand in 2015. Other noninterest income of $1.7 million in 2016 was up from $1.1 million in 2015 primarily due to increased revenue as a result of the merger. In 2017, we expect non-interest income to average assets to increase as a result of increased loan sales from the mortgage unit, increased SBA loan sales, and higher services charges on deposit accounts.
2015 compared to 2014
Non-interest income totaled $2.2 million in 2015, which was an increase from $1.2 million in 2014. Noninterest income to average assets of 0.33 percent was up substantially from 0.22 percent in 2014. Charges and fees on deposit accounts increased $400 thousand primarily due to increased deposit accounts from the merger. In 2015, there was a loss on sale on loans and other assets of $112 thousand due to the loss on the sale of a bank owned property compared to a gain on sale of loans and other assets of $189 thousand in 2014. In 2015, there were gains of $266 thousand on the sale of foreclosed assets, compared to a loss of $625 thousand in 2014, which was driven by write-downs of $643 thousand on foreclosed assets. Other noninterest income of $1.1 million in 2015 was up from $1.0 million in 2014 primarily due to increased revenue as a result of the merger.
Non-Interest Expense
The following table provides a summary of non-interest expense for the periods presented.
Year ended December 31, | ||||||||||||
(Dollars in thousands) | 2016 | 2015 | 2014 | |||||||||
Salaries and employee benefits | $ | 17,715 | $ | 11,831 | $ | 9,141 | ||||||
Net occupancy and equipment expense | 3,996 | 2,682 | 2,176 | |||||||||
Depository insurance | 606 | 488 | 386 | |||||||||
Foreclosed assets | 236 | 290 | 178 | |||||||||
Advertising | 616 | 453 | 420 | |||||||||
Data processing1 | 1,893 | 1,197 | 671 | |||||||||
Professional services1 | 2,123 | 2,454 | 1,041 | |||||||||
Amortization of other intangible assets | 305 | 233 | 163 | |||||||||
Service contracts | 1,154 | 751 | 546 | |||||||||
Other operating expenses | 3,856 | 2,787 | 1,721 | |||||||||
Total non-interest expense | $ | 32,500 | $ | 23,166 | $ | 16,443 | ||||||
(1) | In 2015 Data processing and Professional services included $1.3 million of merger and conversion related expenses |
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2016 compared to 2015
Non-interest expense totaled $32.5 million in 2016 compared to $23.2 million in 2015. Noninterest expense to average assets decreased from 3.39 percent in 2015 to 3.20 percent in 2016. Salaries and employee benefits, occupancy and equipment, data processing, and other non-interest expense categories in 2016 were all higher as a result of twelve full months of post-merger expense compared to four months in 2015. In 2016, the reduction of professional services was due the absence of merger expenses. In 2017, we expect non-interest expense to average assets to decrease as a result of assets growing faster than expenses.
2015 compared to 2014
Non-interest expense totaled $23.2 million in 2015 compared to $16.4 million in 2014. Noninterest expense to average assets increased from 3.26 percent in 2014 to 3.39 percent in 2015. Salaries and employee benefits, occupancy and equipment, data processing, and other non-interest expense categories in 2015 were all significantly impacted by the merger which added employees, branches and other facilities, and equipment to the Company's expense base. In addition in 2015 there were $1.3 million in merger and conversion costs, which included professional fees and other expenses required to close the merger as well as costs to convert data processing to the Company's integrated platform, and $536 thousand in expenses from the newly established residential mortgage unit.
Taxes
2016 compared to 2015
In 2016, income tax expense totaled $3.4 million compared to $1.6 million in 2015. Income taxes to average assets were 0.33 percent compared to 0.24 percent in the prior year. Taxes in the prior year were elevated by $0.3 million due to nondeductible merger and acquisition expenses resulting in an effective tax rate of about 52 percent compared to about 37 percent in 2016. In 2017, we expect our effective tax rate to be in the range of 37 percent.
2015 compared to 2014
In 2015, income tax expense totaled $1.6 million compared to $1.1 million in 2014. Income taxes to average assets were 0.24 percent compared to 0.22 percent in the prior year. Taxes were elevated by $0.3 million due to merger and acquisition expenses which were nondeductible resulting in an effective tax rate of about 52 percent compared to about 38 percent in 2014.
Loan Portfolio Composition
The Company had total net loans outstanding, including organic and purchased loans, of approximately $808.3 million at December 31, 2016, and $723.4 million million at December 31, 2015. Loans secured by real estate, consisting of commercial or residential property, are the principal component of our loan portfolio. We do not generally originate traditional long-term residential mortgages for our portfolio but we do originate and hold traditional second mortgage residential real estate loans, adjustable rate mortgages and home equity lines of credit. Even if the principal purpose of the loan is not to finance real estate, when reasonable, we attempt to obtain a security interest in the real estate in addition to any other available collateral to increase the likelihood of ultimate repayment or collection of the loan.
Organic Loans
Our net organic loans increased $160.4 million, or 35.5 percent to $611.9 million at December 31, 2016, from December 31, 2015, as we continue to originate well-underwritten loans. Our goal of streamlining the credit process has improved our efficiency and is a competitive advantage in many of our markets. In addition, continued training and recruiting of experienced loan officers has provided us with the opportunity to close larger and more complex deals than we historically have. Finally, the overall business environment continues to rebound from recessionary conditions. Organic loans include loans which were originally purchased non-credit impaired loans but have been renewed.
Purchased Loans
Purchased non-credit impaired loans of $169.2 million at December 31, 2016 were down $64.4 million from December 31, 2015 as a result of pay-downs and renewals. During 2016, our purchased credit impaired (“PCI”) loans decreased by $11.1 million to $27.2 million at December 31, 2016. The activity within the purchased credit impaired loans will be impacted by how quickly these loans are resolved and/or our future acquisition activity. Prior to the GulfSouth transaction in 2012 the Company had no purchased loans.
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The following tables summarize the composition of our loan portfolio for the periods presented (dollars in thousands):
2016 | |||||||||||||||||||
Organic Loans | Purchased Non-Credit Impaired Loans | Purchased Credit Impaired Loans | Total Amount | % of Gross Total | |||||||||||||||
Commercial real estate-mortgage | $ | 297,689 | $ | 102,576 | $ | 14,943 | $ | 415,208 | 51.0 | % | |||||||||
Consumer real estate-mortgage | 135,923 | 42,875 | 9,004 | 187,802 | 23.1 | % | |||||||||||||
Construction and land development | 108,390 | 7,801 | 1,678 | 117,869 | 14.5 | % | |||||||||||||
Commercial and industrial | 68,235 | 15,219 | 1,568 | 85,022 | 10.5 | % | |||||||||||||
Consumer and other | 6,786 | 689 | — | 7,475 | 0.9 | % | |||||||||||||
Total gross loans receivable, net of deferred fees | 617,023 | 169,160 | 27,193 | 813,376 | 100.0 | % | |||||||||||||
Allowance for loan and lease losses | (5,105 | ) | — | — | (5,105 | ) | |||||||||||||
Total loans, net | $ | 611,918 | $ | 169,160 | $ | 27,193 | $ | 808,271 | |||||||||||
2015 | |||||||||||||||||||
Organic Loans | Purchased Non-Credit Impaired Loans | Purchased Credit Impaired Loans | Total Amount | % of Gross Total | |||||||||||||||
Commercial real estate-mortgage | $ | 229,203 | $ | 120,524 | $ | 20,050 | $ | 369,777 | 50.8 | % | |||||||||
Consumer real estate-mortgage | 95,233 | 53,697 | 12,764 | 161,694 | 22.2 | % | |||||||||||||
Construction and land development | 73,028 | 29,755 | 2,695 | 105,478 | 14.5 | % | |||||||||||||
Commercial and industrial | 53,761 | 28,422 | 2,768 | 84,951 | 11.7 | % | |||||||||||||
Consumer and other | 4,692 | 1,123 | — | 5,815 | 0.8 | % | |||||||||||||
Total gross loans receivable, net of deferred fees | 455,917 | 233,521 | 38,277 | 727,715 | 100.0 | % | |||||||||||||
Allowance for loan and lease losses | (4,354 | ) | — | — | (4,354 | ) | |||||||||||||
Total loans, net | $ | 451,563 | $ | 233,521 | $ | 38,277 | $ | 723,361 | |||||||||||
2014 | |||||||||||||||||||
Organic Loans | Purchased Non-Credit Impaired Loans | Purchased Credit Impaired Loans | Total Amount | % of Gross Total | |||||||||||||||
Commercial real estate-mortgage | $ | 186,444 | $ | 3,905 | $ | 3,102 | $ | 193,451 | 53.2 | % | |||||||||
Consumer real estate-mortgage | 75,066 | 1,968 | 4,380 | 81,414 | 22.4 | % | |||||||||||||
Construction and land development | 52,421 | 48 | 36 | 52,505 | 14.5 | % | |||||||||||||
Commercial and industrial | 33,716 | — | 3 | 33,719 | 9.3 | % | |||||||||||||
Consumer and other | 2,314 | — | — | 2,314 | 0.6 | % | |||||||||||||
Total gross loans receivable, net of deferred fees | 349,961 | 5,921 | 7,521 | 363,403 | 100.0 | % | |||||||||||||
Allowance for loan and lease losses | (3,880 | ) | — | — | (3,880 | ) | |||||||||||||
Total loans, net | $ | 346,081 | $ | 5,921 | $ | 7,521 | $ | 359,523 | |||||||||||
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2013 | |||||||||||||||||||
Organic Loans | Purchased Non-Credit Impaired Loans | Purchased Credit Impaired Loans | Total Amount | % of Gross Total | |||||||||||||||
Commercial real estate-mortgage | $ | 150,849 | $ | 4,448 | $ | 3,969 | $ | 159,266 | 50.6 | % | |||||||||
Consumer real estate-mortgage | 69,588 | 6,966 | 5,276 | 81,830 | 26.0 | % | |||||||||||||
Construction and land development | 35,111 | 1,087 | 489 | 36,687 | 11.6 | % | |||||||||||||
Commercial and industrial | 33,763 | 28 | 15 | 33,806 | 10.7 | % | |||||||||||||
Consumer and other | 2,916 | 347 | 227 | 3,490 | 1.1 | % | |||||||||||||
Total gross loans receivable, net of deferred fees | 292,227 | 12,876 | 9,976 | 315,079 | 100.0 | % | |||||||||||||
Allowance for loan and lease losses | (3,755 | ) | — | (381 | ) | (4,136 | ) | ||||||||||||
Total loans, net | $ | 288,472 | $ | 12,876 | $ | 9,595 | $ | 310,943 | |||||||||||
2012 | |||||||||||||||||||
Organic Loans | Purchased Non-Credit Impaired Loans | Purchased Credit Impaired Loans | Total Amount | % of Gross Total | |||||||||||||||
Commercial real estate-mortgage | $ | 130,715 | $ | 7,250 | $ | 7,136 | $ | 145,101 | 46.4 | % | |||||||||
Consumer real estate-mortgage | 60,756 | 15,828 | 7,683 | 84,267 | 27.0 | % | |||||||||||||
Construction and land development | 29,910 | 9,098 | 6,625 | 45,633 | 14.6 | % | |||||||||||||
Commercial and industrial | 30,266 | 1,264 | 247 | 31,777 | 10.2 | % | |||||||||||||
Consumer and other | 2,858 | 1,427 | 1,453 | 5,738 | 1.8 | % | |||||||||||||
Total gross loans receivable, net of deferred fees | 254,505 | 34,867 | 23,144 | 312,516 | 100.0 | % | |||||||||||||
Allowance for loan and lease losses | (3,691 | ) | — | — | (3,691 | ) | |||||||||||||
Total loans, net | $ | 250,814 | $ | 34,867 | $ | 23,144 | $ | 308,825 | |||||||||||
Loan Portfolio Maturities
The following table sets forth the maturity distribution of our loans, including the interest rate sensitivity for loans maturing after one year.
Rate Structure for Loans | ||||||||||||||||||||||||
Maturing Over One Year | ||||||||||||||||||||||||
One Year or Less | One through Five Years | Over Five Years | Total | Fixed Rate | Floating Rate | |||||||||||||||||||
Commercial real estate-mortgage | $ | 35,678 | $ | 228,676 | $ | 150,854 | $ | 415,207 | $ | 242,175 | $ | 137,355 | ||||||||||||
Consumer real estate-mortgage | 23,965 | 92,088 | 71,749 | 187,802 | 99,565 | 64,272 | ||||||||||||||||||
Construction and land development | 42,756 | 47,493 | 27,620 | 117,869 | 34,932 | 40,181 | ||||||||||||||||||
Commercial and industrial | 26,377 | 42,212 | 16,433 | 85,022 | 45,873 | 12,772 | ||||||||||||||||||
Consumer and other | 4,634 | 2,530 | 311 | 7,475 | 2,302 | 539 | ||||||||||||||||||
Total Loans | $ | 133,410 | $ | 412,999 | $ | 266,967 | $ | 813,375 | $ | 424,847 | $ | 255,119 | ||||||||||||
Nonaccrual, Past Due, and Restructured Loans
Loans are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. Loans are generally classified as nonaccrual if they are past due for a period of 90 days or more, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower in accordance with the contractual terms.
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PCI loans with common risk characteristics are grouped in pools at acquisition. These loans are evaluated for accrual status at the pool level rather than the individual loan level and performance is based on our ability to reasonably estimate the amount and timing of future cash flows rather than a borrower's ability to repay contractual loan amounts. Since we are able to reasonably estimate the amount and timing of future cash flows on the Company's PCI loan pools, none of these loans have been identified as nonaccrual. However, PCI loans included in pools are identified as nonperforming if they are past due 90 days or more at acquisition or become 90 days or more past due after acquisition. The past due status is determined based on the contractual terms of the individual loans.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Assets acquired as a result of foreclosure are recorded at estimated fair value in foreclosed assets. Any excess of cost over estimated fair value at the time of foreclosure is charged to the allowance for loan losses. Valuations are periodically performed on these properties, and any subsequent write-downs are charged to earnings. Routine maintenance and other holding costs are included in non-interest expense.
Loans, excluding pooled PCI loans, are classified as troubled debt restructurings (“TDR”) by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. The Company grants concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. The Company does not generally grant concessions through forgiveness of principal or accrued interest. The Company’s policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until there is demonstrated performance under new terms. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on non-accrual status. The Company closely monitors these loans and ceases accruing interest on them if we believe that the borrowers may not continue performing based on the restructured note terms.
PCI loans that were classified as TDRs prior to acquisition are not classified as TDRs by the Company after the acquisition date. Subsequent modification of a PCI loan accounted for in a pool that would otherwise meet the definition of a TDR is not reported, or accounted for, as a TDR since pooled PCI loans are excluded from the scope of TDR accounting. A PCI loan not accounted for in a pool would be reported, and accounted for, as a TDR if modified in a manner that meets the definition of a TDR after the acquisition date.
Nonperforming loans as a percentage of gross loans, net of deferred fees, was 0.26 percent as of December 31, 2016, compared to 0.38 percent as of December 31, 2015. Total nonperforming assets as a percentage of total assets as of December 31, 2016 totaled 0.42 percent compared to 0.79 percent as of December 31, 2015. Acquired PCI loans that are included in loan pools are reclassified at acquisition to accrual status and thus are not included as nonperforming assets unless they are 90 days or greater past due. In 2016, there was $161 thousand in interest income recognized on nonaccrual and restructured loans compared to the $288 thousand in gross interest income that would have been recognized if the loans had been current in accordance with their original terms.
The following table summarizes the Company's nonperforming assets as of December 31 for the periods presented.
(Dollars in thousands) | 2016 | 2015 | 2014 | 2013 | 2012 | |||||||||||||||
Nonaccrual loans | $ | 1,415 | $ | 2,252 | $ | 5,067 | $ | 1,492 | $ | 5,752 | ||||||||||
Accruing loans past due 90 days or more (1) | 699 | 502 | — | — | 2,902 | |||||||||||||||
Total nonperforming loans | 2,114 | 2,754 | 5,067 | 1,492 | 8,654 | |||||||||||||||
Foreclosed assets | 2,386 | 5,358 | 4,983 | 5,221 | 5,812 | |||||||||||||||
Total nonperforming assets | $ | 4,500 | $ | 8,112 | $ | 10,050 | $ | 6,713 | $ | 14,466 | ||||||||||
Restructured loans not included above | $ | 166 | $ | 3,693 | $ | 1,937 | $ | 2,699 | $ | 907 | ||||||||||
(1) | Balances include PCI loans past due 90 days or more that are grouped in pools which accrue interest based on pool yields. |
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Potential Problem Loans
At December 31, 2016 problem loans amounted to approximately $611.9 thousand or 0.08 percent of total loans outstanding. Potential problem loans, which are not included in nonperforming loans, represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have doubts about the borrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Bank's primary regulators, for loans classified as substandard or worse, but not considered nonperforming loans.
Allocation of the Allowance for Loan Losses
We maintain the allowance at a level that we deem appropriate to adequately cover the probable losses inherent in the loan portfolio. As of December 31, 2016 and December 31, 2015, our allowance for loan losses was $5.1 million and $4.4 million, respectively, which we deemed to be adequate at each of the respective dates. The increase in the allowance for loan losses in 2016 as compared to 2015 is primarily the result of increases in organic loan growth offset slightly by improving overall credit metrics within our portfolio, including the reduction in net charge-offs. Our allowance for loan loss as a percentage of total loans has increased from 0.60 percent at December 31, 2015 to 0.63 percent at December 31, 2016, as a result of the increase in organic loan balances as a percentage of the total portfolio. As a percentage of organic loans the allowance for loan losses decreased from 0.95 percent at December 31, 2015 to 0.83 percent at December 31, 2016. In 2017, we expect the allowance to organic loans to remain in the range of 0.80 to 0.90 percent.
Our purchased loans were recorded at fair value upon acquisition. The fair value adjustments on the performing purchased loans will be accreted into income over the life of the loans. At December 31, 2016, the remaining accretable yield was $9.0 million. Also at the end of 2016, the balance on PCI loans was $35.6 million and the carrying value was $27.2 million, for a net difference of $8.4 million in discounts. These loans are subject to the same allowance methodology as our legacy portfolio. The calculated allowance is compared to the remaining fair value discount to determine if additional provisioning should be recognized. At December 31, 2016, there were no allowances on purchased loans. The judgments and estimates associated with our allowance determination are described in Note 1 in the “Notes to Consolidated Financial Statements.”
The following table sets forth, based on our best estimate, the allocation of the allowance to types of loans as well as the unallocated portion as of December 31 for each of the past five years and the percentage of loans in each category to total loans (in thousands):
December 31, | |||||||||||||||||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | |||||||||||||||||||||||||||||||
Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | ||||||||||||||||||||||||||
Commercial real estate-mortgage | $ | 2,369 | 46.4 | % | $ | 1,906 | 43.8 | % | $ | 1,734 | 44.7 | % | $ | 1,608 | 38.8 | % | $ | 926 | 25.1 | % | |||||||||||||||
Consumer real estate-mortgage | 1,382 | 27.1 | % | 1,015 | 23.3 | % | 906 | 23.3 | % | 1,041 | 25.2 | % | 1,264 | 34.3 | % | ||||||||||||||||||||
Construction and land development | 717 | 14.0 | % | 627 | 14.4 | % | 690 | 17.8 | % | 727 | 17.6 | % | 833 | 22.6 | % | ||||||||||||||||||||
Commercial and industrial | 520 | 10.2 | % | 777 | 17.8 | % | 524 | 13.5 | % | 497 | 12.0 | % | 556 | 15.0 | % | ||||||||||||||||||||
Consumer and other | 117 | 2.3 | % | 29 | 0.7 | % | 26 | 0.7 | % | 263 | 6.4 | % | 112 | 3.0 | % | ||||||||||||||||||||
Total allowance for loan losses | $ | 5,105 | 100.0 | % | $ | 4,354 | 100.0 | % | $ | 3,880 | 100.0 | % | $ | 4,136 | 100.0 | % | $ | 3,691 | 100.0 | % | |||||||||||||||
The increase in the overall allowance for loan losses is due to the increased balance of organic loans offset by improvements of our loan portfolio and the reduction of nonperforming loans and net charge-offs, which is largely influenced by the overall improvement in the economies in our market areas. The allocation by category is determined based on the assigned risk rating, if applicable, and environmental factors applicable to each category of loans. For impaired loans, those loans are reviewed for a specific allowance allocation. As we have worked to rehabilitate impaired loans and total impaired loans has decreased, the specific allocations for impaired loans have generally decreased. Specific valuation allowances related to impaired loans were approximately $4 thousand at December 31, 2016, compared to $258 thousand at December 31, 2015. Additional information on the allocation of the allowance between performing and impaired loans is provided in Note 4 to the “Notes to Consolidated Financial Statements.”
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Analysis of the Allowance for Loan Losses
The following is a summary of changes in the allowance for loan losses for each of the years in the five-year period ended December 31, 2016 and the ratio of the allowance for loan losses to total loans as of the end of each period (in thousands):
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
Balance at beginning of period | $ | 4,354 | $ | 3,880 | $ | 4,136 | $ | 3,691 | $ | 3,652 | ||||||||||
Provision for loan losses | 788 | 923 | 432 | 582 | 871 | |||||||||||||||
Charged-off loans: | ||||||||||||||||||||
Commercial real estate-mortgage | — | (95 | ) | — | (123 | ) | (118 | ) | ||||||||||||
Consumer real estate-mortgage | (102 | ) | (247 | ) | (623 | ) | — | (408 | ) | |||||||||||
Construction and land development | (14 | ) | (50 | ) | (7 | ) | (17 | ) | (234 | ) | ||||||||||
Commercial and industrial | (35 | ) | — | (118 | ) | — | (45 | ) | ||||||||||||
Consumer and other | (155 | ) | (114 | ) | (65 | ) | (30 | ) | (39 | ) | ||||||||||
Total charged-off loans | (306 | ) | (506 | ) | (813 | ) | (170 | ) | (844 | ) | ||||||||||
Recoveries of previously charged-off loans: | ||||||||||||||||||||
Commercial real estate-mortgage | 45 | — | 2 | — | — | |||||||||||||||
Consumer real estate-mortgage | 76 | — | — | — | — | |||||||||||||||
Construction and land development | 22 | 26 | — | 10 | — | |||||||||||||||
Commercial and industrial | 58 | 19 | — | — | — | |||||||||||||||
Consumer and other | 68 | 12 | 123 | 23 | 12 | |||||||||||||||
Total recoveries of previously charged-off loans | 269 | 57 | 125 | 33 | 12 | |||||||||||||||
Net charge-offs | (37 | ) | (449 | ) | (688 | ) | (137 | ) | (832 | ) | ||||||||||
Balance at end of period | $ | 5,105 | $ | 4,354 | $ | 3,880 | 4,136 | $ | 3,691 | |||||||||||
Ratio of allowance for loan losses to total loans outstanding at end of period | 0.63 | % | 0.60 | % | 1.07 | % | 1.31 | % | 1.18 | % | ||||||||||
Ratio of net charge-offs to average loans outstanding for the period | — | % | (0.09 | )% | (0.20 | )% | (0.04 | )% | (0.32 | )% | ||||||||||
We assess the adequacy of the allowance at the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon our evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, the views of the Bank's regulators, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan quality indications and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
Investment Portfolio
Our investment portfolio, consisting primarily of Federal agency bonds, mortgage-backed securities, and state and municipal securities amounted to $129.4 million and $166.4 million at December 31, 2016 and 2015, respectively. This decrease was a result of selling portions of the investment portfolio to fund loan demand. In 2014, the investment portfolio amounted to$98.9 million and it increased in 2015 to $166.4 million a primarily as a result of the merger. Our investment to asset ratio has decreased from18.5 percent at December 31, 2014, to 16.3 percent at December 31, 2015, and then to 12.2 percent at December 31, 2016. Over the last several years we have reduced the ratio of investments to total assets and the absolute level of investment securities on our balance sheet as we have allocated more funding to loans. Our investment portfolio serves many purposes including serving as a potential liquidity source, collateral for public funds, and as a stable source of income.
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The following table shows the book value of the Company’s investment securities. In 2016, 2015, and 2014, all investment securities were classified as available for sale.
Book Value of Investment Securities
(in thousands)
2016 | 2015 | 2014 | ||||||||||
U.S. Government agencies | $ | 18,279 | $ | 22,745 | $ | 21,267 | ||||||
State and political subdivisions | 8,182 | 7,614 | 2,012 | |||||||||
Mortgage-backed securities | 104,585 | 136,625 | 76,089 | |||||||||
Total securities | $ | 131,046 | $ | 166,984 | $ | 99,368 | ||||||
The following table presents the contractual maturity of investment securities by contractual maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis). The composition and maturity / repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.
Expected Maturity of Investment Securities
As of December 31, 2016
(in thousands)
Maturity By Years | ||||||||||||||||||||
1 or Less | 1 to 5 | 5 to 10 | Over 10 | Total | ||||||||||||||||
U.S. Government agencies | $ | 2,022 | $ | 12,987 | $ | 3,270 | $ | — | $ | 18,279 | ||||||||||
State and political subdivisions | — | 400 | 4,325 | 3,457 | 8,182 | |||||||||||||||
Mortgage-backed securities | — | 3,065 | 29,360 | 72,160 | 104,585 | |||||||||||||||
Total securities available for sale | $ | 2,022 | $ | 16,452 | $ | 36,955 | $ | 75,617 | $ | 131,046 | ||||||||||
Weighted average yield (1) | 1.05 | % | 1.76 | % | 1.88 | % | 1.85 | % | 1.82 | % | ||||||||||
(1) Based on amortized cost, taxable equivalent basis
Deposits
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 non-interest bearing checking accounts, interest bearing checking accounts, savings accounts, money market accounts, Individual Retirement Accounts ("IRAs") and certificates of deposit ("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 December 31, 2016, brokered deposits represented approximately 10.5 percent of total deposits.
The composition of the deposit portfolio, by category, as of December 31, 2016 was as follows: 34.9 percent in time deposits, 30.3 percent in money market and savings, 17.9 percent in interest-bearing demand deposit, and 16.9 percent in non-interest bearing demand deposits. The composition of the deposit portfolio, by category, as of December 31, 2015 was as follows: 39.7 percent in time deposits, 27.6 percent in money market and savings, 17.4 percent in interest-bearing demand deposit, and 15.3 percent in non-interest bearing demand deposits.
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The following table summarizes the average balances outstanding and average interest rates for each major category of deposits for 2016 and 2015.
2016 | 2015 | |||||||||||||||||||
Average | Average | |||||||||||||||||||
(Dollars in thousands) | Balance | % of Total | Average Rate | Balance | % of Total | Average Rate | ||||||||||||||
Non-interest demand | $ | 139,652 | 16.2 | % | — | $ | 80,794 | 13.8 | % | — | ||||||||||
Interest-bearing demand | 150,649 | 17.4 | % | 0.19 | % | 117,036 | 20.0 | % | 0.15 | % | ||||||||||
Money market and savings | 258,092 | 29.9 | % | 0.45 | % | 161,405 | 27.5 | % | 0.41 | % | ||||||||||
Time deposits | 316,046 | 36.5 | % | 0.84 | % | 227,317 | 38.7 | % | 0.79 | % | ||||||||||
Total average deposits | $ | 864,439 | 100.0 | % | 0.47 | % | $ | 586,552 | 100.0 | % | 0.45 | % | ||||||||
During 2016 the overall mix of average deposits has shifted to a higher percentage of non-interest bearing and money market and savings deposits, with reductions in the percentage of deposits held in interest-bearing demand accounts. The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of deposits was 0.47 percent in 2016 compared to 0.45 percent in 2015 due to changes in deposit mix and higher deposit interest rates.
Total deposits as of December 31, 2016 were $907.1 million, which was an increase of $48.6 million from December 31, 2015. As of December 31, 2016, the Company had outstanding time deposits under $100,000 of $106.5 million, time deposits over $100,000 of $209.5 million, and a time deposit fair value adjustment of $304 thousand. The following table summarizes the maturities of time deposits $100,000 or more as of December 31, 2016.
December 31, | |||
(Dollars in thousands) | 2016 | ||
Remaining maturity: | |||
Three months or less | $ | 37,405 | |
Three to six months | 24,289 | ||
Six to twelve months | 57,685 | ||
More than twelve months | 90,133 | ||
Total | $ | 209,512 | |
Borrowings
The Company uses short-term borrowings and long-term debt to provide both funding and, to a lesser extent, regulatory capital for debt at the Company level which can be downstreamed as Tier 1 capital to the Bank. Short-term borrowings totaled $18.5 million at December 31, 2016, and consisted of $5.0 million in FHLB advances maturing within twelve months and $13.5 million federal funds purchased. Short-term borrowings totaled $22 million at December 31, 2015, and consisted of $18 million in FHLB advances maturing within twelve months and $4 million federal funds purchased. Long-term debt totaled $12.0 million at December 31, 2015, consisting of outstanding long-term FHLB advances of $10.0 million and $2.0 million outstanding on a line of credit. There was no long term debt outstanding at December 31, 2016.
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 Banks' Common Equity Tier 1 capital, Tier 1 capital, leverage and total capital ratios. At December 31, 2016 and 2015, our capital ratios, including our Banks’ 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. Additional information on capital is provided in Note 13 to the “Notes to Consolidated Financial Statements.”
40
Off-Balance Sheet Arrangements
At December 31, 2016, we had $145.3 million of pre-approved but unused lines of credit and $3.2 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. Additional information about our off-balance sheet risk exposure is presented in Note 12 of the "Notes to the Consolidated Financial Statements."
Market Risk and Liquidity Risk Management
The Bank’s Asset Liability Management Committee (“ALCO”) is responsible for making decisions regarding liquidity and funding solutions based upon approved liquidity, loan, capital and investment policies. The ALCO must consider interest rate sensitivity and liquidity risk management when rendering a decision on funding solutions and loan pricing. To assist in this process the Bank has contracted with an independent third party to prepare quarterly reports that summarize several key asset-liability measurements. In addition, the third party will also provide recommendations to the Bank’s ALCO regarding future balance sheet structure, earnings and liquidity strategies. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.
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 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 and 24 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 flat interest rate forecast over the next 12 and 24 months, limits in the decline in net interest income are as follows:
Maximum Percentage Decline in Net Interest Income from the Budgeted or Base Case Projection of Net Interest Income | ||||||
Next 12 Months | Next 24 Months | |||||
An instantaneous, parallel rate increase or decrease of the following at the beginning of the first quarter: | ||||||
± 100 basis points | 9 | % | 9 | % | ||
± 200 basis points | 14 | % | 14 | % | ||
± 300 basis points | 20 | % | 20 | % | ||
± 400 basis points | 25 | % | 25 | % | ||
We were in compliance with our earnings simulation model policies as of December 31, 2016, indicating what we believe to be a fairly neutral profile.
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.
41
To help monitor our related risk, we’ve established the following policy limits regarding simulated changes in our economic value of equity:
Instantaneous, Parallel Change in Prevailing Interest Rates Equal to | Maximum Percentage Decline in Economic Value of Equity from the Economic Value of Equity at Currently Prevailing Interest Rates | |
±100 basis points | 20 | % |
±200 basis points | 25 | % |
±300 basis points | 30 | % |
±400 basis points | 35 | % |
At December 31, 2016, our model results indicated that we were within these policy limits.
Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates.
In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as interest rate caps and floors) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. Our ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies.
Liquidity Risk Management
The purpose of liquidity risk management is to ensure that there are sufficient cash flows to satisfy loan 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 payments are a relatively stable source of funds, but loan payoffs and deposit flows fluctuate significantly, being influenced by interest rates, general economic conditions and competition. Additionally, debt security investments 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.
Impact of Inflation and Changing Prices
As a financial institution, we have an asset and liability make-up that is distinctly different from that of an entity with substantial investments in plant and inventory, because the major portions of a commercial bank’s assets are monetary in nature. As a result, our performance may be significantly influenced by changes in interest rates. Although we, and the banking industry, are more affected by changes in interest rates than by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the cost of supplies and outside services tend to increase more during periods of high inflation.
42
Critical Accounting Policies
The Company has identified accounting policies that are the most critical to fully understand and evaluate its reported financial results and require management's most difficult, subjective or complex judgments. Management has reviewed the following critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. These policies along with a brief discussion of the material implications of the uncertainties of each policy are below. For a full description of these critical accounting policies, see Note 1 in the “Notes to Consolidated Financial Statements.”
Allowance for loan losses – In establishing the allowance we take into account reserves required for impaired loans, historical charge-offs for loan types, and a variety of qualitative factors including economic outlook, portfolio concentrations, and changes in portfolio credit quality. Many of the qualitative factors are measurable but there is also a level of subjective assumptions. If those assumptions change it could have a material impact on the level of the allowance required and as a result the earnings of the Company. As an example an increase in the amount of the reserve to organic loans of 0.05 percent in 2016 would have resulted in a reduction of approximately 3 percent in pre-tax income.
Fair values for acquired assets and assumed liabilities- Assets and liabilities acquired are recorded at their respective fair values as of the date of the acquisition. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities is allocated to identifiable intangible assets with the remaining excess allocated to goodwill. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. As of December 31, 2016 there was approximately $4.2 million in goodwill. The Company has not identified any triggering events that would indicate potential impairment of goodwill.
Cash flow estimates on purchased credit-impaired loans- Purchase credit impaired loans do not have traditional loan yields and interest income; instead they have accretable yield and accretion. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income as accretion over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The amount expected to be accreted divided by the accretable discount is the accretable yield. Cash flow estimates are re-evaluated quarterly. If the estimated cash flows increase then the accretable yield over the life of the loan increases. If, however, the estimated cash flows decrease then impairment is generally recognized immediately. As an example a loan with a fair value of $200,000 with estimated cash flows of $300,000 over five years would have an accretable yield of approximately 8.2 percent and would have accretion of approximately $16,400 a year. If the cash flow estimate changed to $350,000 the accretable yield would increase to approximately 10.1 percent and the yearly accretion recognized into income would be approximately $20,300. If, however, the cash flow estimate changed to $250,000 the Company would generally recognize an impairment of $50,000 immediately, instead of reducing the accretion over the life of the loan.
Valuation of foreclosed assets - Foreclosed assets are initially recorded at fair value less selling costs. If the fair value decreases the assets are written down. As of December 31, 2016, there was approximately $2.4 million in foreclosed assets carried at a 12.2 percent discount to appraisal values.
Valuation of deferred tax assets- Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not that the tax position will be realized or sustained upon examination. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2016, there were approximately $3.7 million in net deferred tax assets.
Evaluation of investment securities for other than temporary impairment- We evaluate investment securities for other than temporary impairment taking into account if we do not have the intent to sell a debt security prior to recovery and it is more likely than not that we will not have to sell the debt security prior to recovery, the security would not be considered other than temporarily impaired unless a credit loss has occurred in the security. Temporary impairments are recognized on the balance sheet in other comprehensive income / loss. If a security becomes permanently impaired the impairment expense would be recognized and reduce earnings. As of December 31, 2016, there was approximately $1.8 million in losses on investment securities that were classified as temporarily impaired.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This Item is not applicable to smaller reporting companies.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SMARTFINANCIAL, INC. AND SUBSIDIARY
Report on Consolidated Financial Statements
For the years ended December 31, 2016 and 2015
44
SmartFinancial, Inc. and Subsidiary
Contents
45
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of SmartFinancial is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, SmartFinancial’s principal executive and principal financial officers and effected by SmartFinancial’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
• | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of SmartFinancial’s assets; |
• | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that SmartFinancial’s receipts and expenditures are being made only in accordance with authorizations of SmartFinancial’s management and directors; and |
• | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of SmartFinancial’s assets that could have a material effect on the financial statements. |
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
SmartFinancial’s management has assessed the effectiveness of internal controls over financial reporting as of December 31, 2016. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control-Integrated Framework.”
Based on this assessment management believes that, as of December 31, 2016, SmartFinancial’s internal control over financial reporting was effective based on those criteria.
This annual report does not include an attestation report of SmartFinancial’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by SmartFinancial’s registered public accounting firm pursuant to transitional rules of the Securities and Exchange Commission that permit SmartFinancial’s to provide only management’s report in this annual report.
46
Report of Independent Registered Public Accounting Firm
To the Stockholders and
Board of Directors
SmartFinancial, Inc.
Knoxville, Tennessee
We have audited the accompanying consolidated balance sheets of SmartFinancial, Inc. and Subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SmartFinancial, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Mauldin & Jenkins, LLC
Chattanooga, Tennessee
March 31, 2017
47
SmartFinancial, Inc. and Subsidiary
Consolidated Financial Statements
Consolidated Balance Sheets
December 31, 2016 and 2015
2016 | 2015 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 34,290,617 | $ | 40,358,647 | ||||
Interest-bearing deposits at other financial institutions | 34,457,691 | 33,405,986 | ||||||
Federal funds sold | — | 6,200,000 | ||||||
Total cash and cash equivalents | 68,748,308 | 79,964,633 | ||||||
Securities available for sale | 129,421,914 | 166,413,218 | ||||||
Restricted investments, at cost | 5,627,950 | 4,451,050 | ||||||
Loans, net of allowance for loan losses of $5,105,255 in 2016 and $4,354,513 in 2015 | 808,271,003 | 723,360,786 | ||||||
Bank premises and equipment, net | 30,535,594 | 25,037,510 | ||||||
Foreclosed assets | 2,386,239 | 5,357,950 | ||||||
Goodwill and core deposit intangible, net | 6,635,655 | 6,941,107 | ||||||
Other assets | 10,829,622 | 12,436,625 | ||||||
Total assets | $ | 1,062,456,285 | $ | 1,023,962,879 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Deposits: | ||||||||
Noninterest-bearing demand deposits | $ | 153,482,650 | $ | 131,418,580 | ||||
Interest-bearing demand deposits | 162,702,457 | 149,423,954 | ||||||
Money market and savings deposits | 274,604,724 | 236,900,945 | ||||||
Time deposits | 316,275,340 | 340,739,072 | ||||||
Total deposits | 907,065,171 | 858,482,551 | ||||||
Securities sold under agreement to repurchase | 26,621,984 | 28,068,215 | ||||||
Federal Home Loan Bank advances and other borrowings | 18,505,390 | 34,187,462 | ||||||
Accrued expenses and other liabilities | 5,023,600 | 3,047,792 | ||||||
Total liabilities | 957,216,145 | 923,786,020 | ||||||
Stockholders' equity: | ||||||||
Preferred stock - $1 par value; 2,000,000 shares authorized; 12,000 issued and outstanding in 2016 and 2015 | 12,000 | 12,000 | ||||||
Common stock - $1 par value; 40,000,000 shares authorized; 5,896,033 and 5,806,477 shares issued and outstanding in 2016 and 2015, respectively | 5,896,033 | 5,806,477 | ||||||
Additional paid-in capital | 83,463,051 | 82,616,015 | ||||||
Retained earnings | 16,871,296 | 12,094,488 | ||||||
Accumulated other comprehensive loss | (1,002,240 | ) | (352,121 | ) | ||||
Total stockholders' equity | 105,240,140 | 100,176,859 | ||||||
Total liabilities and stockholders' equity | $ | 1,062,456,285 | $ | 1,023,962,879 | ||||
See Notes to Consolidated Financial Statements
48
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Income
For the years ended December 31, 2016 and 2015
2016 | 2015 | |||||||
INTEREST INCOME | ||||||||
Loans, including fees | $ | 39,763,582 | $ | 25,730,909 | ||||
Securities and interest bearing deposits at other financial institutions | 2,553,652 | 1,861,269 | ||||||
Federal funds sold and other earning assets | 247,157 | 161,055 | ||||||
Total interest income | 42,564,391 | 27,753,233 | ||||||
INTEREST EXPENSE | ||||||||
Deposits | 4,105,304 | 2,625,674 | ||||||
Securities sold under agreements to repurchase | 65,276 | 30,382 | ||||||
Federal Home Loan Bank advances and other borrowings | 129,102 | 101,086 | ||||||
Total interest expense | 4,299,682 | 2,757,142 | ||||||
Net interest income before provision for loan losses | 38,264,709 | 24,996,091 | ||||||
Provision for loan losses | 787,545 | 922,955 | ||||||
Net interest income after provision for loan losses | 37,477,164 | 24,073,136 | ||||||
NONINTEREST INCOME | ||||||||
Customer service fees | 1,127,814 | 912,806 | ||||||
Gain on sale of securities | 199,587 | 52,255 | ||||||
Gain (loss) on sale of loans and other assets | 948,080 | (112,319 | ) | |||||
Gain on sale of foreclosed assets | 191,050 | 266,487 | ||||||
Other noninterest income | 1,716,794 | 1,123,897 | ||||||
Total noninterest income | 4,183,325 | 2,243,126 | ||||||
NONINTEREST EXPENSES | ||||||||
Salaries and employee benefits | 17,715,222 | 11,831,234 | ||||||
Net occupancy and equipment expense | 3,995,631 | 2,682,370 | ||||||
Depository insurance | 605,917 | 487,686 | ||||||
Foreclosed assets | 236,148 | 289,624 | ||||||
Advertising | 615,751 | 452,849 | ||||||
Data processing | 1,893,386 | 1,196,484 | ||||||
Professional services | 2,122,845 | 2,454,339 | ||||||
Amortization of intangible assets | 305,452 | 233,204 | ||||||
Service contracts | 1,154,003 | 750,957 | ||||||
Other operating expenses | 3,855,246 | 2,787,059 | ||||||
Total noninterest expenses | 32,499,601 | 23,165,806 | ||||||
Income before income tax expense | 9,160,888 | 3,150,456 | ||||||
Income tax expense | 3,362,080 | 1,640,744 | ||||||
Net income | 5,798,808 | 1,509,712 | ||||||
Preferred stock dividends | 1,022,000 | 120,000 | ||||||
Net income available to common stockholders | $ | 4,776,808 | $ | 1,389,712 | ||||
EARNINGS PER COMMON SHARE | ||||||||
Basic | $ | 0.82 | $ | 0.35 | ||||
Diluted | 0.78 | 0.32 | ||||||
Weighted average common shares outstanding | ||||||||
Basic | 5,838,574 | 3,985,202 | ||||||
Diluted | 6,118,943 | 4,281,509 | ||||||
Dividends per share | N/A | N/A | ||||||
See Notes to Consolidated Financial Statements
49
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2016 and 2015
2016 | 2015 | |||||||
Net income | $ | 5,798,808 | $ | 1,509,712 | ||||
Other comprehensive loss, net of tax: | ||||||||
Unrealized holding losses arising during the year, net of tax benefit of $326,697 and $10,764 in 2016 and 2015, respectively | (526,954 | ) | (16,522 | ) | ||||
Reclassification adjustment for gains included in net income, net of tax expense of $76,422 and $19,857 in 2016 and 2015, respectively | (123,165 | ) | (32,398 | ) | ||||
Total other comprehensive loss | (650,119 | ) | (48,920 | ) | ||||
Comprehensive income | $ | 5,148,689 | $ | 1,460,792 | ||||
See Notes to Consolidated Financial Statements
50
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2016 and 2015
Preferred Shares | Common Shares | Preferred Stock | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | |||||||||||||||||||||||
BALANCE, December 31, 2014 | 12,000 | 2,965,783 | $ | 12,000 | $ | 2,965,783 | $ | 42,508,429 | $ | 10,704,776 | $ | (303,201 | ) | $ | 55,887,787 | |||||||||||||||
Net income | — | — | — | — | — | 1,509,712 | — | 1,509,712 | ||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | (48,920 | ) | (48,920 | ) | ||||||||||||||||||||
Issuance of common stock | — | 1,000,003 | — | 1,000,003 | 14,000,001 | — | — | 15,000,004 | ||||||||||||||||||||||
Issuance of stock grants | — | 6,659 | — | 6,659 | 93,557 | — | — | 100,216 | ||||||||||||||||||||||
Stock issuance costs | — | — | — | — | (840,418 | ) | — | — | (840,418 | ) | ||||||||||||||||||||
Exercise of stock options | — | 24,292 | — | 24,292 | 189,250 | — | — | 213,542 | ||||||||||||||||||||||
Shares retained by shareholders of Cornerstone Bancshares, Inc. | — | 1,660,836 | — | 1,660,836 | 26,774,239 | — | — | 28,435,075 | ||||||||||||||||||||||
Conversion shares issued to shareholders of SmartFinancial, Inc. | — | 148,904 | — | 148,904 | (148,904 | ) | — | — | — | |||||||||||||||||||||
Dividends on preferred stock | — | — | — | — | — | (120,000 | ) | — | (120,000 | ) | ||||||||||||||||||||
Stock option compensation expense | — | — | — | — | 39,861 | — | — | 39,861 | ||||||||||||||||||||||
BALANCE, December 31, 2015 | 12,000 | 5,806,477 | 12,000 | 5,806,477 | 82,616,015 | 12,094,488 | (352,121 | ) | 100,176,859 | |||||||||||||||||||||
Net income | — | — | — | — | — | 5,798,808 | — | 5,798,808 | ||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | (650,119 | ) | (650,119 | ) | ||||||||||||||||||||
Exercise of stock options | — | 89,556 | — | 89,556 | 714,401 | — | — | 803,957 | ||||||||||||||||||||||
Dividends on preferred stock | — | — | — | — | — | (1,022,000 | ) | — | (1,022,000 | ) | ||||||||||||||||||||
Stock option compensation expense | — | — | — | — | 132,635 | — | — | 132,635 | ||||||||||||||||||||||
BALANCE, December 31, 2016 | 12,000 | 5,896,033 | $ | 12,000 | $ | 5,896,033 | $ | 83,463,051 | $ | 16,871,296 | $ | (1,002,240 | ) | $ | 105,240,140 | |||||||||||||||
See Notes to Consolidated Financial Statements.
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SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the years ended December 31, 2016 and 2015
2016 | 2015 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 5,798,808 | $ | 1,509,712 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 2,189,088 | 1,085,685 | ||||||
Provision for loan losses | 787,545 | 922,955 | ||||||
Stock compensation expense | 132,635 | 140,077 | ||||||
Gains from sale of securities | (199,587 | ) | (52,255 | ) | ||||
Net (gains) losses from sale of loans and other assets | (948,080 | ) | 112,319 | |||||
Gains from sale of foreclosed assets | (191,050 | ) | (266,487 | ) | ||||
Changes in other assets and liabilities: | ||||||||
Accrued interest receivable | 110,952 | 101,189 | ||||||
Accrued interest payable | (8,373 | ) | (11,218 | ) | ||||
Other assets and liabilities | 3,918,803 | (1,200,552 | ) | |||||
Net cash provided by operating activities | 11,590,741 | 2,341,425 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES, net of acquisition | ||||||||
Purchase of securities available for sale | (22,111,781 | ) | (23,180,643 | ) | ||||
Proceeds from security sales, maturities, and paydowns | 57,495,436 | 27,334,550 | ||||||
Purchase of restricted investments | (1,176,900 | ) | (38,000 | ) | ||||
Loan originations and principal collections, net | (82,804,921 | ) | (50,003,157 | ) | ||||
Purchase of bank premises and equipment | (6,994,729 | ) | (1,081,811 | ) | ||||
Proceeds from sale of foreclosed assets | 1,279,554 | 5,529,640 | ||||||
Cash and cash equivalents received in merger | — | 33,501,510 | ||||||
Net cash used in investing activities | (54,313,341 | ) | (7,937,911 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES, net of acquisition | ||||||||
Net increase in deposits | 48,582,620 | 54,213,883 | ||||||
Net increase (decrease) in securities sold under agreements to repurchase | (1,446,231 | ) | 687,811 | |||||
Issuance of common stock | 803,957 | 4,043,011 | ||||||
Payment of dividends on preferred stock | (752,000 | ) | (120,000 | ) | ||||
Repayment of Federal Home Loan Bank advances and other borrowings | (67,282,071 | ) | (20,000,000 | ) | ||||
Proceeds from Federal Home Loan Bank advances and other borrowings | 51,600,000 | — | ||||||
Net cash provided by financing activities | 31,506,275 | 38,824,705 | ||||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (11,216,325 | ) | 33,228,219 | |||||
CASH AND CASH EQUIVALENTS, beginning of year | 79,964,633 | 46,736,414 | ||||||
CASH AND CASH EQUIVALENTS, end of year | $ | 68,748,308 | $ | 79,964,633 | ||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | ||||||||
Cash paid during the period for interest | $ | 4,308,055 | $ | 2,610,476 | ||||
Cash paid during the period for taxes | 3,754,784 | 1,977,958 | ||||||
Cash received during the period from tax refunds | 1,592,224 | — | ||||||
NONCASH INVESTING AND FINANCING ACTIVITIES | ||||||||
Change in unrealized losses on securities available for sale | $ | 1,053,238 | $ | 79,542 | ||||
Acquisition of real estate through foreclosure | 1,431,857 | 864,669 | ||||||
Financed sales of foreclosed assets | 3,315,064 | 898,186 | ||||||
See Notes to Consolidated Financial Statements
52
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies
Nature of Business:
SmartFinancial, Inc. (the "Company") is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, SmartBank (the "Bank"). Prior to their merger on February 26, 2016 the Company operated two wholly-owned subsidiaries; SmartBank and Cornerstone Community Bank. The Company provides a variety of financial services to individuals and corporate customers through its offices in eastern Tennessee, northeast Florida, and north Georgia. The Company's primary deposit products are interest-bearing demand deposits and certificates of deposit. Its primary lending products are commercial, residential, and consumer loans.
Basis of Presentation and Accounting Estimates:
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed assets and deferred taxes, other than temporary impairments of securities, and the fair value of financial instruments.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.
The Company's loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent on local economic conditions.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Company to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term.
The Company has evaluated subsequent events for potential recognition and/or disclosure in the consolidated financial statements and accompanying notes included in this Annual Report.
Cash and Cash Equivalents:
For purposes of reporting consolidated cash flows, cash and due from banks includes cash on hand, cash items in process of collection and amounts due from banks. Cash and cash equivalents also includes interest-bearing deposits in banks and federal funds sold. Cash flows from loans, federal funds sold, securities sold under agreements to repurchase and deposits are reported net.
53
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Cash and Cash Equivalents (continued):
The Bank is required to maintain average balances in cash or on deposit with the Federal Reserve Bank. The reserve requirement was $15,208 and $1,031 at December 31, 2016 and 2015, respectively.
The Company places its cash and cash equivalents with other financial institutions and limits the amount of credit exposure to any one financial institution. From time to time, the balances at these financial institutions exceed the amount insured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses on these accounts and management considers this to be a normal business risk.
Securities:
Management has classified all securities as available for sale. Securities available for sale are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive loss. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The Company evaluates investment securities for other than temporary impairment using relevant accounting guidance specifying that (a) if the Company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other than temporarily impaired unless a credit loss has occurred in the security. If management does not intend to sell the security and it is more likely than not that they will not have to sell the security before recovery of the cost basis, management will recognize the credit component of an other-than- temporary impairment of a debt security in earnings and the remaining portion in other comprehensive loss.
Securities borrowed or purchased under agreements to resell and securities loaned or sold under agreements to repurchase are treated as collateralized financial transactions. These agreements are recorded at the amount at which the securities were acquired or sold plus accrued interest. It is the Company's policy to take possession of securities purchased under resale agreements. The market value of these securities is monitored, and additional securities are obtained when deemed appropriate to ensure such transactions are adequately collateralized. The Company also monitors its exposure with respect to securities sold under repurchase agreements, and a request for the return of excess securities held by the counterparty is made when deemed appropriate.
Restricted - Investments:
The Company is required to maintain an investment in capital stock of various entities. Based on redemption provisions of these entities, the stock has no quoted market value and is carried at cost. At their discretion, these entities may declare dividends on the stock. Management reviews for impairment based on the ultimate recoverability of the cost basis in these stocks.
Loans:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balances less deferred fees and costs on originated loans and the allowance for loan losses. Interest income is accrued on the outstanding principal balance. Loan origination fees, net of certain direct origination costs of consumer and installment loans are recognized at the time the loan is placed on the books. Loan origination fees for all other loans are deferred and recognized as an adjustment of the yield over the life of the loan using the straight-line method without anticipating prepayments.
The accrual of interest on loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due, or at the time the loan is 90 days past due, unless the loan is well-secured and in the process of collection. Unsecured loans are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income or charged to the allowance, unless management believes that the accrual of interest is recoverable through the liquidation of collateral. Interest income on nonaccrual loans is recognized on the cash basis, until the loans are returned to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and the loan has been performing according to the contractual terms for a period of not less than six months.
54
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Acquired Loans:
Acquired loans are those that were acquired when SmartBank assumed all the deposits and certain assets of the former GulfSouth Private Bank (“GulfSouth transaction”) on October 19, 2012 and the former Cornerstone Bancshares, Inc. (“Cornerstone”) on August 31, 2015. The fair values of acquired loans with evidence of credit deterioration, purchased credit impaired loans (“PCI loans”), are recorded net of a nonaccretable discount and accretable discount. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable discount, which is included in the carrying amount of acquired loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable discount. Acquired loans are initially recorded at fair value at acquisition date. Accretable discounts related to certain fair value adjustments are accreted into income over the estimated lives of the loans.
The Company accounts for performing loans acquired in the acquisition using the expected cash flows method of recognizing discount accretion based on the acquired loans' expected cash flows. Management recasts the estimate of cash flows expected to be collected on each acquired impaired loan pool periodically. If the present value of expected cash flows for a pool is less than its carrying value, an impairment is recognized by an increase in the allowance for loan losses and a charge to the provision for loan losses. If the present value of expected cash flows for a pool is greater than its carrying value, any previously established allowance for loan losses is reversed and any remaining difference increases the accretable yield which will be taken into interest income over the remaining life of the loan pool. Acquired impaired loans are generally not subject to individual evaluation for impairment and are not reported with impaired loans, even if they would otherwise qualify for such treatment. Purchased performing loans are recorded at fair value, including a credit discount. Credit losses on acquired performing loans are estimated based on analysis of the performing portfolio. Such estimated credit losses are recorded as nonaccretable discounts in a manner similar to purchased impaired loans. The fair value discount other than for credit loss is accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition.
Allowance for Loan Losses:
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Confirmed losses are charged off immediately. Subsequent recoveries, if any, are credited to the allowance.
The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the uncollectibility of loans in light of historical experience, the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, current economic conditions that may affect the borrower's ability to pay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For impaired loans, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the Company's historical loss experience adjusted for other qualitative factors. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.
55
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Allowance for Loan Losses (continued):
An unallocated component may be maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. As part of the risk management program, an independent review is performed on the loan portfolio, which supplements management’s assessment of the loan portfolio and the allowance for loan losses. The result of the independent review is reported directly to the Audit Committee of the Board of Directors. Loans, for which the terms have been modified at the borrower's request, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
A loan is considered impaired when it is probable, based on current information and events, the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest when due. Loans that experience insignificant payment delays and payment shortfalls are not classified as impaired. Impaired loans are measured by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.
The Company's homogeneous loan pools include consumer real estate loans, commercial real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors. The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans in the pool.
Troubled Debt Restructurings:
The Company designates loan modifications as troubled debt restructurings ("TDRs") when for economic and legal reasons related to the borrower's financial difficulties, it grants a concession to the borrower that it would not otherwise consider. TDRs can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. In circumstances where the TDR involves charging off a portion of the loan balance, the Company typically classifies these restructurings as nonaccrual.
In connection with restructurings, the decision to maintain a loan that has been restructured on accrual status is based on a current, well documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. This evaluation includes consideration of the borrower's current capacity to pay, which among other things may include a review of the borrower's current financial statements, an analysis of global cash flow sufficient to pay all debt obligations, a debt to income analysis, and an evaluation of secondary sources of payment from the borrower and any guarantors. This evaluation also includes an evaluation of the borrower's current willingness to pay, which may include a review of past payment history, an evaluation of the borrower's willingness to provide information on a timely basis, and consideration of offers from the borrower to provide additional collateral or guarantor support. The credit evaluation also reflects consideration of the borrower's future capacity and willingness to pay, which may include evaluation of cash flow projections, consideration of the adequacy of collateral to cover all principal and interest, and trends indicating improving profitability and collectability of receivables.
Restructured nonaccrual loans may be returned to accrual status based on a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. This evaluation must include consideration of the borrower's sustained historical repayment for a reasonable period, generally a minimum of six months, prior to the date on which the loan is returned to accrual status.
56
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Foreclosed Assets:
Foreclosed assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less selling costs. Any write-down to fair value at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Costs of improvements are capitalized, whereas costs relating to holding foreclosed assets and subsequent write-downs to the value are expensed. The amount of residential real estate where physical possession had been obtained included within foreclosed assets at December 31, 2016 and 2015 was $1,500 and $227,000, respectively. The amount of residential real estate in process of foreclosure at December 31, 2016 was $0. The amount of residential real estate in process of foreclosure at December 31, 2015 was $61,000.
Premises and Equipment:
Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.
Buildings and leasehold improvements | 15 - 40 years |
Furniture and equipment | 3-7 years |
Goodwill and Intangible Assets:
Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as business combinations. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. 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. If an entity does a qualitative assessment and determines that this is the case, or if a qualitative assessment is not performed, it is required to perform additional goodwill impairment testing to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on a qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. The Company performs its annual goodwill impairment test as of December 31 of each year. For 2016, the results of the qualitative assessment provided no indication of potential impairment. Goodwill will continue to be monitored for triggering events that may indicate impairment prior to the next scheduled annual impairment test.
Intangible assets consist of core deposit premiums acquired in connection with the Gulf South and Cornerstone transactions. The core deposit premium is initially recognized based on a valuation performed as of the consummation date. The core deposit premium is amortized over the average remaining life of the acquired customer deposits. Amortization expense relating to these intangible assets was $305,452 and $233,204 for the years ended December 31, 2016 and 2015, respectively. The intangible assets were evaluated for impairment as of December 31, 2016, and based on that evaluation it was determined that there was no impairment.
Transfer of Financial Assets:
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
57
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Advertising Costs:
The Company expenses all advertising costs as incurred. Advertising expense was $615,751 and $452,849 for the years ended December 31, 2016 and 2015, respectively.
Income Taxes:
The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
Stock Compensation Plans:
At December 31, 2016, the Company had options outstanding under stock-based compensation plans, which are described in more detail in Note 10. The plans have been accounted for under the accounting guidance (FASB ASC 718, Compensation - Stock Compensation) which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and stock or other stock based awards.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees' service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market value of the Company's common stock at the date of grant is used for restrictive stock awards and stock grants.
Employee Benefit Plan:
Employee benefit plan costs are based on the percentage of individual employee's salary, not to exceed the amount that can be deducted for federal income tax purposes.
Variable interest entities:
An entity is referred to as a variable interest entity (VIE) if it meets the criteria outlined in ASC Topic 810, which are: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (2) the entity has equity investors that cannot make significant decisions about the entity's operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that has a majority of the expected losses, expected residual returns, or both. At December 31, 2016, the Company had an investment in Community Advantage Fund, LLC that qualified as an unconsolidated VIE.
58
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Variable interest entities (continued):
The Company’s investment in a partnership consists of an equity interest in a lending partnership for the purposes of loaning funds to an unrelated entity. This entity will use the funds to make loans through the SBA Community Advantage loan Initiative.
The Company uses the equity method when it owns an interest in a partnership and can exert significant influence over the partnership’s operations. Under the equity method, the Company’s ownership interest in the partnership’s capital is reported as an investment on its consolidated balance sheets in other assets and the Company’s allocable share of the income or loss from the partnership is reported in noninterest income or expense in the consolidated statements of income. The Company ceases recording losses on an investment in partnership when the cumulative losses and distributions from the partnership exceed the carrying amount of the investment and any advances made by the Company. After the Company’s investment in such partnership reaches zero, cash distributions received from these investments are recorded as income.
Comprehensive Income:
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Fair Value of Financial Instruments:
Fair values of financial instruments are estimates using relevant market information and other assumptions, as more fully disclosed in Note 15. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
Business Combinations:
Business combinations are accounted for using the acquisition method of accounting. Under the acquisition method of accounting, acquired assets and assumed liabilities are included with the acquirer's accounts as of the date of acquisition at estimated fair value, with any excess of purchase price over the fair value of the net assets acquired (including identifiable intangible assets) capitalized as goodwill. In the event that the fair value of the net assets acquired exceeds the purchase price, an acquisition gain is recorded for the difference in consolidated statements of income for the period in which the acquisition occurred. An intangible asset is recognized as an asset apart from goodwill when it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred. Estimates of fair value are subject to refinement for a period not to exceed one year from acquisition date as information relative to acquisition date fair values becomes available.
Earnings per common share:
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method
59
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Segment reporting:
ASC Topic 280, “Segment Reporting,” provides for the identification of reportable segments on the basis of distinct business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). ASC Topic 280 permits aggregation or combination of segments that have similar characteristics. In the Company’s operations, each bank branch is viewed by management as being a separately identifiable business or segment from the perspective of monitoring performance and allocation of financial resources. Although the branches operate independently and are managed and monitored separately, each is substantially similar in terms of business focus, type of customers, products, and services. Accordingly, the Company’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.
Recently Issued Not Yet Effective Accounting Pronouncements:
The following is a summary of recent authoritative pronouncements not yet in effect that could impact the accounting, reporting, and/or disclosure of financial information by the Company.
In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers in ASU No. 2014-9, Revenue from Contracts with Customers (Topic 606). The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for annual periods beginning after December 15, 2017, and interim periods within annual reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.
In January 2016, the FASB issued guidance that primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments in ASU No. 2016-1 -Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will be effective in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.
In February 2016, the FASB issued guidance that requires lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability in ASU 2016-2: Leases (Topic 842). For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines. Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model and the new revenue recognition standard. Existing sale-leaseback guidance, including guidance for real estate, is replaced with a new model applicable to both lessees and lessors. The new guidance will be effective for public business entities for annual periods beginning after December 15, 2018 including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.
In March 2016, FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments in this ASU simplify several aspects of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. Excess tax benefits and tax deficiencies will be recognized as income tax expense or benefit in the income statement in the period exercise or vesting occurs. In the statement of cash flows, excess tax benefits should be classified with other income tax cash flows as an operating activity. Cash paid by an employer for tax withholding when directly withholding shares should be classified as a financing activity. An entity can make an entity-wide policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The threshold for determining whether an award is classified as equity or a liability is raised to permit withholding up to the maximum statutory tax rate in the applicable jurisdiction. The amendments in this update are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted and if early adopted, all provisions must be adopted in the same period. The Company does not expect these amendments to have a material effect on its financial statements.
60
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 1. Summary of Significant Accounting Policies, Continued
Recently Issued Not Yet Effective Accounting Pronouncements (continued):
In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU changed the credit loss model on financial instruments measured at amortized cost, available for sale securities and certain purchased financial instruments. Credit losses on financial instruments measured at amortized cost will be determined using a current expected credit loss model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. Purchased financial assets with more-than-insignificant credit deterioration since origination ("PCD assets" which are currently named "PCI Loans") measured at amortized cost will have an allowance for credit losses established at acquisition as part of the purchase price. Subsequent increases or decreases to the allowance for credit losses on PCD assets will be recognized in the income statement. Interest income should be recognized on PCD assets based on the effective interest rate, determined excluding the discount attributed to credit losses at acquisition. Credit losses relating to available-for-sale debt securities will be recognized through an allowance for credit losses. The amount of the credit loss is limited to the amount by which fair value is below amortized cost of the available-for-sale debt security. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years for the Company and other SEC filers. Early adoption is permitted and if early adopted, all provisions must be adopted in the same period. The amendments should be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the period adopted. A prospective approach is required for securities with other than temporary impairment recognized prior to adoption. The Company is still reviewing the impact the adoption of this guidance will have on its financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The ASU intends to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. The guidance is effective for public companies for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted with retrospective application. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.
In January 2017, FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The ASU clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.
In January 2017, FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.
61
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 2. Business Combination
On June 18, 2015, the shareholders of the SmartFinancial, Inc (“Legacy SmartFinancial”) approved a merger with Cornerstone Bancshares, Inc. ticker symbol CSBQ, the one bank holding company of Cornerstone Community Bank, which became effective August 31, 2015 at which time Cornerstone Bancshares changed its name to SmartFinancial. Legacy SmartFinancial shareholders received 1.05 shares of Cornerstone common stock in exchange for each share of Legacy SmartFinancial common stock. After the merger, shareholders of Legacy SmartFinancial owned approximately 56% of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio and new shares issued as part of a capital raise through a private placement.
While Cornerstone was the acquiring entity for legal purposes, the merger is being accounted for as a reverse merger using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, Legacy SmartFinancial is considered the acquirer in the merger, and as a result the historical financial statements of the combined entity will be the historical financial statements of Legacy SmartFinancial.
The merger was effected by the issuance of shares of Cornerstone stock to shareholders of Legacy SmartFinancial. The assets and liabilities of Cornerstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of Legacy SmartFinancial. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill. Goodwill from the transaction was $4.2 million, none of which is deductible for income tax purposes.
In periods following the merger, the financial statements of the combined entity will include the results attributable to Cornerstone Community Bank beginning on the date the merger was completed. In the period ended December 31, 2015, the revenues and net income attributable to Cornerstone Community bank were $7.0 million and $1.6 million, respectively. The pro-forma impact to 2015 revenues and net income if the merger had occurred on December 31, 2014 would have been $19.6 million and $67 thousand, respectively.
The following table details the financial impact of the merger, including the calculation of the purchase price, the allocation of the purchase price to the fair values of net assets assumed, and goodwill recognized:
Calculation of Purchase Price | |||
Shares of CSBQ common stock outstanding as of August 31, 2015 | 6,643,341 | ||
Market price of CSBQ common stock on August 31, 2015 | $ | 3.85 | |
Estimated fair value of CSBQ common stock (in thousands) | 25,577 | ||
Estimated fair value of CSBQ stock options (in thousands) | 2,858 | ||
Total consideration (in thousands) | $ | 28,435 | |
62
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 2. Business Combination, Continued
Allocation of Purchase Price (in thousands) | |||
Total consideration above | $ | 28,435 | |
Fair value of assets acquired and liabilities assumed: | |||
Cash and cash equivalents | 33,502 | ||
Investment securities available for sale | 74,254 | ||
Loans | 314,827 | ||
Premises and equipment | 9,019 | ||
Bank owned life insurance | 1,278 | ||
Core deposit intangible | 2,750 | ||
Other real estate owned | 5,672 | ||
Prepaid and other assets | 4,301 | ||
Deposits | (349,462 | ) | |
Securities sold under agreements to repurchase | (17,622 | ) | |
FHLB advances and other borrowings | (42,307 | ) | |
Payables and other liabilities | (11,943 | ) | |
Total fair value of net assets acquired | 24,269 | ||
Goodwill | $ | 4,166 | |
63
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 3. Securities
The amortized cost and fair value of securities available-for-sale at December 31, 2016 and 2015 are summarized as follow (in thousands):
December 31, 2016 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
U.S. Government-sponsored enterprises (GSEs) | $ | 18,279 | $ | 8 | $ | (564 | ) | $ | 17,723 | |||||||
Municipal securities | 8,182 | 16 | (179 | ) | 8,019 | |||||||||||
Mortgage-backed securities | 104,585 | 185 | (1,090 | ) | 103,680 | |||||||||||
Total | $ | 131,046 | $ | 209 | $ | (1,833 | ) | $ | 129,422 | |||||||
December 31, 2015 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
U.S. Government-sponsored enterprises (GSEs) | $ | 22,745 | $ | 48 | $ | (50 | ) | $ | 22,743 | |||||||
Municipal securities | 7,614 | 52 | (17 | ) | 7,649 | |||||||||||
Mortgage-backed securities | 136,625 | 375 | (979 | ) | 136,021 | |||||||||||
Total | $ | 166,984 | $ | 475 | $ | (1,046 | ) | $ | 166,413 | |||||||
The amortized cost and estimated market value of securities at December 31, 2016, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Cost | Fair Value | |||||||
Due in one year or less | $ | 2,022 | $ | 2,025 | ||||
Due from one year to five years | 13,387 | 12,974 | ||||||
Due from five years to ten years | 7,595 | 7,351 | ||||||
Due after ten years | 3,457 | 3,392 | ||||||
26,461 | 25,742 | |||||||
Mortgage-backed securities | 104,585 | 103,680 | ||||||
Total | $ | 131,046 | $ | 129,422 | ||||
The following tables present the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities available-for-sale have been in a continuous unrealized loss position, as of December 31, 2016 and 2015 (in thousands):
As of December 31, 2016 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||
Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | |||||||||||||||||||
U.S. Government- sponsored enterprises (GSEs) | $ | 14,702 | $ | (564 | ) | $ | — | $ | — | $ | 14,702 | $ | (564 | ) | ||||||||||
Municipal securities | 6,368 | (179 | ) | — | — | 6,368 | (179 | ) | ||||||||||||||||
Mortgage-backed securities | 67,063 | (690 | ) | 8,948 | (400 | ) | 76,011 | (1,090 | ) | |||||||||||||||
Total | $ | 88,133 | $ | (1,433 | ) | $ | 8,948 | $ | (400 | ) | $ | 97,081 | $ | (1,833 | ) | |||||||||
64
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 3. Securities, Continued
As of December 31, 2015 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||
Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | |||||||||||||||||||
U.S. Government- sponsored enterprises (GSEs) | $ | 8,464 | $ | (50 | ) | $ | — | $ | — | $ | 8,464 | $ | (50 | ) | ||||||||||
Municipal securities | 2,456 | (17 | ) | — | — | 2,456 | (17 | ) | ||||||||||||||||
Mortgage-backed securities | 72,641 | (470 | ) | 16,325 | (509 | ) | 88,966 | (979 | ) | |||||||||||||||
Total | $ | 83,561 | $ | (537 | ) | $ | 16,325 | $ | (509 | ) | $ | 99,886 | $ | (1,046 | ) | |||||||||
At December 31, 2016, the categories of temporarily impaired securities, and management’s evaluation of those securities, are as follows:
U.S. Government-sponsored enterprises: At December 31, 2016, seven investments in U.S. GSE securities had unrealized losses. These unrealized losses related principally to changes in market interest rates. The contractual terms of the investments does not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is more likely than not that the Bank will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other-than temporarily impaired at December 31, 2016.
Municipal securities: At December 31, 2016, fifteen investments in obligations of municipal securities had unrealized losses. The Bank believes the unrealized losses on those investments were caused by the interest rate environment and do not relate to the underlying credit quality of the issuers. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other than temporarily impaired at December 31, 2016.
Mortgage-backed securities: At December 31, 2016, fifty-five investments in residential mortgage-backed securities had unrealized losses. This impairment is believed to be caused by the current interest rate environment. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Because the decline in market value is attributable to the current interest rate environment and not credit quality, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other than temporarily impaired at December 31, 2016.
Sales of available for sale securities for the years ended December 31, 2016 and 2015, were as follows (in thousands):
2016 | 2015 | |||||||
Proceeds | $ | 31,599 | $ | 7,304 | ||||
Gains realized | 200 | 52 | ||||||
Losses realized | — | — | ||||||
Securities with a carrying value of approximately $86,351,000 and $124,517,000 at December 31, 2016 and 2015, respectively, were pledged to secure various deposits, securities sold under agreements to repurchase, as collateral for federal funds purchased from other financial institutions and serve as collateral for borrowings at the Federal Home Loan Bank.
65
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses
Portfolio Segmentation:
At December 31, 2016 and 2015, loans consisted of the following (in thousands):
December 31, 2016 | December 31, 2015 | |||||||||||||||||||||||
PCI Loans | All Other Loans | Total | PCI Loans | All Other Loans | Total | |||||||||||||||||||
Commercial real estate | $ | 14,943 | $ | 400,265 | $ | 415,208 | $ | 20,050 | $ | 349,727 | $ | 369,777 | ||||||||||||
Consumer real estate | 9,004 | 178,798 | 187,802 | 12,764 | 148,930 | 161,694 | ||||||||||||||||||
Construction and land development | 1,678 | 116,191 | 117,869 | 2,695 | 102,783 | 105,478 | ||||||||||||||||||
Commercial and industrial | 1,568 | 83,454 | 85,022 | 2,768 | 82,183 | 84,951 | ||||||||||||||||||
Consumer and other | — | 7,475 | 7,475 | — | 5,815 | 5,815 | ||||||||||||||||||
Total loans | 27,193 | 786,183 | 813,376 | 38,277 | 689,438 | 727,715 | ||||||||||||||||||
Less: Allowance for loan losses | — | (5,105 | ) | (5,105 | ) | — | (4,354 | ) | (4,354 | ) | ||||||||||||||
Loans, net | $ | 27,193 | $ | 781,078 | $ | 808,271 | $ | 38,277 | $ | 685,084 | $ | 723,361 | ||||||||||||
For purposes of the disclosures required pursuant to the adoption of ASC 310, the loan portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. There are five loan portfolio segments that include commercial real estate, consumer real estate, construction and land development, commercial and industrial, and consumer and other.
The following describe risk characteristics relevant to each of the portfolio segments:
Commercial Real Estate: Commercial real estate loans include owner-occupied commercial real estate loans and loans secured by income-producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Consumer Real Estate: Consumer real estate loans include real estate loans secured by first liens, second liens, or open end real estate loans, such as home equity lines. These are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. One to four family first mortgage loans are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Construction and Land Development: Loans for real estate construction and development are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio segment includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial, financial, and agricultural 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.
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.
66
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management:
The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan portfolio segments. Credit risk management is guided by credit policies that provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Credit Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans are individually underwritten, risk-rated, approved, and monitored.
Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer real estate and consumer and other portfolio segments, the risk management process focuses on managing customers who become delinquent in their payments. For the other portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit of the portfolios, including a third party review of the largest credits on an annual basis or more frequently as needed. To ensure problem credits are identified on a timely basis, several specific portfolio reviews occur periodically to assess the larger adversely rated credits for proper risk rating and accrual status.
Credit quality and trends in the loan portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by the Senior Credit Officer and the Directors Loan Committee.
The allowance for loan losses is a valuation reserve allowance established through provisions for loan losses charged against income. The allowance for loan losses, which is evaluated quarterly, is maintained at a level that management deems sufficient to absorb probable losses inherent in the loan portfolio. Loans deemed to be uncollectible are charged against the allowance for loan losses, while recoveries of previously charged-off amounts are credited to the allowance for loan losses. The allowance for loan losses is comprised of specific valuation allowances for loans evaluated individually for impairment and general allocations for pools of homogeneous loans with similar risk characteristics and trends.
The allowance for loan losses related to specific loans is based on management's estimate of potential losses on impaired loans as determined by (1) the present value of expected future cash flows; (2) the fair value of collateral if the loan is determined to be collateral dependent or (3) the loan's observable market price. The Company's homogeneous loan pools include commercial real estate loans, consumer real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors.
The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans in the pool.
67
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
The composition of loans by loan classification for impaired and performing loan status at December 31, 2016 and 2015, is summarized in the tables below (amounts in thousands):
December 31, 2016 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Performing loans | $ | 400,146 | $ | 177,977 | $ | 115,326 | $ | 83,244 | $ | 7,475 | $ | 784,168 | ||||||||||||
Impaired loans | 119 | 821 | 865 | 210 | — | 2,015 | ||||||||||||||||||
400,265 | 178,798 | 116,191 | 83,454 | 7,475 | 786,183 | |||||||||||||||||||
PCI loans | 14,943 | 9,004 | 1,678 | 1,568 | — | 27,193 | ||||||||||||||||||
Total | $ | 415,208 | $ | 187,802 | $ | 117,869 | $ | 85,022 | $ | 7,475 | $ | 813,376 | ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Performing loans | $ | 347,775 | $ | 145,289 | $ | 101,751 | $ | 81,715 | $ | 5,815 | $ | 682,345 | ||||||||||||
Impaired loans | 1,952 | 3,641 | 1,032 | 468 | — | 7,093 | ||||||||||||||||||
349,727 | 148,930 | 102,783 | 82,183 | 5,815 | 689,438 | |||||||||||||||||||
PCI loans | 20,050 | 12,764 | 2,695 | 2,768 | — | 38,277 | ||||||||||||||||||
Total loans | $ | 369,777 | $ | 161,694 | $ | 105,478 | $ | 84,951 | $ | 5,815 | $ | 727,715 | ||||||||||||
The following tables show the allowance for loan losses allocation by loan classification for impaired and performing loans as of December 31, 2016 and 2015 (amounts in thousands):
December 31, 2016 | ||||||||||||||||||||||||
Construction | Commercial | Consumer | ||||||||||||||||||||||
Commercial | Consumer | and Land | and | and | ||||||||||||||||||||
Real Estate | Real Estate | Development | Industrial | Other | Total | |||||||||||||||||||
Performing loans | $ | 2,369 | $ | 1,382 | $ | 717 | $ | 516 | $ | 117 | $ | 5,101 | ||||||||||||
Impaired loans | — | — | — | 4 | — | 4 | ||||||||||||||||||
Total | $ | 2,369 | $ | 1,382 | $ | 717 | $ | 520 | $ | 117 | $ | 5,105 | ||||||||||||
68
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
December 31, 2015 | ||||||||||||||||||||||||
Construction | Commercial | Consumer | ||||||||||||||||||||||
Commercial | Consumer | and Land | and | and | ||||||||||||||||||||
Real Estate | Real Estate | Development | Industrial | Other | Total | |||||||||||||||||||
Performing loans | $ | 1,906 | $ | 1,015 | $ | 627 | $ | 519 | $ | 29 | $ | 4,096 | ||||||||||||
Impaired loans | — | — | — | 258 | — | 258 | ||||||||||||||||||
Total | $ | 1,906 | $ | 1,015 | $ | 627 | $ | 777 | $ | 29 | $ | 4,354 | ||||||||||||
The following tables detail the changes in the allowance for loan losses for the year ending December 31, 2016 and December 31, 2015, by loan classification (amounts in thousands):
December 31, 2016 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Beginning balance | $ | 1,906 | $ | 1,015 | $ | 627 | $ | 777 | $ | 29 | $ | 4,354 | ||||||||||||
Loans charged off | — | (102 | ) | (14 | ) | (35 | ) | (155 | ) | (306 | ) | |||||||||||||
Recoveries of loans charged off | 45 | 76 | 22 | 58 | 68 | 269 | ||||||||||||||||||
Provision (reallocation) charged to operating expense | 418 | 393 | 82 | (280 | ) | 175 | 788 | |||||||||||||||||
Ending balance | $ | 2,369 | $ | 1,382 | $ | 717 | $ | 520 | $ | 117 | $ | 5,105 | ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Beginning balance | $ | 1,734 | $ | 906 | $ | 690 | $ | 524 | $ | 26 | $ | 3,880 | ||||||||||||
Loans charged off | (95 | ) | (247 | ) | (50 | ) | — | (114 | ) | (506 | ) | |||||||||||||
Recoveries of loans charged off | — | — | 26 | 19 | 12 | 57 | ||||||||||||||||||
Provision (reallocation) charged to operating expense | 267 | 356 | (39 | ) | 234 | 105 | 923 | |||||||||||||||||
Ending balance | $ | 1,906 | $ | 1,015 | $ | 627 | $ | 777 | $ | 29 | $ | 4,354 | ||||||||||||
69
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
A description of the general characteristics of the risk grades used by the Company is as follows:
Pass: Loans in this risk category involve borrowers of acceptable-to-strong credit quality and risk who have the apparent ability to satisfy their loan obligations. Loans 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 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 may remain in this risk category for six months and then are either upgraded or downgraded upon subsequent evaluation.
Special Mention: Loans in this risk grade are the equivalent of the regulatory definition of "Other Assets Especially Mentioned" classification. Loans 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 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 so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans 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 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 has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Charge-offs against the allowance for loan losses are taken in the period in which the loan becomes uncollectible. Consequently, the Company typically does not maintain a recorded investment in loans within this category.
The following tables outline the amount of each loan classification and the amount categorized into each risk rating as of December 31, 2016 and 2015 (amounts in thousands):
Non PCI Loans
December 31, 2016 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Pass | $ | 399,505 | $ | 177,466 | $ | 115,237 | $ | 82,992 | $ | 7,238 | $ | 782,438 | ||||||||||||
Watch | 640 | 550 | 89 | 252 | — | 1,531 | ||||||||||||||||||
Special mention | — | 104 | — | — | 237 | 341 | ||||||||||||||||||
Substandard | 120 | 678 | 865 | 210 | — | 1,873 | ||||||||||||||||||
Doubtful | — | — | — | — | — | — | ||||||||||||||||||
Total | $ | 400,265 | $ | 178,798 | $ | 116,191 | $ | 83,454 | $ | 7,475 | $ | 786,183 | ||||||||||||
70
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
PCI Loans
December 31, 2016 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Pass | $ | 11,836 | $ | 6,811 | $ | 1,019 | $ | 1,507 | $ | — | $ | 21,173 | ||||||||||||
Watch | 1,045 | 1,577 | 645 | 22 | — | 3,289 | ||||||||||||||||||
Special mention | — | — | — | 12 | — | 12 | ||||||||||||||||||
Substandard | 2,062 | 616 | 14 | — | — | 2,692 | ||||||||||||||||||
Doubtful | — | — | — | 27 | — | 27 | ||||||||||||||||||
Total | $ | 14,943 | $ | 9,004 | $ | 1,678 | $ | 1,568 | $ | — | $ | 27,193 | ||||||||||||
Total loans | $ | 415,208 | $ | 187,802 | $ | 117,869 | $ | 85,022 | $ | 7,475 | $ | 813,376 | ||||||||||||
Non PCI Loans
December 31, 2015 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Pass | $ | 349,030 | $ | 146,645 | $ | 101,751 | $ | 81,683 | $ | 5,815 | $ | 684,924 | ||||||||||||
Watch | 184 | 327 | — | — | — | 511 | ||||||||||||||||||
Special mention | 387 | — | — | 32 | — | 419 | ||||||||||||||||||
Substandard | 126 | 1,958 | 1,032 | 468 | — | 3,584 | ||||||||||||||||||
Doubtful | — | — | — | — | — | — | ||||||||||||||||||
Total | $ | 349,727 | $ | 148,930 | $ | 102,783 | $ | 82,183 | $ | 5,815 | $ | 689,438 | ||||||||||||
PCI Loans
December 31, 2015 | ||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | Construction and Land Development | Commercial and Industrial | Consumer and Other | Total | |||||||||||||||||||
Pass | $ | 17,127 | $ | 11,635 | $ | 1,947 | $ | 2,458 | $ | — | $ | 33,167 | ||||||||||||
Watch | — | 260 | — | — | — | 260 | ||||||||||||||||||
Special mention | 1,975 | — | 526 | 221 | — | 2,722 | ||||||||||||||||||
Substandard | 948 | 869 | 222 | 89 | — | 2,128 | ||||||||||||||||||
Doubtful | — | — | — | — | — | — | ||||||||||||||||||
Total | $ | 20,050 | $ | 12,764 | $ | 2,695 | $ | 2,768 | $ | — | $ | 38,277 | ||||||||||||
Total loans | $ | 369,777 | $ | 161,694 | $ | 105,478 | $ | 84,951 | $ | 5,815 | $ | 727,715 | ||||||||||||
71
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Past Due Loans:
A loan 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 agreement. Generally, management places a loan on nonaccrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due.
The following tables present the aging of the recorded investment in loans and leases as of December 31, 2016 and 2015 (amounts in thousands):
December 31, 2016 | ||||||||||||||||||||||||||||
30-89 Days Past Due and Accruing | Past Due 90 Days or More and Accruing | Nonaccrual | Total Past Due | PCI Loans | Current Loans | Total Loans | ||||||||||||||||||||||
Commercial real estate | $ | 395 | $ | — | $ | — | $ | 395 | $ | 14,943 | $ | 399,870 | $ | 415,208 | ||||||||||||||
Consumer real estate | 695 | 699 | 386 | 1,780 | 9,004 | 177,018 | 187,802 | |||||||||||||||||||||
Construction and land development | 690 | — | 865 | 1,555 | 1,678 | 114,636 | 117,869 | |||||||||||||||||||||
Commercial and industrial | 257 | — | 164 | 421 | 1,568 | 83,033 | 85,022 | |||||||||||||||||||||
Consumer and other | 17 | — | — | 17 | — | 7,458 | 7,475 | |||||||||||||||||||||
Total | $ | 2,054 | $ | 699 | $ | 1,415 | $ | 4,168 | $ | 27,193 | $ | 782,015 | $ | 813,376 | ||||||||||||||
December 31, 2015 | ||||||||||||||||||||||||||||
30-89 Days Past Due and Accruing | Past Due 90 Days or More and Accruing | Nonaccrual | Total Past Due | PCI Loans | Current Loans | Total Loans | ||||||||||||||||||||||
Commercial real estate | $ | 471 | $ | 258 | $ | — | $ | 729 | $ | 20,050 | $ | 348,998 | $ | 369,777 | ||||||||||||||
Consumer real estate | 581 | 232 | 1,351 | 2,164 | 12,764 | 146,766 | 161,694 | |||||||||||||||||||||
Construction and land development | 137 | — | 483 | 620 | 2,695 | 102,163 | 105,478 | |||||||||||||||||||||
Commercial and industrial | 207 | 12 | 418 | 637 | 2,768 | 81,546 | 84,951 | |||||||||||||||||||||
Consumer and other | 12 | — | — | 12 | — | 5,803 | 5,815 | |||||||||||||||||||||
Total | $ | 1,408 | $ | 502 | $ | 2,252 | $ | 4,162 | $ | 38,277 | $ | 685,276 | $ | 727,715 | ||||||||||||||
72
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Impaired Loans:
A loan 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 agreement.
The following is an analysis of the impaired loan portfolio detailing the related allowance recorded as of and for the years ended December 31, 2016 and 2015 (amounts in thousands):
For the year ended | ||||||||||||||||||||
At December 31, 2016 | December 31, 2016 | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||
Impaired loans without a valuation allowance: | ||||||||||||||||||||
Non PCI Loans: | ||||||||||||||||||||
Commercial real estate | $ | 119 | $ | 119 | $ | — | $ | 1,311 | $ | 73 | ||||||||||
Consumer real estate | 821 | 849 | — | 2,334 | 100 | |||||||||||||||
Construction and land development | 865 | 865 | — | 967 | 3 | |||||||||||||||
Commercial and industrial | 46 | 46 | — | 47 | 4 | |||||||||||||||
Consumer and other | — | — | — | — | — | |||||||||||||||
1,851 | 1,879 | — | 4,659 | 180 | ||||||||||||||||
PCI loans: None in 2016 | ||||||||||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||||||||||
Non PCI Loans: | ||||||||||||||||||||
Commercial real estate | — | — | — | — | — | |||||||||||||||
Consumer real estate | — | — | — | — | — | |||||||||||||||
Construction and land development | — | — | — | — | — | |||||||||||||||
Commercial and industrial | 164 | 243 | 4 | 306 | 70 | |||||||||||||||
Consumer and other | — | — | — | — | — | |||||||||||||||
164 | 243 | 4 | 306 | 70 | ||||||||||||||||
PCI loans: None in 2016 | ||||||||||||||||||||
Total impaired loans | $ | 2,015 | $ | 2,122 | $ | 4 | $ | 4,965 | $ | 250 | ||||||||||
73
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Impaired Loans (continued):
For the year ended | ||||||||||||||||||||
At December 31, 2015 | December 31, 2015 | |||||||||||||||||||
Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||
Impaired loans without a valuation allowance: | ||||||||||||||||||||
Non PCI Loans: | ||||||||||||||||||||
Commercial real estate | $ | 1,952 | $ | 1,952 | $ | — | $ | 1,898 | $ | 73 | ||||||||||
Consumer real estate | 3,641 | 4,341 | — | 4,003 | 81 | |||||||||||||||
Construction and land development | 1,033 | 1,033 | — | 1,044 | 26 | |||||||||||||||
Commercial and industrial | 49 | 49 | — | 54 | 3 | |||||||||||||||
Consumer and other | — | — | — | — | — | |||||||||||||||
6,675 | 7,375 | — | 6,999 | 183 | ||||||||||||||||
PCI loans: None in 2015 | ||||||||||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||||||||||
Non PCI Loans: | ||||||||||||||||||||
Commercial real estate | — | — | — | — | — | |||||||||||||||
Consumer real estate | — | — | — | — | — | |||||||||||||||
Construction and land development | — | — | — | — | — | |||||||||||||||
Commercial and industrial | 418 | 418 | 258 | 448 | — | |||||||||||||||
Consumer and other | — | — | — | — | — | |||||||||||||||
418 | 418 | 258 | 448 | — | ||||||||||||||||
PCI loans: None in 2015 | ||||||||||||||||||||
Total impaired loans | $ | 7,093 | $ | 7,793 | $ | 258 | $ | 7,447 | $ | 183 | ||||||||||
Troubled Debt Restructurings:
At December 31, 2016 and 2015, impaired loans included loans that were classified as Troubled Debt Restructurings ("TDRs"). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.
In assessing whether or not a borrower is experiencing financial difficulties, the Company considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy; and (iv) the debtor's projected cash flow is sufficient to satisfy contractual payments due under the original terms of the loan without a modification.
The Company considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Company include the debtor's ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan.
74
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
Troubled Debt Restructurings (continued):
The most common concessions granted by the Company generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt; (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk; (iii) a temporary period of interest-only payments; and (iv) a reduction in the contractual payment amount for either a short period or remaining term of the loan. As of December 31, 2016 and 2015, management had approximately $608,000 and $4,990,000, respectively, in loans that met the criteria for restructured, which included approximately $442,000 and $1,297,000, respectively, of loans on nonaccrual. A loan is placed back on accrual status when both principal and interest are current and it is probable that management will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
The following table presents a summary of loans that were modified as troubled debt restructurings during the year ended December 31, 2016 (amounts in thousands):
December 31, 2016 | Number of Contracts | Pre-Modification Outstanding Recorded Investment | Post-Modification Outstanding Recorded Investment | |||||||
Construction and land development | 1 | $ | 278 | $ | 278 | |||||
Commercial and industrial | 1 | 164 | 164 | |||||||
There were no loans modified as troubled debt restructurings during the year ended December 31, 2015.
There were no loans that were modified as troubled debt restructurings during the past twelve months and for which there was a subsequent payment default.
Purchased Credit Impaired Loans:
The Company has acquired loans which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans at for the years ended December 31, 2016 and 2015 is as follows (in thousands):
2016 | 2015 | |||||
Commercial real estate | $ | 18,473 | $ | 22,995 | ||
Consumer real estate | 12,111 | 16,909 | ||||
Construction and land development | 2,553 | 3,553 | ||||
Commercial and industrial | 2,482 | 3,660 | ||||
Consumer and other | — | — | ||||
Total loans | $ | 35,619 | $ | 47,117 | ||
Less remaining purchase discount | (8,426 | ) | (8,840 | ) | ||
Total, gross | 27,193 | 38,277 | ||||
Less: Allowance for loan losses | — | — | ||||
Carrying amount, net of allowance | $ | 27,193 | $ | 38,277 | ||
The following is a summary of the accretable discount on acquired loans for the years ended December 31, 2016 and 2015 (in thousands):
75
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 4. Loans and Allowance for Loan Losses, Continued
2016 | 2015 | |||||||
Accretable yield, beginning of period | $ | 10,217 | $ | 7,983 | ||||
Additions | — | 4,282 | ||||||
Accretion income | (2,588 | ) | (1,805 | ) | ||||
Reclassification from nonaccretable | 1,585 | 151 | ||||||
Other changes, net | (264 | ) | (394 | ) | ||||
Accretable yield, end of period | $ | 8,950 | $ | 10,217 | ||||
The Company did not increase the allowance for loan losses on purchase credit impaired loans during the years ended December 31, 2016 and 2015.
Related Party Loans:
In the ordinary course of business, the Company has granted loans to certain related parties, including directors, executive officers, and their affiliates. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan. A summary of activity in loans to related parties is as follows (in thousands):
2016 | 2015 | |||||||
Balance, beginning of year | $ | 10,851 | $ | 14,813 | ||||
Disbursements | 855 | 548 | ||||||
Removal of credit lines | (1,153 | ) | — | |||||
Changes in ownership | 4,830 | — | ||||||
Repayments | (2,384 | ) | (4,510 | ) | ||||
Balance, end of year | $ | 12,999 | $ | 10,851 | ||||
At December 31, 2016, the Company had pre-approved but unused lines of credit totaling approximately $2,247,000 to related parties.
Note 5. Premises and Equipment
A summary of premises and equipment at December 31, 2016 and 2015, is as follows (in thousands):
2016 | 2015 | |||||||
Land and land improvements | $ | 8,354 | $ | 7,012 | ||||
Building and leasehold improvements | 18,507 | 16,933 | ||||||
Furniture, fixtures and equipment | 7,043 | 5,701 | ||||||
Construction in progress | 2,789 | 188 | ||||||
Total, gross | 36,693 | 29,834 | ||||||
Accumulated depreciation | (6,157 | ) | (4,796 | ) | ||||
Total, net | $ | 30,536 | $ | 25,038 | ||||
At December 31, 2016 management estimates the cost necessary to complete the construction in progress will be approximately $890 thousand.
76
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 5. Premises and Equipment, Continued
The Company leases several branch locations and also has one ground lease under non-cancelable operating lease agreements. The leases expire between May 2017 and August 2021. Lease expense under the leases was $728,004 and $565,667 in 2016 and 2015, respectively. At December 31, 2016, the remaining minimum lease payments relating to these leases were as follows (in thousands):
2017 | $ | 518 | |
2018 | 300 | ||
2019 | 292 | ||
2020 | 292 | ||
2021 | 173 | ||
Depreciation expense was $1,435,090 and $992,746 for the years ended December 31, 2016 and 2015, respectively.
Related party transaction:
On September 25, 2014, the board of directors voted to approve the purchase of the Cornerstone Community Bank Miller Plaza Branch facility located at 835 Georgia Avenue, Chattanooga, Tennessee in the form of a condominium from Lamp Post Properties. The chairman of the board, Miller Welborn, previously owned 20% of Lamp Post Properties and, therefore, Mr. Welborn abstained from the September 25, 2014 vote. The purchase price of the building was $1.4 million and included two full floors and one partial floor of the building, parking, naming rights and signage privileges for the building, among certain other property rights. The transaction closed on February 24, 2015. As of October 1, 2015, Mr. Welborn has no ownership in Lamp Post Properties.
Note 6. Deposits
The aggregate amount of time deposits in denominations of $250,000 or more was approximately $123,053,000 and $102,694,000 at December 31, 2016 and 2015, respectively. At December 31, 2016, the scheduled maturities of time deposits are as follows (in thousands):
2017 | $ | 193,389 | |
2018 | 82,529 | ||
2019 | 18,403 | ||
2020 | 14,713 | ||
2021 | 6,817 | ||
Thereafter | 120 | ||
Total | $ | 315,971 | |
As of December 31, 2016 there was a fair value adjustment of $303,981 to time deposits as a result of the business combination discussed in Note 2.
At December 31, 2016 and 2015, the Company had $76,380 and $81,859, respectively, of deposit accounts in overdraft status that have been reclassified to loans on the accompanying consolidated balance sheets. From time to time, the Company engages in deposit transactions with its directors, executive officers and their related interests (collectively referred to as "related parties"). Such deposits are made in the ordinary course of business and on substantially the same terms as those for comparable transactions prevailing at the time and do not present other unfavorable features. The total amount of related party deposits was $15.1 million and $5.6 million at December 31, 2016 and 2015, respectively.
77
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 7. Goodwill and Intangible Assets
Goodwill
Goodwill represents the excess of the purchase price over the fair value of acquired net assets under the acquisition method of accounting. The merger with Cornerstone discussed in Note 2 generated $4,166,069 in goodwill on August 31, 2015. Goodwill is reviewed for potential impairment at least annually at the reporting unit level. 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. If an entity does a qualitative assessment and determines that this is the case, or if a qualitative assessment is not performed, it is required to perform additional goodwill impairment testing to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on a qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required.
Intangible Assets
Finite lived intangible assets of the Company represent a core deposit premium recorded upon the purchase of certain assets and liabilities from other financial institutions. The Company reviews the carrying value of this intangible on an annual basis and on an interim basis if certain events or circumstances indicate that an impairment loss may have been incurred. Management has determined that no impairment has occurred on this asset.
The following table presents information about our core deposit premium intangible asset at December 31 (in thousands):
2016 | 2015 | |||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | |||||||||||||
Amortized intangible asset: | ||||||||||||||||
Core deposit intangible | $ | 2,750 | $ | 280 | $ | 3,375 | $ | 600 | ||||||||
The following table presents information about aggregate amortization expense for 2016 and 2015 and for the succeeding fiscal years as follows (in thousands):
2016 | 2015 | |||||||
Aggregate amortization expense of core deposit premium intangible | $ | 305 | $ | 233 | ||||
Estimated aggregate amortization expense of the core deposit premium intangible for the year ending December 31 (in thousands):
2017 | $ | 210 | |
2018 | 210 | ||
2019 | 210 | ||
2020 | 210 | ||
2021 | 210 | ||
Thereafter | 1,420 | ||
Total | $ | 2,470 | |
78
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 8. Income Taxes
Income tax expense in the consolidated statements of income for the years ended December 31, 2016 and 2015, includes the following (in thousands):
2016 | 2015 | |||||||
Current tax expense | ||||||||
Federal | $ | 2,503 | $ | 77 | ||||
State | 531 | 167 | ||||||
Deferred tax expense (benefit) related to: | ||||||||
Provision for loan losses | (320 | ) | (250 | ) | ||||
Depreciation | 203 | (12 | ) | |||||
Fair value adjustments | 356 | 469 | ||||||
Nonaccrual interest | (26 | ) | 121 | |||||
Foreclosed real estate | 117 | 1,008 | ||||||
Core deposit intangible | (117 | ) | (89 | ) | ||||
Other | 115 | 150 | ||||||
Total income tax expense | $ | 3,362 | $ | 1,641 | ||||
The income tax expense is different from the expected tax expense computed by multiplying income before income tax expense by the statutory income tax rates. The reasons for this difference are as follows (in thousands):
2016 | 2015 | |||||||
Federal income tax expense computed at the statutory rate | $ | 3,115 | $ | 1,071 | ||||
State income taxes, net of federal tax benefit | 393 | 176 | ||||||
Nondeductible acquisition expenses | — | 295 | ||||||
Other | (146 | ) | 99 | |||||
Total income tax expense | $ | 3,362 | $ | 1,641 | ||||
The components of the net deferred tax asset as of December 31, 2016 and 2015, were as follows (in thousands):
2016 | 2015 | |||||||
Deferred tax assets: | ||||||||
Allowance for loan losses | $ | 1,932 | $ | 1,667 | ||||
Fair value adjustments | 3,744 | 4,219 | ||||||
Foreclosed real estate | 539 | 656 | ||||||
Deferred compensation | 415 | 253 | ||||||
State net operating loss carryforward | — | 339 | ||||||
Other | 561 | 618 | ||||||
Total deferred tax assets | 7,191 | 7,752 | ||||||
Deferred tax liabilities: | ||||||||
Accumulated depreciation | 1,903 | 1,699 | ||||||
Core deposit intangible | 946 | 1,063 | ||||||
Other | 639 | 743 | ||||||
Total deferred tax liabilities | 3,488 | 3,505 | ||||||
Net deferred tax asset | $ | 3,703 | $ | 4,247 | ||||
The income tax returns of the Company for 2015, 2014, and 2013 are subject to examination by the federal and state taxing authorities, generally for three years after they were filed.
79
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 9. Federal Home Loan Bank Advances and Other Borrowings
Line of Credit:
On August 28, 2015, the Company entered into a loan agreement (the “Loan Agreement”) with CapStar Bank (the “Lender”) providing for a revolving line of credit of up to $8,000,000. The Company may borrow and reborrow under the revolving line of credit until February 28, 2017, after which no advances under the revolving line of credit may be reborrowed. During the first 90 days of the revolving line of credit or at any time during which the Bank maintains daily settlement accounts at the Lender, borrowings accrue interest at the Lender’s prime rate, subject to a 3.00% floor.
Beginning 90 days after the effective date of the revolving line of credit, the Company is required to pay quarterly payments of interest. In addition, commencing on April 15, 2017, the Company must pay quarterly principal amortization payments of $125,000 for each fiscal quarter in 2017, $190,000 for each fiscal quarter in 2018 and $210,000 for each fiscal quarter in 2019 and 2020 until and including the maturity date. The scheduled principal amortization payments are based upon the assumption that the revolving line of credit is fully drawn, and the required payments will be reduced on a pro-rata basis relative to the amount borrowed if the revolving line of credit is not fully drawn. The loan will mature on August 28, 2020, at which time all outstanding amounts under the loan agreement will become due and payable. In connection with entering into the Loan Agreement, the Company issued to the Lender a line of credit note dated as of August 28, 2015.
The Loan Agreement contains typical representations, warranties and covenants for a revolving line of credit, and the loan agreement has certain financial covenants and capital ratio requirements. Pursuant to the Loan Agreement, the Bank may not permit non-performing assets to be greater than 3.25% of total assets. The Bank must not permit its Texas ratio (nonperforming assets divided by the sum of tangible equity plus the allowance for loan and lease losses) to be greater than 35.00%, and must not permit its liquidity ratio to be less than 9.00% (or less than 10.00% for two consecutive quarters). In addition, the Company will not permit its debt service coverage ratio to be less than 1.25:1.00 or its interest coverage ratio to be less than 2:50:1.00. As of December 31, 2016, the Company and the Bank were in compliance with all of the loan covenants.
The Loan Agreement has standard and commercially reasonable events of default, such as non-payment, failure to perform any covenant or agreement, breach of any representation or warranty, failure to pay other material indebtedness, bankruptcy, insolvency, any ERISA event, any material judgment, any material adverse effect, any change in control, any failure to be insured by the FDIC or any action by a governmental or regulatory authority, etc. The Lender has the right to accelerate the indebtedness upon an event of default.
The obligations of the Company under the Loan Agreement are secured by a pledge of all of the capital stock of the Bank pursuant to stock pledge and security agreements. In the event of a default by the Company under the loan Agreement, the lender may terminate the commitments made under the loan agreement, declare all amounts outstanding to be payable immediately, and exercise or pursue any other remedy permitted under the loan agreement or the pledge agreements, or conferred to the lender by operation of law. As of December 31, 2015, the outstanding borrowings under the line of credit were $2,000,000 and the rate was 3.50%. The line of credit was paid in full in March 2016 and there have been no advances during 2016.
The primary source of liquidity for the Company is the payment of dividends from the Bank. As of December 31, 2016, the Bank was under no dividend restrictions that requires regulatory approval prior to the payment of a dividend from the Bank to the Company.
80
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 9. Federal Home Loan Bank Advances and Other Borrowings, Continued
FHLB borrowings:
The Bank has agreements with the Federal Home Loan Bank of Cincinnati (FHLB) that can provide advances to the Bank in an amount up to $52,550,939. All of the loans are secured by first mortgages on 1-4 family residential, multi-family properties and commercial properties and are pledged as collateral for these advances. Additionally, the Bank pledged securities to FHLB with a carrying amount of $14,844,441 at December 31, 2016 and $23,853,366 at December 31, 2015.
At December 31, 2016, FHLB advances consist of the following (amounts in thousands):
Long-term advance dated January 10, 2007, requiring monthly interest payments, fixed at 4.25%, with a put option exercisable in January 2008 and then quarterly thereafter, principal due in January 2017 | $ | 5,000 | |
At December 31, 2015, FHLB advances consist of the following (amounts in thousands):
Short-term advance dated January 28, 2015, requiring monthly interest payments, fixed at 0.63%, principal due in July 2016 | $ | 5,000 | |
Short-term advance dated January 28, 2015, requiring monthly interest payments, fixed at 0.43%, principal due in January 2016 | 8,000 | ||
Short-term advance dated August 31, 2015, requiring monthly interest payments, fixed at 0.41%, principal due in February 2016 | 5,000 | ||
Long-term advance dated January 20, 2006, requiring monthly interest payments, fixed at 4.18%, with a put option exercisable in January 2009 and then quarterly thereafter, principal due in January 2016 | 5,000 | ||
Long-term advance dated January 10, 2007, requiring monthly interest payments, fixed at 4.25%, with a put option exercisable in January 2008 and then quarterly thereafter, principal due in January 2017 | 5,000 | ||
Total | $ | 28,000 | |
As of December 31, 2016 and December 31, 2015, there was a fair value adjustment of $5,765 and $187,462 , respectively, to FHLB borrowings as a result of the business combination discussed in Note 2.
During the fixed rate term, the advances may be prepaid subject to a prepayment penalty as defined in the agreements. On agreements with put options, the FHLB has the right, at its discretion, to terminate the entire advance prior to the stated maturity date. The termination option may only be exercised on the expiration date of the predetermined lockout period and on a quarterly basis thereafter.
At December 31, 2016, scheduled maturities of the Federal Home Loan Bank advances, federal funds purchased of $13,499,625, and other borrowings are as follows (amounts in thousands):
2017 | $18,500 |
81
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 10. 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 one year of service the Company matches 100 percent of employee contributions up to 3 percent of compensation and 50 percent of employee contributions on the next 2 percent of compensation. The Company's contribution to the Plan was $403,309 in 2016 and $219,017 in 2015.
Stock Option Plans:
The Company has one currently active equity incentive plan administered by the Board of Directors, and four plans or programs, pursuant to which the Company has outstanding prior grants. These plans are described below:
Legacy Cornerstone Bancshares, Inc. 2002 Long Term Incentive Plan – The plan provided Cornerstone Bancshares, Inc. officers and employees incentive stock options or non-qualified stock options to purchase shares of common stock. The exercise price for incentive stock options was not less than 100 percent of the fair market value of the common stock on the date of the grant. The exercise price of the non-qualified stock options was equal to or more or less than the fair market value of the common stock on the date of the grant. This plan expired in 2012.
Legacy Cornerstone Non-Qualified Plan Options — During 2013 and 2014, Cornerstone issued non-qualified options to employees and directors. The options were originally documented in 2013 as being issued out of the Cornerstone Bancshares, Inc. 2002 Long Term Incentive Plan but that plan expired in 2012. The non-qualified options are governed by the grant document issued to the holders which incorporate the terms of the plan by reference.
Legacy SmartBank Stock Option Plan – This plan was assumed by the Company on August 31, 2015. The plan provides for incentive stock options and nonqualified stock options. The maximum number of common shares that could be sold or optioned under the plan is 525,000 shares. Under the plan, the exercise price of each option could not be less than 100 percent of the fair market value of the common stock on the date of grant.
Legacy SmartFinancial, Inc. 2010 Incentive Plan - This plan was assumed by the Company on August 31, 2015. This plan provides for incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance awards, dividend equivalents and stock or other stock-based awards. The maximum number of common shares that could be sold or optioned under the plan is 525,000 shares. Under the plan, the exercise price of each option could not be less than 100 percent of the fair market value of the common stock on the date of grant.
2015 Stock Incentive Plan – This plan provides for incentive stock options, nonqualified stock options, and restricted stock. The maximum number of shares of common stock that can be sold or optioned under the plan is 2,000,000 shares. The term of each option shall be no more than ten years from the date of grant. In the case of an incentive stock option granted to a participant who, at the time the option is granted, owns stock representing more than ten percent of the voting power of all classes of stock of the Company or any parent or subsidiary thereof, the term of the option shall be five years from the date of grant or such shorter term as may be provided in the award agreement.
The per share exercise price for the shares to be issued upon exercise of an option shall be such price as is determined by the plan administrator, subject to the following: In the case of an incentive stock option: (1) granted to an employee who, at the time of grant of such option, owns stock representing more than ten percent of the voting power of all classes of stock of the company or any parent or subsidiary thereof, the exercise price shall be no less than one hundred and ten percent of the fair market value per share on the date of grant; or (2) granted to any other employee, the per share exercise price shall be no less than one hundred percent of the fair market value per share on the date of grant. In the case of a nonstatutory stock option, the per share exercise price shall be no less than one hundred percent of the fair market value per share on the date of grant, unless otherwise determined by the Administrator.
The incentive stock options vest 30 percent on the second anniversary of the grant date, 30 percent on the third anniversary of the grant date and 40 percent on the fourth anniversary of the grant date. Director non-qualified stock options vest 50 percent on the first anniversary of the grant date and 50 percent on the second anniversary of the grant date.
82
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 10. Employee Benefit Plans, Continued
Stock Option Plans (continued):
A summary of the status of these stock option plans is presented in the following table:
Number | Weighted Average Exercisable Price | ||||||
Outstanding at December 31, 2015 | 817,414 | $ | 10.62 | ||||
Granted | — | — | |||||
Exercised | (89,556 | ) | 8.98 | ||||
Forfeited | (10,334 | ) | 28.49 | ||||
Outstanding at December 31, 2016 | 717,524 | $ | 10.57 | ||||
Number | Weighted Average Exercisable Price | ||||||
Outstanding at December 31, 2014 | 483,629 | $ | 10.20 | ||||
Granted | 52,689 | 15.05 | |||||
Exercised | (24,292 | ) | 8.79 | ||||
Share conversion | 23,468 | 9.71 | |||||
Retained by Cornerstone shareholders in merger | 285,209 | 11.22 | |||||
Forfeited | (3,289 | ) | 10.83 | ||||
Outstanding at December 31, 2015 | 817,414 | $ | 10.62 | ||||
Information pertaining to options outstanding at December 31, 2016, is as follows:
Options Outstanding | Options Exercisable | ||||||||||||||
Weighted- Average Remaining | Weighted- Average | Weighted- Average | |||||||||||||
Exercise | Number | Contractual | Exercise | Number | Exercise | ||||||||||
Prices | Outstanding | Life | Price | Exercisable | Price | ||||||||||
6.20 | 750 | 4.3 years | 6.20 | 750 | 6.20 | ||||||||||
6.60 | 47,750 | 5.2 years | 6.60 | 47,750 | 6.60 | ||||||||||
6.80 | 24,375 | 4.2 years | 6.80 | 24,375 | 6.80 | ||||||||||
9.48 | 42,625 | 6.2 years | 9.48 | 42,625 | 9.48 | ||||||||||
9.52 | 380,100 | 0.2 years | 9.52 | 380,100 | 9.52 | ||||||||||
9.60 | 52,875 | 7.2 years | 9.60 | 52,875 | 9.60 | ||||||||||
10.00 | 1,250 | 6.6 years | 10.00 | 1,250 | 10.00 | ||||||||||
10.48 | 76,271 | 0.3 years | 10.48 | 76,271 | 10.48 | ||||||||||
11.67 | 3,250 | 4.1 years | 11.67 | 3,250 | 11.67 | ||||||||||
14.40 | 18,555 | 2.2 years | 14.40 | 18,555 | 14.40 | ||||||||||
15.05 | 52,074 | 8.8 years | 15.05 | 4,104 | 15.05 | ||||||||||
31.96 | 14,166 | 1.2 years | 31.96 | 14,166 | 31.96 | ||||||||||
60.80 | 688 | 0.3 years | 60.80 | 688 | 60.80 | ||||||||||
61.00 | 2,795 | 0.2 years | 61.00 | 2,795 | 61.00 | ||||||||||
Outstanding, end of year | 717,524 | 2.3 years | 10.57 | 669,554 | 10.25 | ||||||||||
83
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 10. Employee Benefit Plans, Continued
Stock Option Plans (continued):
The Company recognized stock-based compensation expense of $132,635 and $140,077 for the periods ended December 31, 2016 and 2015, respectively. There was no direct grant stock grant expense for the period ended December 31, 2016. For the period ended December 31, 2015 direct stock grant expense issued to Directors of $100,216 was included in the stock-based compensation. The total fair value of shares underlying the options which vested during the periods ended December 31, 2016 and 2015, was $95,658 and $103,604, respectively. The income tax benefit recognized for the exercise of options for the periods ended December 31, 2016 and 2015 was $660,567 and $27,738 respectively.
The intrinsic value of options exercised during the periods ended December 31, 2016 and 2015 was $660,476 and $171,574, respectively. The aggregate intrinsic value of total options outstanding and exercisable options at December 31, 2016 was $6,074,252 and $5,905,718, respectively. Cash received from options exercised under all share-based payment arrangements for the period ended December 31, 2016 was $803,957.
Information related to non-vested options for the period ended December 31, 2016, is as follows:
Number | Weighted Average Grant-Date Fair Value | ||||||
Nonvested at December 31, 2015 | 53,739 | $ | 12.12 | ||||
Granted | — | — | |||||
Vested | (5,154 | ) | 10.25 | ||||
Forfeited/expired | (615 | ) | 12.31 | ||||
Nonvested at December 31, 2016 | 47,970 | $ | 12.31 | ||||
As of December 31, 2016, there was approximately $365,000 of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Plans. The cost is expected to be recognized over a weighted-average period of 4.0 years. There were no stock options granted during the twelve months period ended December 31, 2016.
The weighted average grant date fair value of all stock options granted during the twelve months ended December 31, 2015 was $12.31. This was determined using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Dividend yield | — | % |
Expected life | 10 Years | |
Expected volatility | 81.7 | % |
Risk-free interest rate | 1.54 | % |
84
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 11. 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.
At December 31, 2016 and 2015, the Company had securities sold under agreements to repurchase of $26,621,984 and $28,068,215, respectively, with commercial checking customers.
Note 12. Commitments and Contingencies
Loan Commitments:
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 in the balance sheets. 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 at December 31, 2016 is as follows:
Commitments to extend credit | 145.3 | million |
Standby letters of credit, issued by the Company | 3.2 | million |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
Standby letters of credit issued by the Company are conditional commitments to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies and is required in instances which the Company deems necessary.
At December 31, 2016 and 2015, the carrying amount of liabilities related to the Company's obligation to perform under standby letters of credit was insignificant. The Company has not been required to perform on any standby letters of credit, and the Company has not incurred any losses on standby letters of credit for the years ended December 31, 2016 and 2015.
Contingencies:
In the normal course of business, the Company may become involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material effect on the Company's financial statements.
85
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 13. Regulatory Matters
Regulatory Capital Requirements:
The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions, by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.
Effective January 1, 2015, the Company and the Bank are subject to the new regulatory risk-based capital rules adopted by the federal banking agencies implementing Basel III. Under the new capital guidelines, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions. Cumulative preferred stock and trust preferred securities issued after May 19, 2010 will no longer qualify as Tier 1 capital, but such securities issued prior to May 19, 2010, including in the case of bank holding companies with less than $15 billion in total assets at that date, trust preferred securities issued prior to that date, will continue to count as Tier 1 capital subject to certain limitations. Tier 2 capital consists of the allowance for loan and lease losses in an amount not exceeding 1.25 percent of standardized risk-weighted assets, plus qualifying preferred stock, qualifying subordinated debt and qualifying total capital minority interest, net of Tier 2 investments in financial institutions. Total Tier 1 capital, plus Tier 2 capital, constitutes total risk-based capital. The required minimum ratios are as follows:
• | common equity Tier 1 capital ratio (common equity Tier 1 capital to standardized total risk-weighted assets) of 4.5%; |
• | Tier 1 capital ratio (Tier 1 capital to standardized total risk-weighted assets) of 6%; |
• | total capital ratio (total capital to standardized total risk-weighted assets) of 8%; and |
• | leverage ratio (Tier 1 capital to average total consolidated assets) of 4%. |
The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The capital conservation buffer requirement phasing in began on January 1, 2015 at the 0.625% level and will be increased by that same amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019. When fully phased in, the capital conservation buffer effectively will result in a required minimum common equity Tier 1 capital ratio of at least 7.0%, Tier 1 capital ratio of at least 8.5% and total capital ratio of at least 10.5%. The capital guidelines also provide for a “countercyclical capital buffer” that is applicable only to certain covered institutions and does not have any current applicability to the Company and the Bank. Failure to satisfy the capital buffer requirements will result in increasingly stringent limitations on various types of capital distributions, including dividends, share buybacks and discretionary payments on Tier 1 instruments, and discretionary bonus payments.
The final regulatory capital rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for “adequately capitalized” banking organizations are equal to the new minimum capital requirements. Under this framework, in order to be considered “well capitalized”, insured depository institutions are required to maintain a Tier 1 leverage ratio of 5%, a common equity Tier 1 risk-based capital measure of 6.5%, a Tier 1 risked-based capital ratio of 8% and a total risk-based capital ratio of 10%.
As permitted for regulated institutions that are not designated as ”advanced approach” banking organizations (those with assets greater than $250 billion or with foreign exposures greater than $10 billion), the Company and the Bank made a one-time, permanent election to opt out of the requirement to include most components of accumulated other comprehensive income in regulatory capital.
At December 31, 2016, both the Company and the Bank were well capitalized. At December 31, 2015, the Company and the Banks were well capitalized under the standards in effect at that time.
86
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 13. Regulatory Matters, Continued
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 (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. During the year ended December 31, 2016, SmartBank paid $3,000,000 in dividends to the Company. As of December 31, 2016, the Bank could pay approximately $6.6 million of additional dividends to the Company without prior approval of the Commissioner of the TDFI.
Regulatory Capital Levels:
Actual and required capital levels at December 31, 2016 and 2015 are presented below (dollars in thousands):
Actual | Minimum for capital adequacy purposes | Minimum to be well capitalized under prompt corrective action provisions | |||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||
December 31, 2016 | |||||||||||||||||||||
SmartFinancial, Inc. | |||||||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 105,756 | 11.99 | % | $ | 70,553 | 8.00 | % | $ | 88,191 | 10.00 | % | |||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 100,651 | 11.42 | % | 52,915 | 6.00 | % | 70,553 | 8.00 | % | ||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 88,651 | 10.05 | % | 39,686 | 4.50 | % | 57,324 | 6.50 | % | ||||||||||||
Tier 1 Capital (to Average Assets) | 100,651 | 9.81 | % | 41,052 | 4.00 | % | 51,315 | 5.00 | % | ||||||||||||
SmartBank | |||||||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 104,705 | 11.88 | % | $ | 70,535 | 8.00 | % | $ | 88,169 | 10.00 | % | |||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 99,600 | 11.30 | % | 52,901 | 6.00 | % | 70,535 | 8.00 | % | ||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 99,600 | 11.30 | % | 39,676 | 4.50 | % | 57,310 | 6.50 | % | ||||||||||||
Tier 1 Capital (to Average Assets) | 99,600 | 9.71 | % | 41,041 | 4.00 | % | 51,301 | 5.00 | % | ||||||||||||
87
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 13. Regulatory Matters, Continued
Regulatory Capital Levels (continued):
Actual | Minimum for capital adequacy purposes | Minimum to be well capitalized under prompt corrective action provisions | |||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||
December 31, 2015 | |||||||||||||||||||||
SmartFinancial, Inc. | |||||||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 99,616 | 12.32 | % | $ | 64,668 | 8.00 | % | $ | 80,835 | 10.00 | % | |||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 95,253 | 11.78 | % | 48,501 | 6.00 | % | 64,668 | 8.00 | % | ||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 83,253 | 10.30 | % | 36,376 | 4.50 | % | 52,543 | 6.50 | % | ||||||||||||
Tier 1 Capital (to Average Assets) | 95,253 | 9.45 | % | 40,307 | 4.00 | % | 50,383 | 5.00 | % | ||||||||||||
Cornerstone Community Bank | |||||||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 40,227 | 11.69 | % | $ | 27,559 | 8.00 | % | $ | 34,449 | 10.00 | % | |||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 39,717 | 11.53 | % | 20,669 | 6.00 | % | 27,559 | 8.00 | % | ||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 39,717 | 11.53 | % | 15,502 | 4.50 | % | 22,392 | 6.50 | % | ||||||||||||
Tier 1 Capital (to Average Assets) | 39,717 | 9.05 | % | 17,550 | 4.00 | % | 21,938 | 5.00 | % | ||||||||||||
SmartBank | |||||||||||||||||||||
Total Capital (to Risk-Weighted Assets) | $ | 60,349 | 13.03 | % | $ | 37,057 | 8.00 | % | $ | 46,322 | 10.00 | % | |||||||||
Tier 1 Capital (to Risk-Weighted Assets) | 56,546 | 12.21 | % | 27,793 | 6.00 | % | 37,057 | 8.00 | % | ||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 56,546 | 12.21 | % | 20,845 | 4.50 | % | 30,109 | 6.50 | % | ||||||||||||
Tier 1 Capital (to Average Assets) | 56,546 | 10.05 | % | 22,501 | 4.00 | % | 28,126 | 5.00 | % | ||||||||||||
Note 14. Concentrations of Credit Risk
The Company originates primarily commercial, residential, and consumer loans to customers in eastern Tennessee, northwest Florida and north Georgia. The ability of the majority of the Company's customers to honor their contractual loan obligations is dependent on the economy in these areas.
Eighty-nine percent of the Company's loan portfolio is concentrated in loans secured by real estate, of which a substantial portion is secured by real estate in the Company's primary market areas. Commercial real estate, including commercial construction loans, represented 61 percent of the loan portfolio at December 31, 2016, and 65 percent of the loan portfolio at December 31, 2015. Accordingly, the ultimate collectability of the loan portfolio and recovery of the carrying amount of foreclosed assets is susceptible to changes in real estate conditions in the Company's primary market areas. The other concentrations of credit by type of loan are set forth in Note 4.
The Bank, as a matter of policy, does not generally extend credit to any single borrower or group of related borrowers in excess of 25% of statutory capital, or approximately $25,256,000.
88
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 15. Fair Value of Assets and Liabilities
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 Fair Value Measurements and Disclosures topic (FASB ASC 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. However, in many instances, there are no quoted market prices for the Company's various financial instruments. 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.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) 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 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 I 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.
89
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 15. Fair Value of Assets and Liabilities, Continued
Fair Value Hierarchy (continued):
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and Cash Equivalents: For cash and due from banks, interest-bearing deposits, and federal funds sold, the carrying amount is a reasonable estimate of fair value based on the short-term nature of the assets and are considered Level 1 inputs.
Securities Available for Sale: Where quoted prices are available in an active market, management classifies the securities within Level 1 of the valuation hierarchy. If quoted market prices are not available, management estimates fair values using pricing models and discounted cash flows that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, and credit spreads. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, including GSE obligations, corporate bonds, and other securities. Mortgage-backed securities are included in Level 2 if observable inputs are available. In certain cases where there is limited activity or less transparency around inputs to the valuation, management classifies those securities in Level 3.
Restricted Investments: It is not practicable to determine the fair value of restricted investments due the restrictions placed on its transferability.
Loans:For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair value for fixed rate loans are estimated using discounted cash flow analyses, using market interest rates for comparable loans. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. These methods are considered Level 3 inputs.
Deposits:The fair values disclosed for demand deposits (for example, interest and noninterest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts) and are considered Level 1 inputs. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates on comparable instruments to a schedule of aggregated expected monthly maturities on time deposits, and are considered Level 2 inputs.
Securities Sold Under Agreement to Repurchase: The carrying value of these liabilities approximates their fair value, and are considered Level 1 inputs.
Federal Home Loan Bank Advances and Other Borrowings: The fair value of the FHLB fixed rate borrowings are estimated using discounted cash flows, based on the current incremental borrowing rates for similar types of borrowing arrangements, and are considered Level 2 inputs.
Commitments to Extend Credit and Standby Letters of Credit: Because commitments to extend credit and standby letters of credit are made using variable rates and have short maturities, the carrying value and the fair value are immaterial for disclosure.
90
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 15. Fair Value of Assets and Liabilities, Continued
Assets Measured at Fair Value on a Recurring Basis:
Assets recorded at fair value on a recurring basis are as follows, in thousands
Balance as of December 31, 2016 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Other Unobservable Inputs (Level 3) | |||||||||||||
Securities available-for-sale: | ||||||||||||||||
U.S. Government-sponsored enterprises (GSEs) | $ | 17,723 | $ | — | $ | 17,723 | $ | — | ||||||||
Municipal securities | 8,019 | — | 8,019 | — | ||||||||||||
Mortgage-backed securities | 103,680 | — | 103,680 | — | ||||||||||||
Total securities available-for-sale | $ | 129,422 | $ | — | $ | 129,422 | $ | — | ||||||||
Balance as of December 31, 2015 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Other Unobservable Inputs (Level 3) | |||||||||||||
Securities available-for-sale: | ||||||||||||||||
U.S. Government-sponsored enterprises (GSEs) | $ | 22,743 | $ | — | $ | 22,743 | $ | — | ||||||||
Municipal securities | 7,649 | — | 7,649 | — | ||||||||||||
Mortgage-backed securities | 136,021 | — | 136,021 | — | ||||||||||||
Total securities available-for-sale | $ | 166,413 | $ | — | $ | 166,413 | $ | — | ||||||||
The Company has no assets or liabilities whose fair values are measured on a recurring basis using Level 3 inputs. Additionally, there were no transfers between Level 1 and Level 2 in the fair value hierarchy.
Assets Measured at Fair Value on a Nonrecurring Basis:
Under certain circumstances management makes adjustments to 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):
Balance as of December 31, 2016 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Other Unobservable Inputs (Level 3) | |||||||||||||
Impaired loans | $ | 239 | $ | — | $ | — | $ | 239 | ||||||||
Foreclosed assets | 2,386 | — | — | 2,386 | ||||||||||||
91
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 15. Fair Value of Assets and Liabilities, Continued
Assets Measured at Fair Value on a Nonrecurring Basis (continued):
Balance as of December 31, 2015 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Other Unobservable Inputs (Level 3) | |||||||||||||
Impaired loans | $ | 160 | $ | — | $ | — | $ | 160 | ||||||||
Foreclosed assets | 5,358 | — | — | 5,358 | ||||||||||||
For Level 3 assets measured at fair value on a non-recurring basis as of December 31, 2016 and 2015, the significant unobservable inputs used in the fair value measurements are presented below.
Balance as of December 31, 2016 (in thousands) | Valuation Technique | Significant Other Unobservable Input | Weighted Average of Input | ||||||||
Impaired loans | $ | 239 | Cash Flow | Discounted Cash Flow / Appraisal Discounts | 2.4 | % | |||||
Foreclosed assets | 2,386 | Appraisal | Appraisal Discounts | 12.2 | % | ||||||
Balance as of December 31, 2015 (in thousands) | Valuation Technique | Significant Other Unobservable Input | Weighted Average of Input | ||||||||
Impaired loans | $ | 160 | Appraisal | Discounted Cash Flow / Appraisal Discounts | 6.0 | % | |||||
Foreclosed assets | 5,358 | Appraisal | Appraisal Discounts | 22.2 | % | ||||||
Impaired Loans: Loans considered impaired under ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent.
The fair value of impaired loans were measured based on the value of the collateral securing these loans or the discounted cash flows of the loans, as applicable. Impaired 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. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.
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SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 15. Fair Value of Assets and Liabilities, Continued
Assets Measured at Fair Value on a Nonrecurring Basis (continued):
Foreclosed assets: Foreclosed assets, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at fair value less estimated costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, a loss is recognized in noninterest expense.
Carrying value and estimated fair value:
The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2016 and December 31, 2015 are as follows (in thousands):
December 31, 2016 | December 31, 2015 | |||||||||||||||
Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | |||||||||||||
Assets: | ||||||||||||||||
Cash and cash equivalents | $ | 68,748 | $ | 68,748 | $ | 79,965 | $ | 79,965 | ||||||||
Securities available for sale | 129,422 | 129,422 | 166,413 | 166,413 | ||||||||||||
Restricted investments | 5,628 | N/A | 4,451 | N/A | ||||||||||||
Loans, net | 808,271 | 803,057 | 723,361 | 721,338 | ||||||||||||
Liabilities: | ||||||||||||||||
Noninterest-bearing demand deposits | 153,483 | 153,483 | 131,419 | 131,419 | ||||||||||||
Interest-bearing demand deposits | 162,702 | 162,702 | 149,424 | 149,424 | ||||||||||||
Savings deposits | 274,605 | 274,605 | 236,901 | 236,901 | ||||||||||||
Time deposits | 316,275 | 316,734 | 340,739 | 342,873 | ||||||||||||
Securities sold under agreements to repurchase | 26,622 | 26,622 | 28,068 | 28,068 | ||||||||||||
Federal Home Loan Bank advances and other borrowings | 18,505 | 18,505 | 34,187 | 34,169 | ||||||||||||
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. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. 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 the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
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SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 16. Small Business Lending Fund
During 2011, the Company issued to the Secretary of the Treasury 12,000 shares of preferred stock at $1,000 per share under the Small Business Lending Fund Program (the "SBLF Program"). Subject to regulatory approval, the Company may redeem the preferred stock for $1,000 per share, plus accrued and unpaid dividends, in whole or in part at any time. The SBLF Program is a voluntary program authorized under the Business Jobs Acts of 2010, whereby the United States Treasury can make capital investments in eligible institutions; the capital investments, in turn, are designed to increase the availability of credit for small businesses and promote economic growth by providing capital to qualified community banks at favorable rates. The Company paid cash dividends at a one percent rate or $120,000 for the year ended December 31, 2015. On February 4, 2016 the dividend rate for the preferred shares increased to nine percent and as a result the company incurred preferred stock dividends of $1,022,000 for the year ended December 31, 2016 .
On January 30, 2017, the Company completed a public offering of 2,010,084 million shares of its common stock, par value $1.00 per share, with the net proceeds to the Company of approximately $33.2 million. Subsequent to the public offering the Company used $12 million of the proceeds to redeem the preferred stock on March 6, 2017.
Note 17. Concentration in Deposits
The Company had a concentration in its deposits of one customer totaling approximately $28,527,000 at December 31, 2015 and two customers totaling approximately $60,153,000 concentration of deposits at December 31, 2016.
Note 18. Earnings Per Share
Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per 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. The effect from the stock options on incremental shares from the assumed conversions for net income per share-basic and net income per share-diluted are presented below. There were antidilutive shares of 17,649 and 22,300 for the years ended December 31, 2016 and 2015, respectively.
(Dollars in thousands, except share amounts) | 2016 | 2015 | ||||||
Basic earnings per share computation: | ||||||||
Net income available to common stockholders | $ | 4,777 | $ | 1,390 | ||||
Average common shares outstanding – basic | 5,838,574 | 3,985,202 | ||||||
Basic earnings per share | $ | 0.82 | $ | 0.35 | ||||
Diluted earnings per share computation: | ||||||||
Net income available to common stockholders | $ | 4,777 | $ | 1,390 | ||||
Average common shares outstanding – basic | 5,838,574 | 3,985,202 | ||||||
Incremental shares from assumed conversions: | ||||||||
Stock options | 280,369 | 296,307 | ||||||
Average common shares outstanding - diluted | 6,118,943 | 4,281,509 | ||||||
Diluted earnings per share | $ | 0.78 | $ | 0.32 | ||||
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SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 19. Condensed Parent Information
(Dollars in thousands)
CONDENSED BALANCE SHEETS | ||||||||
December 31, | December 31, | |||||||
2016 | 2015 | |||||||
ASSETS | ||||||||
Cash | $ | 2,068 | $ | 503 | ||||
Investment in subsidiaries | 100,023 | 97,020 | ||||||
Other assets | 4,392 | 4,817 | ||||||
Total assets | $ | 106,483 | $ | 102,340 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Other liabilities | $ | 1,243 | $ | 163 | ||||
Other borrowings | — | 2,000 | ||||||
Total liabilities | 1,243 | 2,163 | ||||||
Stockholders’ equity | 105,240 | 100,177 | ||||||
Total liabilities and stockholders’ equity | $ | 106,483 | $ | 102,340 | ||||
CONDENSED STATEMENTS OF INCOME | ||||||||
Years Ended December 31, | ||||||||
2016 | 2015 | |||||||
INCOME | ||||||||
Dividends | $ | 3,000 | $ | — | ||||
Interest income | — | — | ||||||
3,000 | — | |||||||
EXPENSES | ||||||||
Interest expense | 17 | 40 | ||||||
Other operating expenses | 1,146 | 1,817 | ||||||
Income (loss) before equity in undistributed earnings of subsidiaries and income tax benefit | 1,837 | (1,857 | ) | |||||
Equity in undistributed earnings of subsidiaries | 3,520 | 2,993 | ||||||
Income tax benefit | 442 | 374 | ||||||
Net income | 5,799 | 1,510 | ||||||
Preferred stock dividend requirements | 1,022 | 120 | ||||||
Net income available to common stockholders | $ | 4,777 | $ | 1,390 | ||||
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SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2016 and 2015
Note 19. Condensed Parent Information, Continued
STATEMENTS OF CASH FLOWS | ||||||||
2016 | 2015 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 5,799 | $ | 1,510 | ||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||
Equity in undistributed income of subsidiary | (3,520 | ) | (2,993 | ) | ||||
Other | 1,234 | (247 | ) | |||||
Net cash provided by (used in) operating activities | 3,513 | (1,730 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Proceeds from issuance of note payable | — | 6,000 | ||||||
Repayment of note payable | (2,000 | ) | (4,000 | ) | ||||
Proceeds from issuance of common stock | 804 | 4,043 | ||||||
Payment of dividends on preferred stock | (752 | ) | (120 | ) | ||||
Net cash (used in) provided by financing activities | (1,948 | ) | 5,923 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Acquisition of Cornerstone Bancshares, Inc. | — | (4,166 | ) | |||||
Net cash used in investing activities | — | (4,166 | ) | |||||
NET INCREASE IN CASH AND CASH EQUIVALENTS | 1,565 | 27 | ||||||
CASH AND CASH EQUIVALENTS, beginning of year | 503 | 476 | ||||||
CASH AND CASH EQUIVALENTS, end of year | $ | 2,068 | $ | 503 | ||||
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
SmartFinancial maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and that such information is accumulated and communicated to SmartFinancial’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. SmartFinancial carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of December 31, 2016. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2016, SmartFinancial’s disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
The report of SmartFinancial’s management on internal control over financial reporting is set forth in Item 8 of this Annual Report on Form 10-K and incorporated herein by reference.
Changes in Internal Controls
There were no changes in SmartFinancial’s internal control over financial reporting during SmartFinancial’s fiscal quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, SmartFinancial’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The response to this Item is incorporated by reference to SmartFinancial's proxy statement for the annual meeting of stockholders to be held May 18, 2017 under the headings “Proposal One Election of Directors,” “Security Ownership of Certain Beneficial Owners and Management,” “Corporate Governance and Board of Directors,” “Compensation of Directors and Executive Officers,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
ITEM 11. EXECUTIVE COMPENSATION
The response to this Item is incorporated by reference to SmartFinancial's proxy statement for the annual meeting of stockholders to be held May 18, 2017 under the headings, “Proposal One Election of the Directors” and “Compensation of Directors and Executive Officers.”
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The responses to this Item will be included in SmartFinancial's proxy statement for the annual meeting of stockholders to be held May 18, 2017 under the heading, “Security Ownership of Certain Beneficial Owners and Management.”
The following table summarizes information concerning SmartFinancial’s equity compensation plans at December 31, 2016:
Plan category | Number of securities to be issued upon exercise of outstanding options | Weighted average exercise price of outstanding options | Number of securities remaining available for future issuance | |||||||
Equity compensation plans approved by security holders: | ||||||||||
2002 Long-Term Incentive Plan | 109,079 | $ | 13.00 | — | ||||||
SmartBank Stock Option Plan | 456,371 | $ | 9.68 | 20,337 | ||||||
SmartFinancial 2010 Incentive Plan | 3,250 | $ | 11.67 | 519,750 | ||||||
2015 Stock Incentive Plan | 52,074 | $ | 15.05 | 1,947,926 | ||||||
Equity compensation plans not approved by shareholders | 96,750 | $ | 9.55 | — | ||||||
Total | 717,524 | $ | 10.57 | 2,488,013 | ||||||
Equity Compensation Plans not Approved by Shareholders
During 2013 and 2014, Cornerstone issued non-qualified options to employees and directors. These non-qualified options are governed by the grant document issued to the holders. The non-qualified stock options for employees were issued at the market value of the common stock on the grant date and vest 30% on the second anniversary of the grant date, 60% on the third anniversary of the grant date and 100% on the fourth anniversary of the grant date. The non-qualified stock options for directors are issued at the market value of the common stock on the grant date and vest 50% on the first anniversary of the grant date and 100% on the second anniversary of the grant date. The term of all grants were determined by the compensation committee, not to exceed ten years. As of December 31, 2016, a total of 128,500 non-qualified stock options had been issued to Company employees and directors, of which 96,750 remained outstanding and exercisable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this Item is incorporated by reference to SmartFinancial's proxy statement for the annual meeting of stockholders to be held May 18, 2017 under the heading, “Proposal One Election of Directors.”
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The response to this Item is incorporated by reference to SmartFinancial's proxy statement for the annual meeting of stockholders to be held May 18, 2017 under the heading, “Proposal Three Ratification of Independent Registered Public Accountants.”
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this report: | |
(1) | Financial Statements |
The following report and consolidated financial statements of SmartFinancial and Subsidiary are included in Item 8: | |
Report of Independent Registered Public Accounting Firm | |
Consolidated Balance Sheets as of December 31, 2016 and 2015 | |
Consolidated Statements of Income for the years ended December 31, 2016 and 2015 | |
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016 and 2015 | |
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016 and 2015 | |
Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015 | |
Notes to Consolidated Financial Statements | |
(2) | Financial Statement Schedules: |
Schedule II: Valuation and Qualifying Accounts | |
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. | |
(3) | The following documents are filed, furnished or incorporated by reference as exhibits to this report: |
Exhibit No. | Description | Location | ||
2.1 | Agreement and Plan of Merger dated as of December 5, 2014 by and among SmartFinancial, Inc., SmartBank, Cornerstone Bancshares, Inc. and Cornerstone Community Bank | Incorporated by reference to Appendix A to Form S-4 filed April 16, 2015 | ||
2.2 | Loan Agreement, dated as of August 28, 2015, by and between Cornerstone Bancshares, Inc. (renamed SmartFinancial, Inc.) and CapStar Bank | Incorporated by reference to Exhibit 2.2 to Form 8-K filed September 2, 2015 | ||
2.3 | Line of Credit Note, dated as of August 28, 2015 | Incorporated by reference to Exhibit 2.3 to Form 8-K filed September 2, 2015 | ||
2.4 | Stock Pledge and Security Agreement, effective as of September 1, 2015, by and between SmartFinancial, Inc. and CapStar Bank | Incorporated by reference to Exhibit 2.5 to Form 8-K filed September 2, 2015 | ||
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 | ||
4.1 | The right of securities holders are defined in the Charter and Bylaws provided in exhibits 3.1 and 3.2 | |||
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4.2 | Specimen Common Stock Certificate | Incorporated by reference to Exhibit 2 to From 10-K filed March 30, 2016 | ||
10.1* | SmartFinancial, Inc. 2015 Stock Incentive Plan | Incorporated by reference to Exhibit H to the Form S-4 filed April 16, 2015 | ||
10.2* | Form of 2015 Stock Incentive Agreement | Incorporated by reference to Exhibit 10.2 to From 10-K filed March 30, 2016 | ||
10.3* | SmartFinancial, Inc. 2010 Incentive Plan and Form of Option Agreement, assumed by SmartFinancial | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 | ||
10.4* | SmartBank Stock Option Plan and Form of Option Agreement, assumed by SmartFinancial | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 | ||
10.5* | Employment Agreement, dated as of February 1, 2015, by and among William Y. Carroll, Jr., SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.2 to Form 8-K filed September 2, 2015 | ||
10.6* | Employment Agreement, dated as of February 1, 2015, by and among William Y. Carroll, Sr., SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.3 to Form 8-K filed September 2, 2015 | ||
10.7* | Employment Agreement, dated as of April 15, 2015, by and among C. Bryan Johnson, SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.4 to Form 8-K filed September 2, 2015 | ||
10.8* | Employment Agreement by and between John H. Coxwell, Sr., Cornerstone Bancshares, Inc. and Cornerstone Community Bank dated December 5, 2014 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed December 9, 2015 | ||
10.9* | First Amendment to Employment Agreement by and between John H. Coxwell, Sr., SmartFinancial, Inc. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed December 9, 2015 | ||
10.10* | First Amendment to Employment Agreement by and between James R. Vercoe, Jr. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed December 9, 2015 | ||
10.11* | First Amendment to Employment Agreement by and between Gary W. Petty, Jr., SmartFinancial, Inc. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 9, 2015 | ||
10.12* | Employment Agreement, dated as of December 5, 2014, by and between Felicia F. Barbee and Cornerstone Community Bank | Incorporated by reference to Exhibit 10.1 to Form 8-K filed March 2, 2016 | ||
10.13* | First Amendment to Employment Agreement, dated as of February 27, 2016, by and between SmartBank and Felicia F. Barbee | Incorporated by reference to Exhibit 10.2 to Form 8-K filed March 2, 2016 | ||
10.14* | First Amendment to Employment Agreement, dated as of February 27, 2016, by and between SmartBank and Robert B. Watson | Incorporated by reference to Exhibit 10.3 to Form 8-K filed March 2, 2016 | ||
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10.15 | Form of Subscription Agreement for 2015 Equity Financing | Incorporated by reference to Exhibit 10.1 to Form 8-K filed August 20, 2015 | ||
10.16 | Form of Registration Rights Agreement for 2015 Equity Financing | Incorporated by reference to Exhibit 10.2 to Form 8-K filed August 20, 2015 | ||
10.17* | Employment Agreement with Nathaniel F. Hughes, dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc. and Nathaniel F. Hughes | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 10, 2014 | ||
10.18* | Employment Agreement with Gary W. Petty, Jr. dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc., Cornerstone Community Bank, and Gary W. Petty, Jr. | Incorporated by reference to Exhibit 10.3 to Form 8-K filed December 10, 2014 | ||
10.19* | Employment Agreement with Robert B. Watson, dated as of December 5, 2014, by and between Cornerstone Community Bank and Robert B. Watson | Incorporated by reference to Exhibit 10.4 to Form 8-K filed December 10, 2014 | ||
10.20* | Employment Agreement with James R. Vercoe, Jr., dated as of December 5, 2014, by and between Cornerstone Community Bank and James R Vercoe, Jr. | Incorporated by reference to Exhibit 10.5 to Form 8-K filed December 10, 2014 | ||
10.21* | Cornerstone Bancshares, Inc. 2002 Long-Term Incentive Plan | Incorporated by reference to Exhibit 99.1 to Form S-8 filed on March 5, 2004 | ||
10.22* | Form of Incentive Agreement under 2002 Long-Term Incentive Plan | Incorporated by reference to Exhibit 10.22 to From 10-K filed March 30, 2016 | ||
21.1 | Subsidiary of the registrant | Filed herewith | ||
23.1 | Consent of Mauldin & Jenkins, LLC | Filed herewith | ||
31.1 | Certification of principal executive officer | Filed herewith | ||
31.2 | Certification of principal financial officer | Filed herewith | ||
32.1 | Section 906 certifications of chief executive officer and chief financial officer | Filed herewith | ||
101.INS | XBRL Instance Document | Filed herewith | ||
101.SCH | XBRL Taxonomy Extension Schema | Filed herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | Filed herewith | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | Filed herewith | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase | Filed herewith | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | Filed herewith | ||
101
102
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SMARTFINANCIAL, INC. | |||
Date: March 31, 2017 | By: | /s/ William Y. Carroll, Jr. | |
William Y. Carroll, Jr. | |||
President and Chief Executive Officer and Director | |||
(principal executive officer) | |||
By: | /s/ C. Bryan Johnson | ||
C. Bryan Johnson | |||
Executive Vice President and Chief Financial Officer | |||
(principal financial officer and accounting officer) | |||
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 31, 2017.
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Signature | Title | |
/s/ William Y. Carroll, Jr. | President and Chief Executive Officer and Director | |
William Y. Carroll, Jr. | ||
(Principal Executive Officer) | ||
/s/ C. Bryan Johnson | Executive Vice President and Chief Financial Officer | |
C. Bryan Johnson | ||
(Principal Financial Officer and Principal Accounting Officer) | ||
/s/ Victor L. Barrett | Director | |
Victor L. Barrett | ||
/s/ Monique P. Berke | Director | |
Monique P. Berke | ||
/s/ William Y. Carroll, Sr. | Director | |
William Y. Carroll, Sr. | ||
/s/ Frank S. McDonald | Director | |
Frank S. McDonald | ||
/s/ Ted C. Miller | Director | |
Ted C. Miller | ||
/s/ David A. Ogle | Director | |
David A. Ogle | ||
/s/ Doyce Payne | Director | |
Doyce Payne | ||
/s/ Miller Welborn | Director | |
Miller Welborn | ||
/s/ Keith E. Whaley | Director | |
Keith E. Whaley | ||
/s/ Geoffrey A. Wolpert | Director | |
Geoffrey A. Wolpert | ||
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Exhibit No. | Description | Location | ||
2.1 | Agreement and Plan of Merger dated as of December 5, 2014 by and among SmartFinancial, Inc., SmartBank, Cornerstone Bancshares, Inc. and Cornerstone Community Bank | Incorporated by reference to Appendix A to Form S-4 filed April 16, 2015 | ||
2.2 | Loan Agreement, dated as of August 28, 2015, by and between Cornerstone Bancshares, Inc. (renamed SmartFinancial, Inc.) and CapStar Bank | Incorporated by reference to Exhibit 2.2 to Form 8-K filed September 2, 2015 | ||
2.3 | Line of Credit Note, dated as of August 28, 2015 | Incorporated by reference to Exhibit 2.3 to Form 8-K filed September 2, 2015 | ||
2.4 | Stock Pledge and Security Agreement, effective as of September 1, 2015, by and between SmartFinancial, Inc. and CapStar Bank | Incorporated by reference to Exhibit 2.5 to Form 8-K filed September 2, 2015 | ||
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 | ||
4.1 | The right of securities holders are defined in the Charter and Bylaws provided in exhibits 3.1 and 3.2 | |||
4.2 | Specimen Common Stock Certificate | Incorporated by reference to Exhibit 2 to From 10-K filed March 30, 2016 | ||
10.1* | SmartFinancial, Inc. 2015 Stock Incentive Plan | Incorporated by reference to Exhibit H to the Form S-4 filed April 16, 2015 | ||
10.2* | Form of 2015 Stock Incentive Agreement | Incorporated by reference to Exhibit 10.2 to From 10-K filed March 30, 2016 | ||
10.3* | SmartFinancial, Inc. 2010 Incentive Plan and Form of Option Agreement, assumed by SmartFinancial | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 | ||
10.4* | SmartBank Stock Option Plan and Form of Option Agreement, assumed by SmartFinancial | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 | ||
10.5* | Employment Agreement, dated as of February 1, 2015, by and among William Y. Carroll, Jr., SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.2 to Form 8-K filed September 2, 2015 | ||
10.6* | Employment Agreement, dated as of February 1, 2015, by and among William Y. Carroll, Sr., SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.3 to Form 8-K filed September 2, 2015 | ||
10.7* | Employment Agreement, dated as of April 15, 2015, by and among C. Bryan Johnson, SmartFinancial, Inc. and SmartBank | Incorporated by reference to Exhibit 10.4 to Form 8-K filed September 2, 2015 | ||
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10.8* | Employment Agreement by and between John H. Coxwell, Sr., Cornerstone Bancshares, Inc. and Cornerstone Community Bank dated December 5, 2014 | Incorporated by reference to Exhibit 10.4 to Form 8-K filed December 9, 2015 | ||
10.9* | First Amendment to Employment Agreement by and between John H. Coxwell, Sr., SmartFinancial, Inc. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.3 to Form 8-K filed December 9, 2015 | ||
10.10* | First Amendment to Employment Agreement by and between James R. Vercoe, Jr. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.1 to Form 8-K filed December 9, 2015 | ||
10.11* | First Amendment to Employment Agreement by and between Gary W. Petty, Jr., SmartFinancial, Inc. and Cornerstone Community Bank dated December 8, 2015 | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 9, 2015 | ||
10.12* | Employment Agreement, dated as of December 5, 2014, by and between Felicia F. Barbee and Cornerstone Community Bank | Incorporated by reference to Exhibit 10.1 to Form 8-K filed March 2, 2016 | ||
10.13* | First Amendment to Employment Agreement, dated as of February 27, 2016, by and between SmartBank and Felicia F. Barbee | Incorporated by reference to Exhibit 10.2 to Form 8-K filed March 2, 2016 | ||
10.14* | First Amendment to Employment Agreement, dated as of February 27, 2016, by and between SmartBank and Robert B. Watson | Incorporated by reference to Exhibit 10.3 to Form 8-K filed March 2, 2016 | ||
10.15 | Form of Subscription Agreement for 2015 Equity Financing | Incorporated by reference to Exhibit 10.1 to Form 8-K filed August 20, 2015 | ||
10.16 | Form of Registration Rights Agreement for 2015 Equity Financing | Incorporated by reference to Exhibit 10.2 to Form 8-K filed August 20, 2015 | ||
10.17* | Employment Agreement with Nathaniel F. Hughes, dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc. and Nathaniel F. Hughes | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 10, 2014 | ||
10.18* | Employment Agreement with Gary W. Petty, Jr. dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc., Cornerstone Community Bank, and Gary W. Petty, Jr. | Incorporated by reference to Exhibit 10.3 to Form 8-K filed December 10, 2014 | ||
10.19* | Employment Agreement with Robert B. Watson, dated as of December 5, 2014, by and between Cornerstone Community Bank and Robert B. Watson | Incorporated by reference to Exhibit 10.4 to Form 8-K filed December 10, 2014 | ||
10.20* | Employment Agreement with James R. Vercoe, Jr., dated as of December 5, 2014, by and between Cornerstone Community Bank and James R Vercoe, Jr. | Incorporated by reference to Exhibit 10.5 to Form 8-K filed December 10, 2014 | ||
10.21* | Cornerstone Bancshares, Inc. 2002 Long-Term Incentive Plan | Incorporated by reference to Exhibit 99.1 to Form S-8 filed on March 5, 2004 | ||
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10.22* | Form of Incentive Agreement under 2002 Long-Term Incentive Plan | Incorporated by reference to Exhibit 10.22 to From 10-K filed March 30, 2016 | ||
21.1 | Subsidiary of the registrant | Filed herewith | ||
23.1 | Consent of Mauldin & Jenkins, LLC | Filed herewith | ||
31.1 | Certification of principal executive officer | Filed herewith | ||
31.2 | Certification of principal financial officer | Filed herewith | ||
32.1 | Section 906 certifications of chief executive officer and chief financial officer | Filed herewith | ||
101.INS | XBRL Instance Document | Filed herewith | ||
101.SCH | XBRL Taxonomy Extension Schema | Filed herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | Filed herewith | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | Filed herewith | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase | Filed herewith | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | Filed herewith | ||
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* This item is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 15(b) of this report.
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