SMARTFINANCIAL, INC. 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").SmartBank provides a comprehensive suite of commercial and consumer banking services to clients through 36 full-service bank branches and two loan production offices in select markets in East and Middle Tennessee,Alabama and the FloridaPanhandle . While we offer a wide range of commercial banking services, we focus on making loans secured primarily by commercial real estate and other types of secured and unsecured commercial loans to small and medium-sized businesses in a number of industries, as well as loans to individuals for a variety of purposes. Our principal sources of funds for loans and investing in securities are deposits and, to a lesser extent, borrowings. We offer a broad range of deposit products, including checking ("NOW"), savings, money market accounts and certificates of deposit. We actively pursue business relationships by utilizing the business contacts of our senior management, other bank officers and our directors, thereby capitalizing on our knowledge of our local market areas.
Forward-Looking Statement
SmartFinancial, Inc. ("SmartFinancial") may from time to time make written or oral statements, including statements contained in this report and information incorporated by reference herein (including, without limitation, certain statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2), that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements, including statements regarding the potential effects of the COVID-19 pandemic on the Company's business and financial results and conditions, are based on assumptions and estimates and are not guarantees of future performance. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify some of the forward-looking statements by the use of forward-looking words (and their derivatives), such as "may," "will," "could," "project," "believe," "anticipate," "expect," "estimate," "continue," "potential," "plan," "forecast," and the like, the negatives of such expressions, or the use of the future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of a current condition. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, financial condition, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to:
? weakness or a decline in the
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
global capital and credit markets;
the impact of recently enacted and future legislation and regulation on our
? business, including changes to statutes, regulations or regulatory policies or
practices as a result of, or in response to the COVID-19 pandemic;
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;
expected revenue synergies and cost savings from our recently completed
? acquisition of
realized or may take longer than anticipated to be realized;
? disruption from the merger with customers, suppliers or employees or other
business partners' relationships;
? the risk of successful integration of the PFG's businesses with our business;
? lower than expected revenue following these mergers;
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?
mergers;
? the dilution caused by
common stock in connection with the PFG merger;
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 TDFI, the Board of
Governors of the
? 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
? changes in trade and monetary and fiscal policies and laws, including the
interest rate policies of the
our inability to pay dividends at current levels, or at all, because of
? inadequate future earnings, impairments to goodwill, regulatory restrictions or
limitations, and changes in the composition of qualifying regulatory capital
and minimum capital 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;
adverse results from current or future litigation, regulatory examinations or
? other legal and/or regulatory actions, including as a result of the Company's
participation in and execution of government programs related to the COVID-19
pandemic;
? the impact of the COVID-19 pandemic on the Company's assets, business, cash
flows, financial condition, liquidity, prospects and results of operations;
? potential increases in the provision for loan losses resulting from the
COVID-19 pandemic; and
? the impact of
provisions on potential acquisitions of us.
These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found inSmartFinancial's most recent annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, in each case filed with or furnished to theSecurities and Exchange Commission (the "SEC") and available on theSEC's website (www.sec.gov). Undue reliance should not be placed on forward-looking statements.SmartFinancial disclaims any obligation to update or revise any forward-looking statements contained in this release, which speak only as of the date hereof, whether as a result of new information, future events, or otherwise. Certain captions and amounts in the prior periods presented were reclassified to conform to the current presentation. Such reclassifications had no effect on net income or shareholders' equity.
Executive Summary
The following is a summary of the Company's financial highlights and significant events during the third quarter and first nine months of 2020:
? Completed the acquisition and integration of
("PFG").
? Originated approximately 2,950 Paycheck Protection Program ("PPP") loans
totaling$300.8 million . 39 Table of Contents
Net income totaled
? third quarter of 2020 compared to
share, for the same period in 2019.
Net income totaled
? first nine months of 2020 compared to
common share, for the same period in 2019.
? Annualized return on average assets was 0.76% at
1.01% at
Allowance for loan losses increased to
? the first quarter of 2020, in response to the current economic conditions
related to COVID-19. The COVID-19 pandemic has caused economic and social disruption on an
unprecedented scale.
taken several actions designed to cushion the economic fallout. On
2020, the CARES Act was signed into law. It contained substantial tax and
spending provisions intended to address the impact of the COVID-19 pandemic.
The CARES Act included the PPP, a nearly
small and medium-sized businesses through federally guaranteed loans
distributed through banks. These loans were intended to guarantee eight weeks
of payroll and other costs to help those businesses remain viable and allow
their workers to pay their bills. The initial
supplemented in late
? was signed into law and made significant changes to the PPP to provide
additional relief for small businesses. The new Act increased flexibility for
small businesses that have been unable to rehire employees due to lack of
employee availability or have been unable to operate as normal due to COVID-19
related restrictions. It extended the period that businesses have to use PPP
funds to qualify for loan forgiveness to 24 weeks, up from 8 weeks under the
original rules. The new Act also relaxed the requirements that loan recipients
must adhere to in order to qualify for loan forgiveness. In addition, the new
Act extended the payment deferral period for PPP loans until the date when the
amount of loan forgiveness is determined and remitted to the lender. For PPP
recipients who do not apply for forgiveness, the loan deferral period is 10
months after the applicable forgiveness period ends. The PPP program expired
Analysis of Results of Operations
Third quarter of 2020 compared to 2019
Net income was$6.4 million , or$0.42 per diluted common share, for the third quarter of 2020, compared to$6.0 million , or$0.42 per diluted common share, for the third quarter of 2019. The tax equivalent net interest margin was 3.39% for the third quarter of 2020 compared to 3.91% for the third quarter of 2019. Noninterest income to average assets was 0.49% for the third quarter of 2020, increasing from 0.37% for the third quarter of 2019. Noninterest expense to average assets decreased to 2.28% in the third quarter of 2020, from 2.48% in the third quarter of 2019.
First nine months of 2020 compared to 2019
Net income was$15.3 million , or$1.02 per diluted common share, for the first nine months of 2020, compared to$19.8 million , or$1.41 per diluted common share, for the first nine months of 2019. The decrease in net income for this period was primarily from the$6.4 million termination fee recognized in the second quarter of 2019. The tax equivalent net interest margin was 3.62% for the first nine months of 2020 compared to 3.99% for the first nine months of 2019. Noninterest income to average assets was 0.46% for the first nine months of 2020, decreasing from 0.71% for the first nine months of 2019. Noninterest expense to average assets decreased to 2.52% in the first nine months of 2020, from 2.71% in the first nine months of 2019. The results above include operating effects of the PFG acquisition, which was completed onMarch 1, 2020 .
Net Interest Income and Yield Analysis
Third quarter of 2020 compared to 2019
Net interest income, taxable equivalent, increased to$26.2 million for the third quarter of 2020, up from$21.3 million for the third quarter of 2019. Net interest income was positively impacted, compared to the prior year, primarily by the full-quarters effects of the Company'sMarch 1, 2020 acquisition of PFG, the increase in loan balances and the reduction in interest expense on interest bearing liabilities. Average interest-earning assets increased from$2.16 billion for the third quarter of 2019, to$3.08 billion for the third quarter of 2020, primarily as a result of the acquisition of PFG being completed onMarch 1, 2020 , and the Company's participation in the PPP. Over this period, average loan balances 40 Table of Contents
increased by$568.2 million , average interest-bearing deposits increased by$336.9 million , average noninterest-bearing deposits increased$296.2 million and average borrowings increased$306.0 million . The tax equivalent net interest margin decreased to 3.39% for the third quarter of 2020, compared to 3.91% for the third quarter of 2019. The yield on earning assets decreased from 5.05% for the third quarter of 2019, to 3.88% for the third quarter of 2020, primarily due to rate cuts by theFederal Reserve over the past year and, to a lesser extent, loan yields declining from market competition. The cost of average interest-bearing deposits decreased from 1.37% for the third quarter of 2019, to 0.59% for the third quarter of 2020, primarily due to a lower interest rate environment during the period. The following tables summarizes the major components of net interest income and the related yields and costs for the periods presented (dollars in thousands): Three Months Ended September 30, 2020 2019 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets: Loans, including fees1$ 2,410,173 28,508 4.71 %$ 1,842,007 25,471 5.49 % Loans held for sale 8,048 113 5.57 % 4,189 44 4.17 % Taxable securities 132,642 546 1.64 % 118,955 748 2.49 % Tax-exempt securities2 88,129 515 2.32 % 56,598 448 3.14 % Federal funds sold and other earning assets 438,785 327 0.30 % 135,444 743 2.18 % Total interest-earning assets 3,077,777 30,009 3.88 % 2,157,193 27,454 5.05 % Noninterest-earning assets 262,764 191,940 Total assets$ 3,340,541 $ 2,349,133 Liabilities and Stockholders' Equity: Interest-bearing demand deposits$ 509,999 $ 199 0.16 %$ 343,827 $ 511 0.59 % Money market and savings deposits 833,022 704 0.34 % 637,290 1,829 1.14 % Time deposits 615,714 1,994 1.29 % 640,679 3,265 2.02 % Total interest-bearing deposits 1,958,735 2,897 0.59 % 1,621,796 5,605 1.37 % Borrowings 319,265 334 0.42 % 13,310 15 0.45 % Subordinated debt 39,311 584 5.91 % 39,226 584 5.91 % Total interest-bearing liabilities 2,317,311 3,815 0.65 % 1,674,332 6,204 1.47 %
Noninterest-bearing deposits 649,489 353,315 Other liabilities 25,834 18,286 Total liabilities 2,992,634 2,045,933 Stockholders' equity 347,907 303,200 Total liabilities and stockholders' equity$ 3,340,541 $ 2,349,133 Net interest income, taxable equivalent$ 26,194 $ 21,250 Interest rate spread 3.22 % 3.58 % Tax equivalent net interest margin 3.39 % 3.91 % Percentage of average interest-earning assets to average interest-bearing liabilities 132.82 % 128.84 % Percentage of average equity to average assets 10.41 % 12.91 % 1Includes nonaccrual loans and accretion income on acquired loans of$960 thousand and$1.2 million for the quarters endedSeptember 30, 2020 and 2019, respectively. Also includes accretion of loan fees on PPP loans of$1.8 million for the quarter endedSeptember 30, 2020 . No loan fees on PPP loans are included for the quarter endedSeptember 30, 2019 . 2Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 21.0%. The taxable-equivalent adjustment was$151 thousand for the three month period endedSeptember 30, 2020 and$110 thousand for the three month period endedSeptember 30, 2019 .
First nine months of 2020 compared to 2019
Net interest income, taxable equivalent, increased to$88.2 million for the first nine months of 2020, up from$81.9 million for the first nine months of 2019. Net interest income was positively impacted, compared to the prior year, primarily due to increases in loan balances and a reduction in interest expense on deposits. Average interest-earning assets increased from$2.12 billion for the first nine months of 2019, to$2.76 billion for the first nine months of 2020, primarily as a result of the acquisition of PFG completedMarch 1, 2020 , organic loan growth and the Company's participation in the PPP. Over this period, average loan balances increased by$428.6 million , average interest-bearing deposits increased by$200.9 million , average noninterest-bearing deposits increased$246.6 million and average borrowings increased$184.8 million . 41 Table of Contents The tax equivalent net interest margin decreased to 3.62% for the first nine months of 2020, compared to 3.99% for the first nine months of 2019. The yield on earning assets decreased from 5.17% for the first nine months of 2019, to 4.27% for the first nine months of 2020, primarily due to rate cuts by theFederal Reserve over the past year and, to a lesser extent loan yields declining from market competition. The cost of average interest-bearing deposits decreased from 1.37% for the first nine months of 2019, to 0.79% for the first nine months of 2020, primarily due to a lower interest rate environment during the period. Nine Months Ended September 30, 2020 2019 Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost Assets: Loans, including fees1$ 2,252,075 $ 83,487 4.95 %$ 1,823,523 $ 75,645 5.55 % Loans held for sale 6,409 231 4.81 % 3,589 123 4.58 % Taxable Securities 123,895 1,813 1.95 % 134,230 2,591 2.58 % Tax-exempt securities2 81,604 1,486 2.43 % 55,585 1,512 3.64 % Federal funds and other earning assets 296,449 1,206 0.54 % 102,528 2,056 2.68 % Total interest-earning assets 2,760,432 88,223 4.27 % 2,119,455 81,927 5.17 % Noninterest-earning assets 248,293 205,984 Total assets$ 3,008,725 $ 2,325,439 Liabilities and Stockholders' Equity: Interest-bearing demand deposits$ 451,074 782 0.23 %$ 326,764 1,397 0.57 % Money market and savings deposits 749,316 2,707 0.48 % 669,067 4,302 1.30 % Time deposits 667,303 7,527 1.51 % 633,601 5,850 1.86 % Total interest-bearing deposits 1,867,693 11,016 0.79 % 1,621,108 16,644 1.37 % Borrowings 203,202 674 0.44 % 18,377 250 1.82 % Subordinated debt 39,290 1,751 5.95 % 39,205 1,757 5.99 % Total interest-bearing liabilities 2,110,185 13,441 0.85 % 1,678,690 18,651 1.49 %
Noninterest-bearing deposits 537,860 336,895 Other liabilities 23,826 14,509 Total liabilities 2,671,871 2,030,094 Stockholders' equity 336,854 295,345 Total liabilities and stockholders' equity$ 3,008,725 $ 2,325,439 Net interest income, taxable equivalent$ 74,782 $ 63,276 Interest rate spread 3.42 % 3.68 % Tax equivalent net interest margin 3.62 % 3.99 % Percentage of average interest-earning assets to average interest-bearing liabilities 130.81 % 126.26 % Percentage of average equity to average assets 11.20 % 12.70 % 1Includes nonaccrual loans and accretion income on acquired loans of$3.7 million and$4.3 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Also includes accretion of loan fees on PPP loans of$3.7 million for the nine months endedSeptember 30, 2020 . No loan fees on PPP loans are included for the nine months endedSeptember 30, 2019 . 2Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 21.0%. The taxable-equivalent adjustment was$422 thousand for the nine month period endedSeptember 30, 2020 and$336 thousand for the nine month period endedSeptember 30, 2019 . 42 Table of Contents Noninterest Income The following table summarizes noninterest income by category (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019
Service charges on deposit accounts$ 892 $ 767 $ 2,370 $ 2,129 Gain on sale of securities, net (9) 1
6 34
Mortgage banking 1,029 518 2,544 1,192
Investment services 359 260 1,159 684
Insurance commissions 560 - 1,302 -Interchange and debit card transaction fees 868 148
1,652 467 Merger termination fee - - - 6,400 Other 422 502 1,417 1,405 Total noninterest income$ 4,121 $ 2,196 $ 10,450 $ 12,311
Third quarter of 2020 compared to 2019
Noninterest income increased by
? Increase in service charges on deposit accounts, related to the PFG acquisition
and deposit growth;
? Increase in mortgage banking, from increased volume due to low rate
environment;
? Increase in investment services, stemming from increased production from
personnel hires in 2019;
? Addition of insurance commissions from the PFG acquisition; and
? Increase in interchange and debit card transaction fees, related to the PFG
acquisition and deposit growth.
First nine months of 2020 compared to 2019
Noninterest income decreased by
? Decrease in merger termination fee recognized in the second quarter of 2019;
? Increase in service charges on deposit accounts, related to the PFG acquisition
and deposit growth;
? Increase in mortgage banking, from increased volume due to low rate
environment;
? Increase in investment services, stemming from increased production from
personnel hires in 2019;
? Addition of insurance commissions from the PFG acquisition; and
? Increase in interchange and debit card transaction fees, related to the PFG
acquisition and deposit growth.
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Noninterest Expense
The following table summarizes noninterest expense by category (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019Salaries and employee benefits$ 11,032 $ 9,072 $
31,395$ 26,357 Occupancy and equipment 2,186 1,635 6,093 4,967 FDIC insurance 534 (219) 894 140
Other real estate and loan related expense 643 335
1,535 1,067 Advertising and marketing 253 263 653 817 Data processing 558 273 1,689 1,465 Professional services 594 573 2,172 1,724 Amortization of intangibles 402 341 1,169 1,027 Software as service contracts 573 560 1,604 1,696
Merger related and restructuring expenses 290 73
3,863 2,792 Other 2,102 1,802 5,699 5,045 Total noninterest expense$ 19,167 $ 14,708 $ 56,766 $ 47,097
Third quarter of 2020 compared to 2019
Noninterest expense increased by$4.5 million , or 30.3%, in the third quarter of 2020 as compared to the same period in 2019. The quarterly increase in total noninterest expense primarily resulted from the following:
? Increase in salary and employee benefits due to the overall franchise growth,
including the acquisition of PFG;
Increase in occupancy and equipment associated with ongoing infrastructure and
? facilities added to accommodate our growth in operations and the additional
branches of the PFG acquisition;
Increase in
assets growth stemming from our acquisition of PFG, deposit growth and
? production of PPP loans. The Company recognized a credit in the third quarter
of 2019 from the
insured deposits as of
Increase in other real estate and loan related expenses, primarily attributable
? to increased activity in loan related production and an evaluation adjustment
on other real estate owned;
? Increase in data processing is attributable to credit recognized from core
processor in third quarter of 2019;
? Increase in merger related and restructure expenses from the acquisition of
PFG; and
? Increase in other noninterest expenses due to overall franchise growth.
First nine months of 2020 compared to 2019
Noninterest expense increased by
? Increase in salary and employee benefits due to the overall franchise growth,
including the acquisition of PFG;
Increase in occupancy and equipment associated with ongoing infrastructure and
? facilities added to accommodate our growth in operations and the additional
branches of the PFG acquisition;
Increase in
growth stemming from our acquisition of PFG, deposit growth and production of
? PPP loans. The Company recognized a credit in the third quarter of 2019 from
the
as of
? Increase in other real estate and loan related expenses, primarily attributable
to increased activity in loan related production;
? Increase in data processing is attributable to credit recognized from core
processor in third quarter of 2019;
44
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? Increase in professional services from increases in legal and auditing
services;
? Increase in merger related and restructure expenses from the acquisition of
PFG; and
? Increase in other noninterest expenses due to overall franchise growth.
Taxes
Third quarter of 2020 compared to 2019
In the third quarter of 2020 income tax expense totaled$2.0 million compared to$1.9 million a year ago. The effective tax rate was approximately 23.5% in the third quarter of 2020 compared to 24.6% a year ago. The lower effective tax rate for the third quarter of 2020 compared to same quarter in 2019 was due to having a proportionately higher amount of non-taxable income in relation to income before taxes, as well as tax benefit derived from the reconciliation of our tax rates from operations.
First nine months of 2020 compared to 2019
In the first nine months of 2020 income tax expense totaled$4.6 million compared to$6.4 million a year ago. The effective tax rate was approximately 21.0% for first nine months of 2020 compared to 24.5% a year ago. The lower effective tax rate for the first nine months of 2020 compared to same period in 2019 was primarily from the CARES Act legislation and having a proportionately higher amount of non-taxable income in relation to income before taxes and a tax benefit realized from the recognition of net operating loss carryforwards from past acquisitions. Loan Portfolio The Company had total net loans outstanding, including organic and purchased loans, of approximately$2.39 billion atSeptember 30, 2020 compared to$1.89 billion atDecember 31, 2019 . Loans secured by real estate, consisting of commercial or residential property, are the principal component of our loan portfolio.
Organic Loans
Our organic net loans, which excludes loans purchased through acquisitions, increased by$440.9 million , or 29.1%, fromDecember 31, 2019 , to$1.96 billion atSeptember 30, 2020 . Included in the growth was$300.8 million of PPP loans that were originated and funded during the second and third quarters of 2020. Total net deferred fees associated with the PPP loans was approximately$11.0 million and$3.7 million was accreted into income during the second and third quarters of 2020. Purchased Loans
Purchased non-credit impaired loans of$393.1 million atSeptember 30, 2020 increased by$44.0 million fromDecember 31, 2019 . SinceDecember 31, 2019 , our net purchased credit impaired ("PCI") loans increased by$7.3 million to$34.1 million atSeptember 30, 2020 . The increase in purchased non-credit impaired loans and PCI loans is related to the acquisition of PFG and offset by maturities, paydowns and payoffs. 45
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The following tables summarize the composition of our loan portfolio for the periods presented (dollars in thousands):
September 30, 2020
Purchased Purchased
Non-Credit Credit % of
Organic Impaired Impaired Total Gross
Loans Loans Loans Amount TotalCommercial real estate-mortgage$ 812,191 $ 201,993 $ 16,469 $ 1,030,653 42.9 % Consumer real estate-mortgage 295,912 133,596 10,801 440,309 18.3 % Construction and land development 246,112 22,650 6,409 275,171 11.4 % Commercial and industrial 611,439 32,742 317 644,498 26.8 % Consumer and other 9,119 4,220 87 13,426 0.6 % Total gross loans receivable, net of deferred fees 1,974,773 395,201 34,083 2,404,057 100.0 % Allowance for loan losses (16,704)$ (2,113) - (18,817) Total loans, net$ 1,958,069 $ 393,088 $ 34,083 $ 2,385,240 December 31, 2019 Purchased Purchased Non-Credit Credit % of Organic Impaired Impaired Total Gross Loans Loans Loans Amount Total
Commercial real estate-mortgage$ 705,691 $ 184,360 $ 15,255 $ 905,306 47.7 % Consumer real estate-mortgage 295,915 115,026 6,541 417,482 22.0 % Construction and land development 210,421 12,747 4,458 227,626 12.0 % Commercial and industrial 306,521 30,147 407 337,075 17.8 % Consumer and other 2,817 6,760 326 9,903 0.5 % Total gross loans receivable, net of deferred fees 1,521,365 349,040 26,987 1,897,392 100.0 % Allowance for loan losses (10,087) - (156) (10,243) Total loans, net$ 1,511,278 $ 349,040 $ 26,831 $ 1,887,149 Loan Portfolio Maturities
The following table sets forth the maturity distribution of our loans at
Rate Structure for Loans
Maturing Over One Year
One Year One through Over Five Fixed Floating
or Less Five Years Years Total Rate Rate
Commercial real estate-mortgage
27,080 169,931 243,299 440,310 209,880 203,350
Construction and land development 83,912 96,043 95,216 275,171 91,711 99,548
Commercial and industrial 86,276 476,926 82,421 645,623 520,240 39,107
Consumer and other 4,591 6,658 388 11,637 6,738 308
Total Loans $ 316,169 $ 1,172,443 $ 915,445 $ 2,404,057 $ 1,496,958 $ 590,930 Nonaccrual, Past Due, and Restructured Loans
Nonperforming loans as a percentage of total gross loans, net of deferred fees, was 0.09% as ofSeptember 30, 2020 , which decreased from 0.18% as ofDecember 31, 2019 . Total nonperforming assets as a percentage of total assets as ofSeptember 30, 2020 totaled 0.18% compared to 0.21% as ofDecember 31, 2019 . Acquired PCI loans that are included in loan pools are reclassified at acquisition to accrual status and thus are not included as nonperforming assets. 46 Table of Contents
The following table summarizes the Company's nonperforming assets for the periods presented (in thousands):
September 30, December 31,
2020 2019
Nonaccrual loans $ 2,248 $ 2,743Accruing loans past due 90 days or more -
607 Total nonperforming loans 2,248 3,350 Other real estate owned 3,932 1,757 Total nonperforming assets $ 6,180 $ 5,107
Restructured loans not included above $ 8 $
61 Potential Problem Loans AtSeptember 30, 2020 potential problem loans amounted to approximately$1.1 million or 0.04% 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. COVID-19 Loan Modifications As a result of the CARES Act, the Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. AtSeptember 30, 2020 , COVID-19 modified loans amounted to$232.5 million , or 9.7% of the total loans outstanding. The Company offered deferral options of: 1) three months deferral of payment and then three months of interest only, 2) three months of interest only, 3) three months deferral of payment, 4) six months of interest only, and approximately all of the$232.5 million remaining COVID-19 modified loans will mature during the fourth quarter of 2020. Included in the COVID-19 modified loans were$56.2 million and$30.4 million of hospitality and restaurant loans, respectively. These sectors had increased vulnerability from COVID-19. AtSeptember 30, 2020 , the short-term loan modifications were still expected to mature on the original maturity schedule. All of the COVID-19 modified loans were transitioned into watchlist categories internally.
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. Our provision for loan losses for the nine months endedSeptember 30, 2020 , is$8.7 million compared to$1.9 million in the same period of 2019, an increase of$6.8 million . As ofSeptember 30, 2020 , andDecember 31, 2019 , our allowance for loan losses was$18.8 million and$10.2 million , respectively, which we deemed to be adequate at each of the respective dates. The increase in the allowance for loan losses atSeptember 30, 2020 , as compared toDecember 31, 2019 , is primarily attributable to the ongoing economic uncertainties related to the COVID-19 pandemic. Also, during 2020, the Company updated the Allowance for Loan Loss policy to increase the additional basis points allowed for the unallocated risk portion from 100 basis points to 125 basis points. In addition, the Company added a new qualitative factor based on the percentage of COVID modified loans / total loans. The qualitative factors were also expanded to provide additional granularity related to the hospitality and restaurant industries which are most impacted by the pandemic within our footprint. The changes in our economic factors and the addition of the COVID modified factors equated to an additional$8.3 million in reserve. Our allowance for loan loss as a percentage of total loans was 0.78% atSeptember 30, 2020 and 0.54% atDecember 31, 2019 . 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. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition. As ofSeptember 30, 2020 , the notional balances on PCI loans was$47.2 47
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million while the carrying value was
The following table sets forth, based on our best estimate, the allocation of
the allowance to types of loans for the periods presented, and the percentage of
loans in each category to total loans (dollars in thousands):
September 30, 2020 December 31, 2019
Amount Percent Amount Percent
Commercial real estate-mortgage
47.7 % Consumer real estate-mortgage 3,444 18.3 % 2,576 22.0 % Construction and land development 2,060 11.4 % 1,127
12.0 % Commercial and industrial 5,463 26.8 % 1,957 17.8 % Consumer and other 121 0.6 % 75 0.5 %
Total allowance for loan losses$ 18,817 100.0 %$ 10,243
100.0 % The allocation by category is determined based on the loans individually 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. Specific valuation allowances related to impaired, non PCI, loans were approximately$475 thousand atDecember 31, 2019 compared to$486 thousand atSeptember 30, 2020 . 48
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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 the
periods presented including the ratio of the allowance for loan losses to total
loans as of the end of each period (dollars in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Balance at beginning of
period $ 16,254 $ 9,097 $ 10,243 $ 8,275
Provision for loan losses 2,634 724 8,683 1,914
Charged-off loans:
Commercial real
estate-mortgage - (36) - (36)
Consumer real
estate-mortgage (21) (1) (23) (3)
Construction and land
development - - - -
Commercial and industrial (60) (20) (77) (353)
Consumer and other (89) (50) (231) (260)
Total charged-off loans (170) (107) (331) (652)
Recoveries of previously
charged-off loans:
Commercial real
estate-mortgage 11 39 16 63
Consumer real
estate-mortgage 17 17 34 37
Construction and land
development - 3 2 7
Commercial and industrial 55 12 103 66
Consumer and other 16 7 67 82
Total recoveries of
previously charged-off
loans 99 78 222 255
Net loan charge-offs (71) (29) (109) (397)
Balance at end of period $ 18,817 $ 9,792 $ 18,817 $ 9,792
Ratio of allowance for loan
losses to total loans
outstanding at end of
period 0.78 % 0.53 % 0.78 % 0.53 %
Ratio of net loan
charge-offs to average
loans outstanding for the
period (annualized) - % 0.01 % - % 0.03 %
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 portfolio, past loan loss
experience, known and inherent risks in the portfolio, the views of the Bank's
regulators, adverse situations that may affect borrowers' ability to repay
(including the timing of future payments), the estimated value of any underlying
collateral, composition of the loan 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.
Securities Portfolio
Our securities portfolio, consisting primarily of Federal agency bonds, state and municipal securities, and mortgage-backed securities, amounted to fair values of$214.6 million and$178.3 million atSeptember 30, 2020 andDecember 31, 2019 , respectively. Our investments to assets ratio decreased from 7.3% atDecember 31, 2019 to 6.3% atSeptember 30, 2020 . Our securities portfolio serves many purposes including serving as a potential liquidity source, collateral for public funds, and as a stable source of income. All of the Company's securities are designated as available-for-sale. 49
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The following table shows the amortized cost of the Company's securities by investment categories (in thousands):
September 30 ,December 31, 2020 2019
19,015 Municipal securities 88,864 63,792 Other debt securities 17,519 3,481 Mortgage-backed securities 74,424 91,531 Total securities$ 211,118 $ 177,819 The following table presents the contractual maturity of the Company's securities by contractual maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis) atSeptember 30, 2020 . The composition and maturity / repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs (dollars in thousands): Maturity By Years 1 or Less 1 to 5 5 to 10 Over 10 Total U.S. Government agencies $ -$ 641 $ 7,402 $ 22,268 $ 30,311
State and political subdivisions 4,624 3,385 4,757
76,098 88,864
Other debt securities - 983 14,036 2,500 17,519
Mortgage-backed securities - 3,569 13,524 57,331 74,424
Total securities $ 4,624 $ 8,578 $ 39,719 $ 158,197 $ 211,118
Weighted average yield (1) 1.92 % 1.22 % 3.24 % 2.56 % 2.62 %
(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 noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money market accounts, IRAs and CDs. These accounts generally earn interest at rates the Company establishes based on market factors and the anticipated amount and timing of funding needs. The establishment or continuity of a core deposit relationship can be a factor in loan pricing decisions. While the Company's primary focus is on establishing customer relationships to attract core deposits, at times, the Company uses brokered deposits and other wholesale deposits to supplement its funding sources. As ofSeptember 30, 2020 , brokered deposits represented approximately 3.0% of total deposits. The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of interest-bearing deposits for the three months endedSeptember 30, 2020 was 0.59% compared to 1.37% for the same period in 2019 and 0.79% and 1.37% for the nine months endedSeptember 30, 2020 andSeptember 30, 2019 , respectively. The decreased cost of interest-bearing deposits was due to changes in rates caused by federal rate-changes during the periods. Total deposits as ofSeptember 30, 2020 were$2.65 billion , which was an increase of$604.8 million fromDecember 31, 2019 . This increase was primarily from the completed acquisition of PFG and deposits related to the PPP loans. As ofSeptember 30, 2020 , the Company had outstanding time deposits under$250,000 with balances of$437.1 million and time deposits over$250,000 with balances of$140.0 million . 50 Table of Contents The following table summarizes the maturities of time deposits$250,000 or more (in thousands). September 30, 2020 Three months or less $ 31,107 Three to six months 31,974 Six to twelve months 44,221 More than twelve months 32,681 Total$ 139,983 Borrowings The Company uses short-term borrowings and long-term debt to provide both funding and, to a lesser extent, regulatory capital using debt at the Company level which can be downstreamed as Tier 1 capital to the Bank. Borrowings totaled$319.4 million atSeptember 30, 2020 , and primarily consisted of$75.0 million in FHLB borrowings,$237.8 million from the PPPLF and short-term borrowings totaled$6.2 million and consisted entirely of securities sold under repurchase agreements. Long-term debt totaled$39.3 million atSeptember 30, 2020 andDecember 31, 2019 , respectively and consisted entirely of subordinated debt. For more information regarding our borrowings, see "Part I - Item 1. Consolidated Financial Statements - Note 7 - Borrowings and Line of Credit."
Capital Resources
The Company uses leverage analysis to examine the potential of the institution to increase assets and liabilities using the current capital base. The key measurements included in this analysis are the Bank's Common Equity Tier 1 capital, Tier 1 capital, leverage and total capital ratios. AtSeptember 30, 2020 andDecember 31, 2019 , our capital ratios, including our Bank's capital ratios, exceeded regulatory minimum capital requirements. From time to time we may be required to support the capital needs of our bank subsidiary. We believe we have various capital raising techniques available to us to provide for the capital needs of our bank, if necessary. For more information regarding our capital, leverage and total capital ratios, see "Part I - Item 1. Consolidated Financial Statements - Note 13 - Regulatory Matters."
Liquidity and Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing and depository needs of its customers. AtSeptember 30, 2020 , we had$468.4 million of pre-approved but unused lines of credit and$5.5 million of standby letters of credit. These commitments generally have fixed expiration dates and many will expire without being drawn upon. The total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank has the ability to liquidate Federal funds sold or securities available-for-sale, or on a short-term basis to borrow and purchase Federal funds from other financial institutions. For more information regarding our off-balanc8e sheet arrangements, see "Part I - Item 1. Consolidated Financial Statements - Note 9 - Commitments and Contingent Liabilities."
Market Risk and Liquidity Risk Management
The Bank's Asset Liability Management Committee ("ALCO") 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
51
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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 dynamic 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
Estimated % Change in Net or Base Case
Interest Income Over 12 Projection of Net Interest
Months Income
September 30, 2020: Increase + Decrease - Next 12 Months
An instantaneous, parallel rate increase
or decrease of the following at the
beginning of the third quarter:
± 100 basis points 4.15% 0.68% 8%
± 200 basis points 6.36% 1.01% 14%
Economic Value of Equity Our economic value of equity model measures the extent
that estimated economic values of our assets, liabilities and off-balance sheet
items will change as a result of interest rate changes. Economic values are
determined by discounting expected cash flows from assets, liabilities and
off-balance sheet items, which establishes a base case economic value of equity.
To help monitor our related risk, we've established the following policy limits regarding simulated changes in our economic value of equity:
Maximum
Percentage
Decline in
Economic Value
of Equity from
the Economic
Value of Equity
Current EstimatedInstantaneous at Currently
Rate Change Prevailing
September 30, 2020 : Increase + Decrease - Interest Rates
Instantaneous, Parallel Change in Prevailing
Interest Rates Equal to:
±100 basis points 7.07% (3.35)% 10%
±200 basis points 8.86% 14.17% 15%
At
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.
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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. The Company has$4.6 million in investments that mature throughout the next 12 months. The Company also anticipates$17.8 million of principal payments from mortgage-backed securities over the same period. The Company also has unused borrowing capacity in the amount of$304.2 million available with theFederal Reserve , FHLB, several correspondent banks and a line of credit. With these sources of funds, the Company currently anticipates adequate liquidity to meet the expected obligations of its customers. 53 Table of Contents
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