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Section 1: 10-Q (10-Q SMARTFINANCIAL, INC JUNE 30, 2018)

Document


United States Securities and Exchange Commission
Washington, D.C. 20549
 
FORM 10-Q
(Mark One) 
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
¨
TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to               

 
Commission File Number:333-203449
394585170_tlogoa01.jpg 

(Exact name of small business issuer 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)
 
 
 
865-453-2650
 
 
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal
 
 
year, if changes since last report)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x   No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such period that the registrant was required to submit and post such files).
Yes  x    No  ¨
 
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. (Check one):
Large accelerated filer  ¨
Accelerated filer  x
Non-accelerated filer  ¨
Smaller reporting company ¨
Emerging growth company ¨
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨    No  x
 
As of July 31, 2018 there were 12,704,581 shares of common stock, $1.00 par value per share, issued and outstanding.

1



TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



FORWARD-LOOKING STATEMENTS
 


Certain of the statements made in this report may constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements, including statements regarding the intent, belief or current expectations of SmartFinancial's management regarding the company's strategic direction, prospects, future results and benefits of the merger, are subject to numerous risks and uncertainties. Such factors include, without limitation, those specifically described in Item 1A of Part I of SmartFinancial’s most recent Annual Report on Form 10-K, as well as the following: (1) the risk that the cost savings and any revenue synergies from the proposed merger (which we refer to as the “merger’) with Foothills Bancorp, Inc. (“Foothills Bancorp”) may not be realized or take longer than anticipated to be realized, (2) disruption from the merger with customers, suppliers or employee relationships, (3) the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement with Foothills Bancorp, (4) the risk of successful integration of the two companies’ businesses, (5) the failure of Foothills Bancorp's shareholders to approve the merger, (6) the amount of the costs, fees, expenses, and charges related to the merger, (7) the ability to obtain required regulatory approvals of the proposed terms of the merger, (8) reputational risk and the reaction of the parties' customers to the merger, (9) the failure of the closing conditions to be satisfied, (10) the risk that the integration of Foothills Bancorp's operations with SmartFinancial will be materially delayed or will be more costly or difficult than expected, (11) the possibility that the merger may be more expensive to complete than anticipated, including as a result of unexpected factors or events, (12) the dilution caused by SmartFinancial's issuance of additional shares of its common stock in the merger, and (13) general competitive, economic, politics of and market conditions. Additional factors which could affect the forward looking statements can be found in SmartFinancial's annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K filed with or furnished to the SEC and available on the SEC's website at http://www.sec.gov. SmartFinancial disclaims any obligation to update or revise any forward-looking statements contained in this report which speak only as of the date hereof, whether as a result of new information, future events or otherwise.

Non-GAAP Financial Measures



Under SEC Regulation G, public companies making disclosures containing financial measures that are not in accordance with GAAP must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure, as well as a statement of the company’s reasons for utilizing the non-GAAP financial measure. The SEC has exempted from the definition of non-GAAP financial measures certain commonly used financial measures that are not based on GAAP. However, two non-GAAP financial measures commonly used by financial institutions, namely tax-equivalent net interest income and tax-equivalent net interest margin (as presented in the tables in the section labeled “Net Interest Income and Yield Analysis”), have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G. We are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G. Management believes that these non-GAAP financial measures are useful in evaluating the Company’s financial performance and facilitate comparisons with the performance of other financial institutions. However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.




3



PART I –FINANCIAL INFORMATION 
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
 
SMARTFINANCIAL, INC. AND SUBSIDIARY 
CONSOLIDATED BALANCE SHEETS 
 
 
Unaudited
June 30,
2018
 
December 31,
2017
ASSETS
 
 

 
 

Cash and due from banks
 
$
66,243,037

 
$
64,097,287

Interest-bearing deposits at other financial institutions
 
101,992,073

 
41,965,597

Federal funds sold
 
2,000,000

 
6,964,000

Total cash and cash equivalents
 
170,235,110

 
113,026,884

 
 
 
 
 
Securities available-for-sale, at fair value
 
156,577,182

 
151,944,567

Restricted investments, at cost
 
8,272,600

 
6,430,700

Loans, net of allowance for loan losses of $7,073,937 at June 30, 2018 and $5,860,291 at December 31, 2017
 
1,568,360,556

 
1,317,397,909

Bank premises and equipment, net
 
52,202,992

 
43,000,249

Foreclosed assets
 
3,524,239

 
3,254,392

Goodwill and core deposit intangible, net
 
68,449,478

 
50,836,840

Cash surrender value of life insurance
 
21,944,300

 
21,646,894

Other assets
 
12,665,515

 
13,232,247

Total assets
 
$
2,062,231,972

 
$
1,720,770,682

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 

 
 

Deposits:
 
 

 
 

Noninterest-bearing demand deposits
 
$
301,317,854

 
$
220,520,287

Interest-bearing demand deposits
 
246,942,432

 
231,643,508

Money market and savings deposits
 
632,518,003

 
543,644,830

Time deposits
 
535,879,278

 
442,774,094

Total deposits
 
1,716,657,567

 
1,438,582,719

 
 
 
 
 
Securities sold under agreement to repurchase
 
18,635,215

 
24,054,730

Federal Home Loan Bank advances and other borrowings
 
72,040,028

 
43,600,000

Accrued expenses and other liabilities
 
7,412,585

 
8,681,393

Total liabilities
 
1,814,745,395

 
1,514,918,842

 
 
 
 
 
Shareholders' equity:
 
 

 
 

Preferred stock - $1 par value; 2,000,000 shares authorized; None issued and outstanding as of June 30,2018 and December 31,2017
 

 

Common stock - $1 par value; 40,000,000 shares authorized; 12,704,581 and 11,152,561 shares issued and outstanding  in 2018 and 2017, respectively
 
12,704,581

 
11,152,561

Additional paid-in capital
 
208,512,862

 
174,008,753

Retained earnings
 
29,234,901

 
21,888,575

Accumulated other comprehensive loss
 
(2,965,767
)
 
(1,198,049
)
Total shareholders' equity
 
247,486,577

 
205,851,840

 
 
 
 
 
Total liabilities and shareholders' equity
 
$
2,062,231,972

 
$
1,720,770,682


The Notes to Consolidated Financial Statements are an integral part of these statements.

4



SMARTFINANCIAL, INC. AND SUBSIDIARY 
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
INTEREST INCOME
 
 

 
 

 
 
 
 
Loans, including fees
 
$
21,652,221

 
$
10,747,217

 
$
39,880,101

 
$
20,962,823

Securities and interest-bearing deposits at other financial institutions
 
1,197,577

 
692,223

 
2,246,933

 
1,353,043

Federal funds sold and other earning assets
 
143,586

 
78,049

 
244,404

 
150,946

Total interest income
 
22,993,384

 
11,517,489

 
42,371,438

 
22,466,812

INTEREST EXPENSE
 
 

 
 

 
 
 
 
Deposits
 
3,237,891

 
1,241,551

 
5,639,354

 
2,339,089

Securities sold under agreements to repurchase
 
10,913

 
15,588

 
23,408

 
31,539

Federal Home Loan Bank advances and other borrowings
 
206,558

 
11,682

 
359,334

 
27,156

Total interest expense
 
3,455,362

 
1,268,821

 
6,022,096

 
2,397,784

Net interest income before provision for loan losses
 
19,538,022

 
10,248,668

 
36,349,342

 
20,069,028

Provision for loan losses
 
616,602

 
298,033

 
1,305,397

 
310,482

Net interest income after provision for loan losses
 
18,921,420

 
9,950,635

 
35,043,945

 
19,758,546

NONINTEREST INCOME
 
 

 
 

 
 
 
 
Customer service fees
 
556,891

 
290,626

 
1,134,894

 
555,299

Loss on sale of securities
 
(1,200
)
 

 
(1,200
)
 

Gain on sale of loans and other assets
 
321,584

 
405,418

 
646,928

 
680,583

Interchange and debit card transaction fees
 
121,219

 
223,329

 
266,754

 
415,722

Other noninterest income
 
578,715

 
332,634

 
985,025

 
542,674

Total noninterest income
 
1,577,209

 
1,252,007

 
3,032,401

 
2,194,278

NONINTEREST EXPENSES
 
 

 
 

 
 
 
 
Salaries and employee benefits
 
7,648,556

 
4,757,618

 
14,824,901

 
9,404,367

Net occupancy and equipment expense
 
1,521,687

 
962,593

 
3,055,100

 
1,941,052

Depository insurance
 
317,409

 
60,987

 
419,213

 
214,286

Sale of foreclosed assets and related expense
 
239,634

 
11,508

 
429,061

 
25,585

Advertising
 
214,632

 
129,398

 
399,107

 
293,659

Data processing
 
600,448

 
475,343

 
1,126,756

 
808,558

Professional services
 
918,135

 
473,351

 
1,816,495

 
1,043,192

Amortization of intangible assets
 
228,866

 
61,071

 
416,623

 
113,648

Service contracts
 
491,774

 
312,905

 
970,381

 
608,534

Merger expenses
 
1,122,976

 
419,992

 
1,620,716

 
419,992

Other operating expenses
 
1,968,249

 
1,163,896

 
3,416,505

 
2,116,265

Total noninterest expenses
 
15,272,366

 
8,828,662

 
28,494,858

 
16,989,138

Income before income tax expense
 
5,226,263

 
2,373,980

 
9,581,488

 
4,963,686

Income tax expense
 
1,294,707

 
725,694

 
2,235,162

 
1,671,548

Net income
 
3,931,556

 
1,648,286

 
7,346,326

 
3,292,138

Preferred stock dividends
 

 

 

 
195,000

Net income available to common shareholders
 
$
3,931,556

 
$
1,648,286

 
$
7,346,326

 
$
3,097,138

EARNINGS PER COMMON SHARE
 
 

 
 

 
 
 
 
Basic
 
$
0.32

 
$
0.20

 
$
0.63

 
$
0.39

Diluted
 
0.32

 
0.20

 
0.62

 
0.39

Weighted average common shares outstanding
 
 

 
 

 
 
 
 
Basic
 
12,201,185

 
8,216,567

 
11,708,746

 
7,872,609

Diluted
 
12,320,498

 
8,325,538

 
11,822,497

 
7,977,282

 
The Notes to Consolidated Financial Statements are an integral part of these statements.

5



SMARTFINANCIAL, INC. AND SUBSIDIARY 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 (Unaudited) 
 
 
Three Months Ended
June 30,
 
 
2018
 
2017
Net income available to common shareholders
 
$
3,931,556

 
$
1,648,286

Other comprehensive (loss) income, net of tax:
 
 

 
 

Unrealized holding gains (losses) on securities arising during the period, net of tax (benefit) expense of $(134,439) and $270,461 in 2018 and 2017, respectively
 
(397,244
)
 
435,890

Reclassification adjustment for losses included in net income, net of tax (benefit) of $(280) and $0 in 2018 and  2017, respectively
 
920

 

Total other comprehensive (loss) income
 
(396,324
)
 
435,890

Comprehensive income
 
$
3,535,232

 
$
2,084,176



 
 
Six Months Ended
June 30,
 
 
2018
 
2017
Net income available to common shareholders
 
$
7,346,326

 
$
3,292,138

Other comprehensive income, net of tax:
 
 

 
 

Unrealized holding gains arising during the period, net of tax (benefit) expense of $(580,433) and $468,293 in 2018 and 2017, respectively
 
(1,768,638
)
 
754,724

Reclassification adjustment for losses included in net income, net of tax (benefit) of $(280) and $0 in 2018 and  2017, respectively
 
920

 

Total other comprehensive (loss) income
 
(1,767,718
)
 
754,724

Comprehensive income
 
$
5,578,608

 
$
4,046,862











The Notes to Consolidated Financial Statements are an integral part of these statements. 


6



SMARTFINANCIAL, INC. AND SUBSIDIARY 
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY - (Unaudited) 
For the Six Months Ended June 30, 2018 and 2017
 
 
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Shareholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2017
 
$
11,152,561

 
$
174,008,753

 
$
21,888,575

 
$
(1,198,049
)
 
$
205,851,840

 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 
7,346,326

 

 
7,346,326

 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss
 

 

 

 
(1,767,718
)
 
(1,767,718
)
 
 
 
 
 
 
 
 
 
 
 
Shares issued to shareholders of TN Bancshares, Inc., net
 
1,458,981

 
33,272,941

 

 

 
34,731,922

 
 
 
 
 
 
 
 
 
 
 
Issuance of stock grants
 
394

 
8,668

 

 

 
9,062

 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
 
92,645

 
978,272

 

 

 
1,070,917

 
 
 
 
 
 
 
 
 
 
 
Stock compensation expense
 

 
244,228

 

 

 
244,228

 
 
 
 
 
 
 
 
 
 
 
BALANCE, June 30, 2018
 
$
12,704,581

 
$
208,512,862

 
$
29,234,901

 
$
(2,965,767
)
 
$
247,486,577

 
 
 
Preferred Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2016
 
$
12,000

 
$
5,896,033

 
$
83,463,051

 
$
16,871,296

 
$
(1,002,240
)
 
$
105,240,140

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
3,292,138

 

 
3,292,138

 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income
 

 

 

 

 
754,724

 
754,724

 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common stock
 

 
1,840,000

 
31,094,676

 

 

 
32,934,676

 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of stock grants
 

 
1,511

 
30,280

 

 

 
31,791

 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
 

 
481,717

 
4,143,295

 

 

 
4,625,012

 
 
 
 
 
 
 
 
 
 
 
 
 
Cash dividends on preferred stock
 

 

 

 
(195,000
)
 

 
(195,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Redemption of preferred stock
 
(12,000
)
 

 
(11,988,000
)
 

 

 
(12,000,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock option compensation expense
 

 

 
50,530

 

 

 
50,530

 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, June 30, 2017
 

 
$
8,219,261

 
$
106,793,832

 
$
19,968,434

 
$
(247,516
)
 
$
134,734,011

 
The Notes to Consolidated Financial Statements are an integral part of these statements 

7



SMARTFINANICAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Six Months Ended June 30,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net income
 
$
7,346,326

 
$
3,292,138

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
1,907,969

 
1,165,930

Provision for loan losses
 
1,305,397

 
310,482

Stock option compensation expense
 
244,228

 
50,530

Loss from redemption of securities
 
1,200

 

Net gains from sale of loans and other assets
 
(646,928
)
 
(680,583
)
Net losses from sale of foreclosed assets
 
371,734

 
15,064

Changes in other assets and liabilities:
 
 
 
 
Accrued interest receivable
 
(250,228
)
 
18,144

Accrued interest payable
 
48,400

 
13,117

Other assets and liabilities
 
1,869,609

 
1,457,176

Net cash provided by operating activities
 
12,197,707

 
5,641,998

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES, net of acquisitions
 
 
 
 
Proceeds from sales, maturities, and paydowns of securities available-for-sale
 
34,524,629

 
10,062,386

Purchase of securities
 
(17,239,649
)
 
(12,507,860
)
Purchase of bank owned life insurance
 

 
(10,070,914
)
Purchase of restricted investments
 
(1,377,600
)
 
(452,750
)
Net cash and cash equivalents received (paid) in business combination
 
5,653,304

 
(1,049,878
)
Loan originations and principal collections, net
 
(73,194,598
)
 
(27,248,001
)
Purchase of bank premises and equipment
 
(992,045
)
 
(1,226,898
)
Proceeds from sale of foreclosed assets
 
2,126,213

 
41,636

Net cash used in investing activities
 
(50,499,746
)
 
(42,452,279
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES, net of acquisitions
 
 
 
 
Net increase in deposits
 
75,409,773

 
47,682,310

Net decrease in securities sold under agreements to repurchase
 
(5,419,515
)
 
(3,676,000
)
Issuance of common stock
 
1,079,979

 
37,591,479

Redemption of preferred stock
 

 
(12,000,000
)
Payment of dividends on preferred stock
 

 
(195,000
)
Proceeds from Federal Home Loan Bank advances and other borrowings
 
127,040,028

 
79,268,072

Repayment of Federal Home Loan Bank advances and other borrowings
 
(102,600,000
)
 
(97,773,462
)
Net cash provided by financing activities
 
95,510,265

 
50,897,399

NET INCREASE IN CASH AND CASH EQUIVALENTS
 
57,208,226

 
14,087,118

CASH AND CASH EQUIVALENTS, beginning of year
 
113,026,884

 
68,748,308

CASH AND CASH EQUIVALENTS, end of period
 
$
170,235,110

 
$
82,835,426

 
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 
 
 
Cash paid during the period for interest
 
$
5,973,696

 
$
2,374,250

Cash paid during the period for income taxes
 
713,000

 
1,366,172

 
 
 
 
 
NONCASH INVESTING AND FINANCING ACTIVITIES
 
 
 
 
Change in unrealized losses on securities available for sale
 
$
2,347,870

 
$
(1,223,017
)
Acquisition of real estate through foreclosure
 
2,350,853

 
39,517

Financed sales of foreclosed assets
 
257,416

 

Change in goodwill due to acquisition
 
15,739,261

 

The Notes to Consolidated Financial Statements are an integral part of these statements.

8

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)



Note 1. Presentation of Financial Information
 
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”). The Company provides a variety of financial services to individuals and corporate customers through its offices in eastern Tennessee, Alabama, Florida, and Georgia. The Company’s primary deposit products are interest-bearing demand deposits and time deposits. Its primary lending products are commercial, residential, and consumer loans. On May 22, 2017, the Company along with the Bank entered into an agreement and plan of merger with Capstone Bancshares, Inc., an Alabama corporation and Capstone Bank, an Alabama-chartered commercial bank and wholly owned subsidiary of Capstone Bancshares, Inc. which became effective on November 1, 2017. On December 12, 2017, the Company along with the Bank entered into an agreement and plan of merger with Tennessee Bancshares, Inc., a Tennessee corporation and Southern Community Bank, a Tennessee-chartered commercial bank and wholly owned subsidiary of Tennessee Bancshares which became effective on May 1, 2018.
 
Interim Financial Information (Unaudited):
 
The financial information in this report for June 30, 2018 and June 30, 2017 has not been audited. The information included herein should be read in conjunction with the Company’s annual consolidated financial statements and footnotes included in the Company's most recent Annual Report on Form 10-K. The consolidated financial statements presented herein conform to U.S. generally accepted accounting principles and to general industry practices. In the opinion of SmartFinancial’s management, the accompanying interim financial statements contain all material adjustments necessary to present fairly the financial condition, the results of operations, and cash flows for the interim period. Results for interim periods are not necessarily indicative of the results to be expected for a full year.
 
Basis of Presentation and Accounting Estimates:
 
All adjustments consisting of normal recurring accruals, that in the opinion of management, are necessary for a fair presentation of the financial position and the results of operations for the periods covered by the report have been included. The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with those appearing in the most recent Annual Report previously filed on Form 10-K.
 
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 U.S, 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. However, the amount of the change that is reasonably possible cannot be estimated. 

9

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 1. Presentation of Financial Information, Continued

Accounting Changes:

We adopted ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)” and its related amendments as of January 1, 2018 utilizing the modified retrospective approach. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including, deposit related fees, interchange fees, merchant income, and insurance and brokerage commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams.

Under ASU 2014-09, we adopted new policies related to revenue recognition. In general, for revenue not associated with financial instruments, guarantees and lease contracts, we apply the following steps when recognizing revenue from contracts with customers: (i) identify the contract, (ii) identify the performance obligations, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations and (v) recognize revenue when performance obligation is satisfied. Our contracts with customers are generally short term in nature, typically due within one year or less or cancellable by us or our customer upon a short notice period. Performance obligations for our customer contracts are generally satisfied at a single point in time, typically when the transaction is complete, or over time. For performance obligations satisfied over time, we primarily use the output method, directly measuring the value of the products/services transferred to the customer, to determine when performance obligations have been satisfied. We typically receive payment from customers and recognize revenue concurrent with the satisfaction of our performance obligations. In most cases, this occurs within a single financial reporting period. For payments received in advance of the satisfaction of performance obligations, revenue recognition is deferred until such time the performance obligations have been satisfied. In cases where we have not received payment despite satisfaction of our performance obligations, we accrue an estimate of the amount due in the period our performance obligations have been satisfied. For contracts with variable components, only amounts for which collection is probable are accrued. We generally act in a principal capacity, on our own behalf, in most of our contracts with customers. In such transactions, we recognize revenue and the related costs to provide our services on a gross basis in our financial statements. In some cases, we act in an agent capacity, deriving revenue through assisting other entities in transactions with our customers. In such transactions, we recognized revenue and the related costs to provide our services on a net basis in our financial statements. These transactions relate to our customers' use of various interchange and ATM/debit card networks.

Based on our underlying contracts, ASU 2014-09 requires us to report network costs associated with debit card and ATM transactions netted against the related fees from such transactions. Previously, such network costs were reported as a component of other noninterest expense. For the three and six months periods ended June 30, 2018, gross interchange and debit card transaction fees totaled $401 thousand and $733 thousand, respectively while related network costs totaled $280 thousand and $467 thousand, respectively. On a net basis, we reported $121 thousand and $267 thousand as interchange and debit card transaction fees in the accompanying Consolidated Statement of Income for the three and six months periods ended June  30, 2018.

For the three and six months periods ended June 30, 2017, we reported interchange and debit card transaction fees totaling $223 thousand and $416 thousand, respectively on a gross basis in the accompanying Consolidated Statement of Income while related network costs totaling $140 thousand and $227 thousand, respectively were reported in other operating expenses included as a component of other noninterest expense.

ASU 2016-01 "Financial Instruments - Overall (Subtopic 825-10): Recognition of Financial Assets and Financial Liabilities, ("ASU 2016-01") makes targeted amendments to the guidance for recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 requires equity investments, other than equity method investments, to be measured at fair value with changes in fair value recognized in net income. The ASU requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption to reclassify the cumulative change in fair value of equity securities previously recognized in Accumulated Other Comprehensive Income. ASU 2016-01 became effective for the Company on January 1, 2018 and there was no adjustment to retained earnings. ASU 2016-01 also emphasizes the existing requirement to use exit prices to measure fair value for disclosure purposes and clarifies that entities should not make use of a practicability exception in determining the fair value of loans. Accordingly, we refined the calculation used to determine the disclosed fair value of our loans held for investment portfolio as part of adopting this standard. The refined calculation is disclosed Note 6 - Fair Value Disclosures.


10

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 1. Presentation of Financial Information, Continued

Accounting Changes (continued):

In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220):  Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income; (“ASU 2018-02”).  ASU 2018-02 amends ASC Topic 220 and allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“Tax Reform Act”).  Consequently, this amendment eliminates the stranded tax effects resulting from the Tax Reform Act and will improve the usefulness of information reported to financial statement users.  However, because the amendments only related to the reclassification of the income tax effects of the Tax Reform Act, the underlying guidance that requires that the effects of the change in tax laws or rates be included in income from continuing operations is not affected.  The guidance is effective for public companies for annual periods beginning on or after December 15, 2018 and interim periods within those fiscal years.  Early adoption is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance.  This amendment should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in U.S. federal corporate income tax rate in the Tax Reform Act is recognized.  The Company early adopted this amendment in the fourth quarter of 2017 and reclassified $197 thousand from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the Tax Reform Act. 

Recently Issued Accounting Pronouncements:
 
During interim periods, the Company follows the accounting policies set forth in its annual audited financial statements for the year ended December 31, 2017 as filed with the Securities and Exchange Commission. The following is a summary of recent authoritative pronouncements not yet effective that could impact the accounting, reporting, and/or disclosure of financial information by the Company issued since December 31, 2017.

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 has several lease agreements, such as branch locations, which are currently considered operating leases, and therefore, not recognized on the Company’s consolidated statements of condition. The Company expects the new guidance will require these lease agreements to be recognized on the consolidated statements of condition as a right-of-use asset and a corresponding lease liability. Therefore, the Company’s preliminary evaluation indicates the provisions of ASU No. 2016-02 are expected to impact the Company’s consolidated statements of condition, along with our regulatory capital ratios. However, the Company continues to evaluate the extent of potential impact the new guidance will have on the Company’s consolidated financial statements. The Company is in the process of identifying a complete inventory of arrangements containing a lease and accumulating the lease data necessary to apply the amended guidance.
 
In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842) Land Easement Practical Expedient Transition to Topic 842 , an amendment to ASU 2016-2: Leases. The amendments in this Update permit an entity to elect an optional transition practical expedient to not evaluate under Topic 842 land easements that exist or expired before the entity’s adoption of Topic 842 and that were not previously accounted for as leases under Topic 840. An entity that elects this practical expedient should apply the practical expedient consistently to all of its existing or expired land easements that were not previously accounted for as leases under Topic 840. Once an entity adopts Topic 842, it should apply that Topic prospectively to all new (or modified) land easements to determine whether the arrangement should be accounted for as a lease. An entity that does not elect this practical expedient should evaluate all existing or expired land easements in connection with the adoption of the new lease requirements in Topic 842 to assess whether they meet the definition of a lease. An entity should continue to apply its current accounting policy for accounting for land easements that existed before the entity’s adoption of Topic 842. For example, if an entity currently accounts for certain land easements as leases under Topic 840, it should continue to account for those land easements as leases before its adoption of Topic 842. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements in Update 2016-02, for which the company is currently evaluating the impact.


11

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 1. Presentation of Financial Information, Continued

Recently Issued 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 continuing its implementation efforts through its Company-wide implementation team. The implementation team meets periodically to discuss the latest developments and ensure progress is being made. The team also keeps current on evolving interpretations and industry practices related to ASU 2016-13 via webcasts, publications, conferences, and peer bank meetings. The team continues to evaluate and validate data resources and different loss methodologies. The Company’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact the Company’s consolidated financial statements, in particular an increase to the level of the reserve for credit losses. However, the Company continues to evaluate the extent of the potential impact.

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 consolidated financial statements.

In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Topic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The premium on individual callable debt securities shall be amortized to the earliest call date. This guidance does not apply to securities for which prepayments are estimated on a large number of similar loans where prepayments are probable and reasonably estimable. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. This update should be adopted on a modified retrospective basis with a cumulative-effect adjustment to retained earnings on the date of adoption. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, which amends the hedge accounting recognition and presentation requirements in Accounting Standards Codification (ASC) 815, Derivatives and Hedging. The goals of the ASU are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.



12

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 1. Presentation of Financial Information, Continued

As part of its Simplification Initiative, the FASB has issued (ASU) No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU No. 2018-07 expands the scope of Topic 718, Compensation-Stock Compensation (which previously only included payments to employees), to include share-based payment transactions for acquiring goods and services from non-employees. This required entities to apply the requirements of Topic 718 to non-employee awards, except for specific guidance on inputs to an option pricing model and the attribution of cost (i.e., the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). Additionally, the amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in the grantor’s own operations by issuing share-based payment awards, and clarify that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer, or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers. The amendments are effective for fiscal years beginning after December 15, 2018, and for the interim periods within those years. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
Reclassifications:

Certain captions and amounts in the 2017 consolidated financial statements were reclassified to conform to the 2018 presentation and these reclassifications had no impact on net income or equity as previously reported.

Earnings per common share:
 
Basic earnings per common share represents income available to common shareholders 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 (excluding tax impact). Potential common shares that may be issued by the Company relate solely to outstanding stock options, determined using the treasury stock method, and restricted stock awards, determined by the fair value of the Company's stock on date of grant.

Note 2.    Business Combination

Acquisition of branch from Atlantic Capital Bank, N.A.

On December 8, 2016, the Bank entered into a purchase and assumption agreement with Atlantic Capital Bank, N.A. that provided for the acquisition and assumption by the Bank of certain assets and liabilities associated with Atlantic Capital Bank’s branch office located at 3200 Keith Street NW, Cleveland, Tennessee 37312. The purchase was completed on May 19, 2017 for total cash consideration of $1.2 million. The assets and liabilities as of the effective date of the transaction were recorded at their respective estimated fair values. 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 the periods following the acquisition, the financial statements will include the results attributable to the Cleveland branch purchase beginning on the date of purchase. For the three and six months period ended June 30, 2018, the revenues attributable to the Cleveland branch were $381 thousand and $754 thousand, respectively. For the three and six months period ended June 30, 2018, net income attributable to the Cleveland branch was a net income of $105 thousand and net income of $194 thousand, respectively. It is impracticable to determine the pro-forma impact to the 2017 revenues and net income if the acquisition had occurred on January 1, 2017 as the Company does not have access to those records for a single branch.

13

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 2.    Business Combination, Continued

The following table details the financial impact of the transaction, including the allocation of the purchase price to the fair values of net assets assumed and goodwill recognized:

Allocation of Purchase Price (in thousands)
 
Total consideration in cash
$
1,183

Fair value of assets acquired and liabilities assumed:
 

Cash and cash equivalents
133

Loans
24,073

Premises and equipment
2,839

Core deposit intangible
310

Prepaid and other assets
77

Deposits
(26,888
)
Payables and other liabilities
(21
)
Total fair value of net assets acquired
523

Goodwill
$
660


As of June 30, 2018 there have not been any changes to the initial fair values recorded as part of the business combination.

Acquisition of Capstone Bancshares, Inc.

On May 22, 2017, the shareholders of the Company approved a merger with Capstone Bancshares, Inc. ("Capstone"), the one bank holding company of Capstone Bank, which became effective November 1, 2017. Capstone shareholders received either: (a) 0.85 shares of common stock, (b) $18.50 in cash, or (c) a combination of 80% common stock and 20% cash. Elections were limited by the requirement that 80% of the total shares of Capstone common stock be exchanged for common stock and 20% be exchanged for cash. Therefore, the allocation of common stock and cash that a Capstone shareholder received depended on the elections of other Capstone shareholders, and were allocated in accordance with the procedures set forth in the merger agreement. Capstone shareholders also received cash instead of any fractional shares they would have otherwise received in the merger.

After the merger, shareholders of SmartFinancial owned approximately 74% of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.
 
The merger is being accounted for using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, the Company is considered the acquirer in the merger, and as a result the historical financial statements of the combined entity are the historical consolidated financial statements of the Company.
 
The merger was effected by the issuance of shares of SmartFinancial stock along with cash consideration to shareholders of Capstone. The assets and liabilities of Capstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of 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 $38.0 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 Capstone beginning on the date the merger was completed. In the three and six month period ended June 30, 2018, the revenues attributable to Capstone were approximately $7.6 million and $14.5 million. In the three and six month period ended June 30, 2018, the net income attributable to Capstone was approximately $3.4 million and $6.0 million, respectively.


14

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 2.    Business Combination, Continued

The pro-forma impact to 2017 revenues if the merger had occurred on December 31, 2016 would have been $6.2 million and $12.5 million for the three and six month period ending June 30, 2017, respectively. The pro-forma impact to 2017 net income if the merger had occurred on December 31, 2016 would have been $237 thousand and $473 thousand for the three and six month period ending June 30, 2017, respectively. While certain adjustments were made for the estimated impact of certain fair value adjustments, they are not indicative of what would have occurred had the merger taken place on the indicated date nor are they intended to represent or be indicative of future results of operations. In particular, no adjustments have been made to eliminate the amount of Capstone's provision for credit losses not have been necessary or any adjustments to estimate any additional income that would have been recorded as a result of fair value adjustments for the first six months of 2017 that may have occurred had the acquired loans been recorded at fair value as of the beginning of 2017. In addition there are no adjustments to reflect any expenses that potentially could have been reduced for the first six months of 2017 had the merger occurred on December 31, 2016. There were $4.6 million in nonrecurring pro forma adjustments to expense included in the reported proforma revenue and earnings.

The fair value estimates of Capstone’s assets and liabilities recorded are preliminary and subject to refinement as additional information becomes available. Under current accounting principles, the Company’s estimates of fair values may be adjusted for a period of up to one year from the acquisition date. As of June 30, 2018 there was a $11 thousand adjustment to reduce fair values initially recorded as part of the business combination.

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 SMBK common stock issued to Capstone shareholders as of November 1, 2017
2,908,094

Market price of SMBK common stock on November 1, 2017
$
23.49

Estimated fair value of SMBK common stock issued (in thousands)
68,311

Estimated fair value of Capstone stock options (in thousands)
1,585

Cash consideration paid
15,826

Total consideration (in thousands)
$
85,722

 
Allocation of Purchase Price (in thousands)
 
Total consideration above
$
85,722

Fair value of assets acquired and liabilities assumed:
 

Cash and cash equivalents
16,810

Investment securities available for sale
51,638

Restricted investments
1,049

Loans
413,023

Premises and equipment
8,668

Bank owned life insurance
10,031

Core deposit intangible
5,530

Other real estate owned
410

Prepaid and other assets
6,360

Deposits
(454,154
)
FHLB advances and other borrowings
(4,887
)
Payables and other liabilities
(6,803
)
Total fair value of net assets acquired
47,675

Goodwill
$
38,047



15

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 2.    Business Combination, Continued

Acquisition of Tennessee Bancshares, Inc.

On May 1, 2018, the Company completed its merger with Tennessee Bancshares, Inc., a Tennessee corporation (“Tennessee Bancshares”), pursuant to an Agreement and Plan of Merger dated December 12, 2017 (the “Tennessee Bancshares merger agreement”), by and among SmartFinancial, Tennessee Bancshares, and Southern Community Bank, a Tennessee-chartered commercial bank and wholly owned subsidiary of Tennessee Bancshares. Tennessee Bancshares merged with and into SmartFinancial, with SmartFinancial continuing as the surviving corporation. Immediately following the merger, Southern Community Bank merged with and into the Bank continuing as the surviving banking corporation.

Pursuant to the Tennessee Bancshares merger agreement, each outstanding share of Tennessee Bancshares common stock was converted into and cancelled in exchange for 0.8065 shares of SmartFinancial common stock.. SmartFinancial issued approximately 1,458,981 shares of SmartFinancial common stock as consideration for the merger. SmartFinancial did not issue fractional shares of its common stock in connection with the merger, but instead paid cash in lieu of fractional shares based on the volume weighted average closing price of SmartFinancial common stock on the Nasdaq Capital Market for the 10 consecutive trading days ending on (and including) April 27, 2018 (calculated as $23.92).

After the merger, shareholders of SmartFinancial owned approximately 88.6% of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.

The merger with Tennessee Bancshares is being accounted for using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, the Company is considered the acquirer in the merger, and as a result the historical financial statements of the combined entity are the historical consolidated financial statements of the Company.
 
The merger was effected by the issuance of shares of SmartFinancial stock along with cash consideration to the fractional shareholders of Tennessee Bancshares, Inc. The assets and liabilities of Tennessee Bancshares as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of 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 $15.7 million, none of which is deductible for income tax purposes.

In periods following the Tennessee Bancshares merger, the financial statements of the combined entity will include the results attributable to Southern Community Bank beginning on the date the merger was completed. In the three and six months period ended June 30, 2018, the revenues and net income attributable to Southern Community Bank were approximately $2.4 million and $800 thousand, respectively.

The pro-forma impact to 2017 revenues if the merger had occurred on December 31, 2016 would have been $3.7 million and $7.3 million for the three and six month period ending June 30, 2017, respectively. The pro-forma impact to 2017 net income if the merger had occurred on December 31, 2016 would have been $909 thousand and $1.8 million for the three and six month period ending June 30, 2017, respectively.

While certain adjustments were made for the estimated impact of certain fair value adjustments, they are not indicative of what would have occurred had the merger taken place on the indicated date nor are they intended to represent or be indicative of future results of operations. In particular, no adjustments have been made to eliminate the amount of Southern Community Bank's provision for credit losses not have been necessary or any adjustments to estimate any additional income that would have been recorded as a result of fair value adjustments for the first six months of 2017 that may have occurred had the acquired loans been recorded at fair value as of the beginning of 2017. In addition there are no adjustments to reflect any expenses that potentially could have been reduced for the first six months of 2017 had the merger occurred on December 31, 2016. There were $1.3 million nonrecurring pro forma adjustments to expense included in the reported proforma earnings.

The fair value estimates of Tennessee Bancshares assets and liabilities recorded are preliminary and subject to refinement as additional information becomes available. Under current accounting principles, the Company’s estimates of fair values may be adjusted for a period of up to one year from the acquisition date. As of June 30, 2018 there were no adjustments to fair values initially recorded as part of the business combination.


16

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 2.    Business Combination, Continued

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 SMBK common stock issued to TN Bancshares shareholders as of May 1, 2018
1,458,981

Market price of SMBK common stock on May 1, 2018
$
23.85

Estimated fair value of SMBK common stock issued (in thousands)
34,797

Cash consideration paid
5

Total consideration (in thousands)
$
34,802

 
Allocation of Purchase Price (in thousands)
 
Total consideration above
$
34,802

Fair value of assets acquired and liabilities assumed:
 

Cash and cash equivalents
5,723

Investment securities available for sale
24,563

Restricted investments
464

Loans
180,490

Premises and equipment
9,470

Core deposit intangible
2,290

Other real estate owned
674

Prepaid and other assets
2,258

Deposits
(202,272
)
FHLB advances and other borrowings
(4,000
)
Payables and other liabilities
(586
)
Total fair value of net assets acquired
19,074

Goodwill
$
15,728


Note 3. Earnings per share
 
The following is a summary of the basic and diluted earnings per share for the three and six months ended June 30, 2018 and 2017.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income available to common shareholders
$
3,931,556

 
$
1,648,286

 
$
7,346,326

 
$
3,097,138

Weighted average common shares outstanding
12,201,185

 
8,216,567

 
11,708,746

 
7,872,609

Effect of dilutive stock options
119,313

 
108,971

 
113,751

 
104,673

Diluted shares
12,320,498

 
8,325,538

 
11,822,497

 
7,977,282

Basic earnings per common share
$
0.32

 
$
0.20

 
$
0.63

 
$
0.39

Diluted earnings per common share
$
0.32

 
$
0.20

 
$
0.62

 
$
0.39


For the three and six months ended June 30, 2018 and 2017, the effects of outstanding antidilutive stock options are excluded from the computation of diluted earnings per common share because the exercise price of such options is higher than the market price. There were no and 13,916 antidilutive stock options for the three and six months ended June 30, 2018 and 2017


17

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 4. Securities
 
The amortized cost and fair value of securities available-for-sale at June 30, 2018 and December 31, 2017 are summarized as follows (in thousands):
 
 
 
June 30, 2018
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Government-sponsored enterprises (GSEs)
 
$
29,137

 
$

 
$
(1,009
)
 
$
28,128

Municipal securities
 
15,896

 
8

 
(320
)
 
15,584

Other debt securities
 
976

 

 
(65
)
 
911

Mortgage-backed securities (GSEs)
 
114,538

 
171

 
(2,755
)
 
111,954

 
 
$
160,547

 
$
179

 
$
(4,149
)
 
$
156,577


 
 
December 31, 2017
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Government-sponsored enterprises (GSEs)
 
$
26,207

 
$
1

 
$
(432
)
 
$
25,776

Municipal securities
 
9,122

 
28

 
(147
)
 
9,003

Other debt securities
 
974

 

 
(24
)
 
950

Mortgage-backed securities (GSEs)
 
117,263

 
136

 
(1,184
)
 
116,215

 
 
$
153,566

 
$
165

 
$
(1,787
)
 
$
151,944

 
At June 30, 2018 and December 31, 2017, securities with a fair value totaling approximately $113.5 million and $97.2 million, respectively were pledged to secure public funds and securities sold under agreements to repurchase.

For the three and six months ended June 30, 2018 and June 30, 2017, there were no available-for-sale securities sold. For the three and six months ended June 30, 2018, a security was called for less than the amortized cost resulting in a realized loss of $1,200.

The amortized cost and estimated fair value of securities at June 30, 2018, by contractual maturity for non-mortgage backed securities, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$

 
$

Due from one year to five years
 
21,554

 
20,901

Due from five years to ten years
 
13,995

 
13,366

Due after ten years
 
10,460

 
10,356

 
 
46,009

 
44,623

Mortgage-backed securities
 
114,538

 
111,954

 
 
$
160,547

 
$
156,577


18

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 4. Securities, Continued

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 June 30, 2018 and December 31, 2017 (in thousands): 
 
 
As of June 30, 2018
 
 
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)
 
$
14,862

 
$
(425
)
 
$
13,266

 
$
(584
)
 
$
28,128

 
$
(1,009
)
Municipal securities
 
11,966

 
(182
)
 
2,072

 
(138
)
 
14,038

 
(320
)
Other debt securities
 

 

 
911

 
(65
)
 
911

 
(65
)
Mortgage-backed securities (GSEs)
 
58,377

 
(1,654
)
 
29,911

 
(1,101
)
 
88,288

 
(2,755
)
 
 
$
85,205

 
$
(2,261
)
 
$
46,160

 
$
(1,888
)
 
$
131,365

 
$
(4,149
)
 
 
As of December 31, 2017
 
 
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)
 
$
1,358

 
$
(1
)
 
$
13,420

 
$
(431
)
 
$
14,778

 
$
(432
)
Municipal securities
 
3,418

 
(43
)
 
2,112

 
(104
)
 
5,530

 
(147
)
Other debt securities
 
950

 
(24
)
 

 

 
950

 
(24
)
Mortgage-backed securities (GSEs)
 
61,332

 
(407
)
 
35,048

 
(777
)
 
96,380

 
(1,184
)
 
 
$
67,058

 
$
(475
)
 
$
50,580

 
$
(1,312
)
 
$
117,638

 
$
(1,787
)

At June 30, 2018, the categories of temporarily impaired securities, and management’s evaluation of those securities, are as follows:

U.S. Government-sponsored enterprises: At June 30, 2018, 8 (or eight) 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 do 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 June 30, 2018.

Municipal securities: At June 30, 2018, 21 (or twenty one) 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 June 30, 2018.

Other debt securities: At June 30, 2018, 1 (or one) investment in other debt securities had unrealized losses. The Bank believes the unrealized loss on this investment was caused by the interest rate environment and does not relate to the underlying credit quality of the issuer. Because the Bank does not intend to sell the investment and it is not more likely than not that the Bank will be required to sell the investment before recovery of its amortized cost bases, which may be maturity, the Bank does not consider this investment to be other-than temporarily impaired at June 30, 2018.

Mortgage-backed securities: At June 30, 2018, 65 (or sixty 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 deem these investments to be other-than-temporarily impaired at June 30, 2018. 

19

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)



Note 5. Loans and Allowance for Loan Losses
 
Portfolio Segmentation:
 
At June 30, 2018 and December 31, 2017, loans are summarized as follows (in thousands):
 
 
 
June 30, 2018
 
December 31, 2017
 
 
PCI Loans1
 
All Other
Loans
 
Total
 
PCI Loans1
 
All Other
Loans
 
Total
Commercial real estate
 
$
18,474

 
$
727,390

 
$
745,864

 
$
17,903

 
$
625,085

 
$
642,988

Consumer real estate
 
6,987

 
348,889

 
355,876

 
7,450

 
286,007

 
293,457

Construction and land development
 
5,690

 
173,741

 
179,431

 
5,120

 
130,289

 
135,409

Commercial and industrial
 
821

 
278,950

 
279,771

 
858

 
237,229

 
238,087

Consumer and other
 
686

 
13,807

 
14,493

 
1,463

 
11,854

 
13,317

Total loans
 
32,658

 
1,542,777

 
1,575,435

 
32,794

 
1,290,464

 
1,323,258

Less:  Allowance for loan losses
 
(19
)
 
(7,055
)
 
(7,074
)
 
(16
)
 
(5,844
)
 
(5,860
)
Loans, net
 
$
32,639

 
$
1,535,722

 
$
1,568,361

 
$
32,778

 
$
1,284,620

 
$
1,317,398

1 Purchased Credit Impaired loans (“PCI loans”) are loans with evidence of credit deterioration at purchase.

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, agricultural, and municipal 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, educational loans, and other loans which do not fall into the categories above. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.


20

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)



Note 5. 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.


21

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 5. 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 June 30, 2018 and December 31, 2017, is summarized in the tables below (in thousands):

 
 
June 30, 2018
 
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Performing loans
 
$
726,356

 
$
347,893

 
$
173,194

 
$
278,431

 
$
13,698

 
$
1,539,572

Impaired loans
 
1,034

 
996

 
547

 
519

 
109

 
3,205

 
 
727,390

 
348,889

 
173,741

 
278,950

 
13,807

 
1,542,777

PCI loans
 
18,474

 
6,987

 
5,690

 
821

 
686

 
32,658

Total
 
$
745,864

 
$
355,876

 
$
179,431

 
$
279,771

 
$
14,493

 
$
1,575,435

 
 
December 31, 2017
 
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Performing loans
 
$
624,638

 
$
284,585

 
$
129,742

 
$
237,016

 
$
11,842

 
$
1,287,823

Impaired loans
 
447

 
1,422

 
547

 
213

 
12

 
2,641

 
 
625,085

 
286,007

 
130,289

 
237,229

 
11,854

 
1,290,464

PCI loans
 
17,903

 
7,450

 
5,120

 
858

 
1,463

 
32,794

Total loans
 
$
642,988

 
$
293,457

 
$
135,409

 
$
238,087

 
$
13,317

 
$
1,323,258


The following tables show the allowance for loan losses allocation by loan classification for impaired, PCI, and performing loans as of June 30, 2018 and December 31, 2017 (in thousands):

 
 
June 30, 2018
 
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and
Other
 
Total
Performing loans
 
$
3,116

 
$
1,491

 
$
744

 
$
1,145

 
$
224

 
$
6,720

PCI loans
 
19

 

 

 

 

 
19

Impaired loans
 

 
37

 

 
222

 
76

 
335

Total
 
$
3,135

 
$
1,528

 
$
744

 
$
1,367

 
$
300

 
$
7,074


 
 
December 31, 2017
 
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and
Other
 
Total
Performing loans
 
$
2,444

 
$
1,340

 
$
521

 
$
890

 
$
204

 
$
5,399

PCI loans
 
16

 

 

 

 

 
16

Impaired loans
 
5

 
256

 

 
172

 
12

 
445

Total
 
$
2,465

 
$
1,596

 
$
521

 
$
1,062

 
$
216

 
$
5,860

 


22

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 5. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):

The following tables detail the changes in the allowance for loan losses for the six month period ending June 30, 2018 and year ending December 31, 2017, by loan classification (in thousands):
 
 
 
June 30, 2018
 
 
Commercial
Real Estate
 
Consumer
Real
Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Beginning balance
 
$
2,465

 
$
1,596

 
$
521

 
$
1,062

 
$
216

 
$
5,860

Loans charged off
 
(38
)
 
(25
)
 

 
(78
)
 
(101
)
 
(242
)
Recoveries of loans charged off
 

 
50

 
5

 
56

 
40

 
151

Provision (reallocation) charged to expense
 
708

 
(93
)
 
218

 
327

 
145

 
1,305

Ending balance
 
$
3,135

 
$
1,528

 
$
744

 
$
1,367

 
$
300

 
$
7,074


 
 
December 31, 2017
 
 
Commercial
Real Estate
 
Consumer
Real
Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Beginning balance
 
$
2,369

 
$
1,382

 
$
717

 
$
520

 
$
117

 
$
5,105

Loans charged off
 

 
(111
)
 

 
(24
)
 
(141
)
 
(276
)
Recoveries of charge-offs
 
8

 
99

 
13

 
67

 
61

 
248

Provision (reallocation) charged to expense
 
88

 
226

 
(209
)
 
499

 
179

 
783

Ending balance
 
$
2,465

 
$
1,596

 
$
521

 
$
1,062

 
$
216

 
$
5,860


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.
 
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.


23

SMARTFINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 5. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):

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 June 30, 2018 and December 31, 2017 (in thousands):

 
 
June 30, 2018
Non PCI Loans
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Pass
 
$
724,763

 
$
343,407

 
$
172,972

 
$
277,384

 
$
13,184

 
$
1,531,710

Watch
 
1,604

 
3,168

 
62

 
1,035

 
123

 
5,992

Special mention
 

 
949

 
160

 
35

 
363

 
1,507

Substandard
 
1,023

 
1,365

 
547

 
483

 
111

 
3,529

Doubtful
 

 

 

 
13

 
26

 
39

Total
 
$