Toggle SGML Header (+)


Section 1: 10-K/A (10-K/A)

Document



UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549
 
_________________________________________________________
 
FORM 10-K/A
Amendment No. 1 
_________________________________________________________
  
 
ý
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2018
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from __________ to __________
 
Commission File Number: 001-37391 
_________________________________________________________
 
SMARTFINANCIAL, INC.
(Exact name of registrant as specified in its charter)
 
_________________________________________________________ 

Tennessee
62-1173944
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
5401 Kingston Pike, Suite 600
Knoxville, Tennessee
37919
(Address of principal executive offices)  
(Zip Code)
 
(865) 437-5700
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $1.00 Par Value

Name of exchange where registered: 
The NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the of the Securities Act.
Yes ¨ No ý
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes ¨ No ý
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
Yes ý No ¨
 
Indicate by check whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
Yes ý No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨
Accelerated filer x
Non-accelerated filer ¨
Smaller reporting company x
Emerging Growth Company ¨
 
 
  
If emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    
Yes  ¨  No  ý
 
As of June 30, 2018, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was approximately $294.2 million. As of March 6, 2019, there were 13,946,283 shares outstanding of the registrant’s common stock, $1.00 par value.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
None in this Amendment No. 1.





EXPLANATORY NOTE

This Amendment No. 1 on Form 10-K/A (this “Amendment”) is being filed by SmartFinancial, Inc. (the “Company”) to amend the Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed by the Company with the Securities and Exchange Commission (the “SEC”) on March 18, 2019 (the “Original Filing”). The Company is filing this Amendment solely for the purpose of including in Part II, Item 8 of its Annual Report on Form 10-K for the fiscal year ended December 31, 2018, the Report of Independent Registered Public Accounting Firm of Mauldin & Jenkins, LLC, dated March 16, 2018, with respect to the 2017 consolidated financial statements of the Company, which was inadvertently omitted from the Original Filing.

As required by Rules 12b-15 and 13a-14 under the Securities Exchange Act of 1934, as amended, new certifications by the Company’s principal executive officer and principal financial officer pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act of 2002 are filed as exhibits to this Amendment.
 
Except as described above, no changes have been made to the Original Filing and this Amendment No. 1 does not modify, amend, or update in any way any of the financial or other information contained in the Original Filing. This Amendment speaks as of the date of the Original Filing and does not reflect events that may have occurred subsequent to the Original Filing. There have been no changes to the XBRL data filed in Exhibit 101 of the Original Filing. This Amendment should be read in conjunction with the Original Filing and the Company’s other filings with the SEC.






TABLE OF CONTENTS
 
Item No.
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  


2




PART II
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
SMARTFINANCIAL, INC. AND SUBSIDIARY
 
Report on Consolidated Financial Statements
 
For the years ended December 31, 2018 and 2017
 


3




SmartFinancial, Inc. and Subsidiary
Contents


 



4




MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
The management of SmartFinancial, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Accordingly, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. In making this assessment, management used the criteria set forth in Internal Control – Integrated Framework (2013 edition) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As permitted by SEC guidance, management excluded from its assessment the operations of the Southern Community Bank acquisition made during 2018, which is described in Note 2 of the Consolidated Financial Statements. The total assets of Southern Community Bank acquired represented approximately 10 percent of the Company’s total consolidated assets as of December 31, 2018 and 8 percent of consolidated revenue for the year then ended. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2018 is effective based on the specified criteria. As permitted by SEC guidance, management excluded from its assessment the operations of the Foothills Bank & Trust acquisition made during 2018, which is described in Note 2 of the Consolidated Financial Statements. The total assets of Foothills Bank & Trust acquired represented approximately 10 percent of the Company’s total consolidated assets as of December 31, 2018 and 1 percent of consolidated revenue for the year then ended. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2018 is effective based on the specified criteria.

Dixon Hughes Goodman LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, is included herein.





5




397189589_dhglogoa04.jpg

Report of Independent Registered Public Accounting Firm
 
 
To the Stockholders and the Board of Directors of SmartFinancial, Inc.

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheet of SmartFinancial, Inc. and Subsidiary (the "Company") as of December 31, 2018, the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows, for the year ended December 31, 2018, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of their operations and their cash flows for the year ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 18, 2019 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial tatements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Dixon Hughes Goodman LLP

We have served as the Company's auditor since 2018.

Atlanta, Georgia
March 18, 2019










6




397189589_dhglogoa05.jpg
Report of Independent Registered Public Accounting Firm
 
To the Stockholders and the Board of Directors of SmartFinancial, Inc.
 
Opinion on Internal Control Over Financial Reporting
 
We have audited SmartFinancial, Inc. and Subsidiary (the “Company”)’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, SmartFinancial, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheet of the Company as of December 31, 2018 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the year then ended and our report dated March 18, 2019, expressed an unqualified opinion thereon.
 
Basis for Opinion
 
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
As described in Management’s Report on Internal Control over Financial Reporting, the scope of management’s assessment of internal control over financial reporting as of December 31, 2018 has excluded Southern Community Bank (“Southern”) acquired on May 1, 2018 and Foothills Bank & Trust (“Foothills”) acquired on November 1, 2018. We have also excluded Southern and Foothills from the scope of our audit of internal control over financial reporting. Southern and Foothills represented 8 percent and 1 percent of consolidated revenues (total interest income and total noninterest income) for the year ended December 31, 2018, and 10 percent and 10 percent of consolidated total assets as of December 31, 2018, respectively.
 
Definition and Limitations of Internal Control Over Financial Reporting
 
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
/s/ Dixon Hughes Goodman LLP
 
Atlanta, Georgia
March 18, 2019

7




397189589_mj.jpg

Report of Independent Registered Public Accounting Firm
 
 
 
To the Stockholders and
Board of Directors
SmartFinancial, Inc.
Knoxville, Tennessee
 
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of SmartFinancial, Inc. and Subsidiaries (the “Company”) as of December 31, 2017 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the year ended December 31, 2017, and the related notes to the consolidated financial statements (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as, evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 
/s/ Mauldin & Jenkins, LLC
 
We served as the Company’s auditor from 2013 to 2018.
 
Chattanooga, Tennessee
March 16, 2018



8




SmartFinancial, Inc. and Subsidiary
Consolidated Financial Statements
Consolidated Balance Sheets
December 31, 2018 and 2017
 
 
2018
 
2017
ASSETS
 
 

 
 

 
 
 
 
 
Cash and due from banks
 
$
40,015,438

 
$
64,097,287

Interest-bearing deposits at other financial institutions
 
75,807,021

 
41,965,597

Federal funds sold
 

 
6,964,000

 
 
 
 
 
Total cash and cash equivalents
 
115,822,459

 
113,026,884

 
 
 
 
 
Securities available-for-sale
 
201,687,683

 
151,944,567

Restricted investments, at cost
 
11,499,000

 
6,430,700

Loans, net of allowance for loan losses of $8,275,055 in 2018 and $5,860,291 in 2017
 
1,768,963,569

 
1,317,397,909

Bank premises and equipment, net
 
56,012,184

 
43,000,249

Foreclosed assets
 
2,495,458

 
3,254,392

Goodwill and core deposit intangible, net
 
79,033,607

 
50,836,840

Cash surrender value of life insurance
 
24,381,485

 
21,646,894

Other assets
 
14,513,890

 
13,232,247

 
 
 
 
 
Total assets
 
$
2,274,409,335

 
$
1,720,770,682

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 

 
 

 
 
 
 
 
Deposits:
 
 

 
 

Noninterest-bearing demand deposits
 
$
319,861,237

 
$
220,520,287

Interest-bearing demand deposits
 
311,482,434

 
231,643,508

Money market and savings deposits
 
641,944,880

 
543,644,830

Time deposits
 
648,675,440

 
442,774,094

 
 
 
 
 
Total deposits
 
1,921,963,991

 
1,438,582,719

 
 
 
 
 
Securities sold under agreement to repurchase
 
11,755,923

 
24,054,730

Federal funds purchased and other borrowings
 
11,242,533

 
43,600,000

Subordinated debt
 
39,176,947

 

Accrued expenses and other liabilities
 
7,258,460

 
8,681,393

 
 
 
 
 
Total liabilities
 
1,991,397,854

 
1,514,918,842

 
 
 
 
 
Stockholders' equity:
 
 

 
 

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

 

Common stock - $1 par value; 40,000,000 shares authorized; 13,933,504 and 11,152,561 shares issued and outstanding in 2018 and 2017, respectively
 
13,933,504

 
11,152,561

Additional paid-in capital
 
231,851,730

 
174,008,753

Retained earnings
 
39,990,990

 
21,888,575

Accumulated other comprehensive loss
 
(2,764,743
)
 
(1,198,049
)
 
 
 
 
 
Total stockholders' equity
 
283,011,481

 
205,851,840

 
 
 
 
 
Total liabilities and stockholders' equity
 
$
2,274,409,335

 
$
1,720,770,682


See Notes to Consolidated Financial Statements

9


SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Income
For the years ended December 31, 2018 and 2017


 
 
2018
 
2017
INTEREST INCOME
 
 

 
 

Loans, including fees
 
$
86,469,051

 
$
48,805,647

Securities and interest-bearing deposits at other financial institutions
 
5,147,002

 
2,862,825

Federal funds sold and other earning assets
 
594,093

 
353,924

Total interest income
 
92,210,146

 
52,022,396

 
 
 
 
 
INTEREST EXPENSE
 
 

 
 

Deposits
 
14,288,090

 
5,518,350

Securities sold under agreements to repurchase
 
44,509

 
61,933

Subordinated debt
 
603,045

 

Federal funds purchased and other borrowings
 
630,533

 
113,070

Total interest expense
 
15,566,177

 
5,693,353

Net interest income before provision for loan losses
 
76,643,969

 
46,329,043

Provision for loan losses
 
2,936,472

 
782,687

Net interest income after provision for loan losses
 
73,707,497

 
45,546,356

 
 
 
 
 
NONINTEREST INCOME
 
 

 
 

Customer service fees
 
2,416,126

 
1,374,068

 Interchange and debit card transaction fees
 
573,194

 
952,294

Gain on sale of securities
 
1,255

 
143,508

Gain on sale of loans and other assets
 
1,432,652

 
1,275,925

Other noninterest income
 
2,160,888

 
1,281,493

Total noninterest income
 
6,584,115

 
5,027,288

 
 
 
 
 
NONINTEREST EXPENSES
 
 

 
 

Salaries and employee benefits
 
30,629,961

 
20,743,153

Net occupancy and equipment expense
 
6,303,466

 
4,271,289

FDIC insurance
 
786,105

 
465,844

Foreclosed assets
 
775,535

 
131,703

Advertising
 
872,547

 
637,600

Data processing
 
1,905,777

 
1,875,462

Professional services
 
3,647,164

 
2,084,735

Amortization of intangible assets
 
976,195

 
346,435

Software as services contracts
 
2,054,411

 
1,398,018

Merger expenses
 
3,780,785

 
2,417,070

Other operating expenses
 
7,223,848

 
4,758,480

Total noninterest expenses
 
58,955,794

 
39,129,789

Income before income tax expense
 
21,335,818

 
11,443,855

Income tax expense
 
3,233,403

 
6,428,791

Net income
 
18,102,415

 
5,015,064

Preferred stock dividends
 

 
195,000

Net income available to common stockholders
 
$
18,102,415

 
$
4,820,064

 
 
 
 
 
EARNINGS PER COMMON SHARE
 
 
 
 
Basic
 
$
1.46

 
$
0.56

Diluted
 
1.45

 
0.55

Weighted average common shares outstanding
 
 

 
 

Basic
 
12,423,618

 
8,639,212

Diluted
 
12,517,640

 
8,793,527

Dividends per common share
 
N/A

 
N/A

See Notes to Consolidated Financial Statements

10




SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2018 and 2017
 
 
2018
 
2017
Net income
 
$
18,102,415

 
$
5,015,064

 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 

 
 

Unrealized holding gains (losses) arising during the year, net of tax (benefit) expense of $(514,287) and $55,405 in 2018 and 2017, respectively
 
(1,565,719
)
 
90,381

 
 
 
 
 
Reclassification adjustment for gains included in net income, net of tax expense of $280 and $54,533 in 2018 and 2017, respectively
 
(975
)
 
(88,975
)
 
 
(1,566,694
)
 
1,406

 
 
 
 
 
Effect of tax rate change on unrealized gains (losses) on available-for-sale securities
 

 
(197,215
)
 
 
 
 
 
Total other comprehensive loss
 
(1,566,694
)
 
(195,809
)
 
 
 
 
 
Comprehensive income
 
$
16,535,721

 
$
4,819,255


See Notes to Consolidated Financial Statements


11




SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2018 and 2017
 
 
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss
 
Total
Stockholders'
Equity
BALANCE, December 31, 2016
 
 
$
12,000

 
$
5,896,033

 
$
83,463,051

 
$
16,871,296

 
$
(1,002,240
)
 
$
105,240,140

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 

 

 
5,015,064

 

 
5,015,064

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive gain
 
 

 

 

 

 
1,406

 
1,406

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Reclassification adjustment for tax rate change
 
 
 
 

 

 
197,215

 
(197,215
)
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common stock
 
 

 
1,840,000

 
31,094,676

 

 

 
32,934,676

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of stock grants
 
 

 
1,511

 
30,280

 

 

 
31,791

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares issued to shareholders of Capstone Bancshares, Inc.
 
 

 
2,908,094

 
66,875,727

 

 

 
69,783,821

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Redemption of preferred stock
 
 
(12,000
)
 

 
(11,988,000
)
 

 

 
(12,000,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
 
 

 
506,923

 
4,378,723

 

 

 
4,885,646

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends on preferred stock
 
 

 

 

 
(195,000
)
 

 
(195,000
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation expense
 
 

 

 
154,296

 

 

 
154,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2017
 
 

 
11,152,561

 
174,008,753

 
21,888,575

 
(1,198,049
)
 
205,851,840

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 

 

 
18,102,415

 

 
18,102,415

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss
 
 

 

 

 

 
(1,566,694
)
 
(1,566,694
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares issued to shareholders of FootHills BancCorp, net
 
 

 
1,183,232

 
22,783,563

 

 

 
23,966,795

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of stock grants and restricted stock
 
 

 
5,947

 
3,115

 

 

 
9,062

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares issued to shareholders of TN Bancshares Inc, net
 
 

 
1,458,981

 
33,272,941

 

 

 
34,731,922

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
 
 

 
132,783

 
1,386,461

 

 

 
1,519,244

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock compensation expense
 
 

 

 
396,897

 

 

 
396,897

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2018
 
 
$

 
$
13,933,504

 
$
231,851,730

 
$
39,990,990

 
$
(2,764,743
)
 
$
283,011,481

 
See Notes to Consolidated Financial Statements. 



12


SmartFinancial, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the years ended December 31, 2018 and 2017


 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Net income
 
$
18,102,415

 
$
5,015,064

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation, amortization, and accretion
 
(3,717,501
)
 
(1,691,396
)
Provision for loan losses
 
2,936,472

 
782,687

Stock compensation expense
 
396,897

 
154,296

Gains from redemption and sale of securities available-for-sale
 
(1,255
)
 
(143,508
)
Deferred income tax expense
 
2,431,705

 
1,599,000

Income on bank owned life insurance, net
 
(595,718
)
 
(295,040
)
Loss on disposal of fixed assets
 
41,215

 

Net gains from sale of loans and other assets
 
(1,432,652
)
 
(1,275,925
)
Net losses from sale of foreclosed assets
 
643,215

 
47,795

Loans originated for sale
 
(52,070,349
)
 
(35,547,322
)
Proceeds from sale of loans originated for sale
 
55,761,398

 
35,576,882

Changes in other assets and liabilities:
 
 

 
 

Accrued interest receivable
 
(377,666
)
 
(331,347
)
Accrued interest payable
 
816,740

 
31,488

Other assets and liabilities
 
(2,110,950
)
 
(2,682,548
)
 
 
 
 
 
Net cash provided by operating activities
 
20,823,966

 
1,240,126

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Purchase of securities available-for-sale
 
(72,149,260
)
 
(53,998,043
)
Proceeds from sales, maturities, and paydowns of securities available-for-sale
 
93,478,332

 
82,636,066

(Purchase) redemption of restricted investments
 
(4,053,000
)
 
246,350

Purchase of bank owned life insurance
 

 
(10,000,000
)
Loan originations and principal collections, net
 
(117,642,156
)
 
(66,724,124
)
Purchase of bank premises and equipment
 
(3,846,490
)
 
(2,798,898
)
Proceeds from sale of foreclosed assets
 
4,972,526

 
82,864

Net cash and cash equivalents paid (received) in business combinations
 
4,365,193

 
(178,312
)
 
 
 
 
 
Net cash used in investing activities
 
(94,874,855
)
 
(50,734,097
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Net increase in deposits
 
95,073,483

 
50,474,866

Net decrease in securities sold under agreements to repurchase
 
(12,599,642
)
 
(2,567,254
)
Issuance of common stock
 
1,528,306

 
37,852,113

Payment of dividends on preferred stock
 

 
(195,000
)
Redemption of preferred stock
 

 
(12,000,000
)
Net proceeds from subordinated debt
 
39,158,444

 

Repayment of Federal Home Loan Bank advances and other borrowings
 
(221,691,352
)
 
(119,196,383
)
Proceeds from Federal Home Loan Bank advances and other borrowings
 
175,377,225

 
139,404,205

 
 
 
 
 
Net cash provided by financing activities
 
76,846,464

 
93,772,547

 
 
 
 
 
 
 
2018
 
2017
NET INCREASE IN CASH AND CASH EQUIVALENTS
 
2,795,575

 
44,278,576

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

 
68,748,308

 
 
 
 
 
CASH AND CASH EQUIVALENTS, end of year
 
$
115,822,459

 
$
113,026,884

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
 

 
 

Cash paid during the period for interest
 
$
14,749,437

 
$
5,399,749

Cash paid during the period for income taxes
 
856,756

 
3,531,984

 
 
 
 
 
NONCASH INVESTING AND FINANCING ACTIVITIES
 
 

 
 

Change in unrealized losses on securities available-for-sale
 
$
2,081,261

 
$
(2,276
)
Acquisition of real estate through foreclosure
 
4,439,866

 
588,775

 Transfer from Bank premises to foreclosed assets
 
(1,289,102
)
 

 Change in goodwill due to acquisitions
 
23,212,962

 
38,707,620

Financed sales of foreclosed assets
 
1,601,471

 


See Notes to Consolidated Financial Statements


13


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies


 
Nature of Business:
 
SmartFinancial, Inc. (the "Company") is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, SmartBank (the "Bank"). The Company provides a variety of financial services to individuals and corporate customers through its offices in Tennessee, Alabama, Florida, and Georgia. The Company's primary deposit products are interest-bearing demand deposits, savings and money market deposits, and time deposits. Its primary lending products are commercial, residential, and consumer loans.
 
Basis of Presentation and Accounting Estimates:
 
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.
 
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed assets and deferred taxes, other than temporary impairments of securities, the fair value of financial instruments, goodwill, and business combination elements (Day 1 and Day 2 Valuation).
 
The Company has evaluated subsequent events for potential recognition and/or disclosure in the consolidated financial statements and accompanying notes included in this Annual Report through the date of the issued consolidated financial statements.
 
Cash and Cash Equivalents:
 
For purposes of reporting consolidated cash flows, cash and due from banks includes cash on hand, cash items in process of collection and amounts due from banks. Cash and cash equivalents also includes interest-bearing deposits in banks and federal funds sold. Cash flows from loans, federal funds sold, securities sold under agreements to repurchase and deposits are reported net.
 
The Bank is required to maintain average balances in cash or on deposit with the Federal Reserve Bank. The reserve requirement was $36.7 million and $16.5 million at December 31, 2018 and 2017, respectively.
 
The Company places its cash and cash equivalents with other financial institutions and limits the amount of credit exposure to any one financial institution. From time to time, the balances at these financial institutions exceed the amount insured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses on these accounts and management considers this to be a normal business risk.
 
Securities:
 
Management has classified all securities as available-for-sale. Securities available-for-sale are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive loss. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
 
The Company evaluates securities quarterly for other than temporary impairment using relevant accounting guidance specifying that (a) if the Company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other than temporarily impaired unless a credit loss has occurred in the security. If management does not intend to sell the security and it is more likely than not that they will not have to sell the security before recovery of the cost basis, management will recognize the credit component of an other-than- temporary impairment of a debt security in earnings and the remaining portion in other comprehensive loss.

14


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Securities (continued):

Securities borrowed or purchased under agreements to resell and securities loaned or sold under agreements to repurchase are treated as collateralized financial transactions. These agreements are recorded at the amount at which the securities were acquired or sold plus accrued interest. It is the Company's policy to take possession of securities purchased under resale agreements. The market value of these securities is monitored, and additional securities are obtained when deemed appropriate to ensure such transactions are adequately collateralized. The Company also monitors its exposure with respect to securities sold under repurchase agreements, and a request for the return of excess securities held by the counterparty is made when deemed appropriate.
 
Restricted Investments:
 
The Company is required to maintain an investment in capital stock of various entities. Based on redemption provisions of these entities, the stock has no quoted market value and is carried at cost. At their discretion, these entities may declare dividends on the stock. Management reviews restricted investments for impairment based on the ultimate recoverability of the cost basis in these stocks.
 
Loans:
 
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balances less deferred fees and costs on originated loans and the allowance for loan losses. Interest income is accrued on the outstanding principal balance. Loan origination fees, net of certain direct origination costs of consumer and installment loans are recognized at the time the loan is placed on the books. Loan origination fees for all other loans are deferred and recognized as an adjustment of the yield over the life of the loan using the straight-line method without anticipating prepayments.
 
The accrual of interest on loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due, or at the time the loan is 90 days past due, unless the loan is well-secured and in the process of collection. Unsecured loans are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal and interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income or charged to the allowance, unless management believes that the accrual of interest is recoverable through the liquidation of collateral. Interest income on nonaccrual loans is recognized on the cash basis, until the loans are returned to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and the loan has been performing according to the contractual terms for a period of not less than six months.

Loans Held for Sale:

Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value. When a loan is placed in the held-for-sale category, we stop amortizing the related deferred fees and costs. The remaining unamortized fees and costs are recognized as part of the cost basis of the loan at the time it is sold. Loans held for sale primarily represent mortgage loans on one-to-four family dwellings ("Mortgage") and to a lesser extent the portion of Small Business Administration (“SBA”) loans intended to be sold. Realized gains and losses for Mortgage loans are recognized when legal title to the loans has been transferred to the purchaser and sales proceeds have been received and are reflected in the accompanying consolidated statement of income in gains on sale of loans and other assets. We generally sell the guaranteed portion of SBA loans in the secondary market and retain the unguaranteed portion in our portfolio. Upon sale of the guaranteed portion of an SBA loan, we recognize a portion of the gain on sale into income and defer a portion of the gain related to the relative fair value of the unguaranteed loan balance we retain. The deferred gain is amortized into income over the remaining life of the loan. Gains and losses on sales of loans held for sale are included in the Consolidated Statements of Operations in gains on sale of loans and other assets.

 

15


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Acquired Loans:
 
Acquired loans are those acquired in business combinations by the Company or Bank. The fair values of acquired loans with evidence of credit deterioration, Purchased Credit Impaired loans (“PCI loans”), are recorded net of a nonaccretable discount and accretable discount. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable discount, which is included in the carrying amount of acquired loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable discount. Acquired loans are initially recorded at fair value at acquisition date. Accretable discounts related to certain fair value adjustments are accreted into income over the estimated lives of the loans.
 
The Company accounts for PCI loans acquired in the acquisition using the expected cash flows method of recognizing discount accretion based on the acquired loans' expected cash flows. Management recasts the estimate of cash flows expected to be collected on each acquired impaired loan pool periodically. If the present value of expected cash flows for a pool is less than its carrying value, an impairment is recognized by an increase in the allowance for loan losses and a charge to the provision for loan losses. If the present value of expected cash flows for a pool is greater than its carrying value, any previously established allowance for loan losses is reversed and any remaining difference increases the accretable yield which will be taken into interest income over the remaining life of the loan pool. Acquired impaired loans are generally not subject to individual evaluation for impairment and are not reported with impaired loans, even if they would otherwise qualify for such treatment. Purchased performing loans are recorded at fair value, including a credit discount. Credit losses on acquired performing loans are estimated based on analysis of the performing portfolio. Such estimated credit losses are recorded as nonaccretable discounts in a manner similar to purchased impaired loans. The fair value discount other than for credit loss is accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition.
 
Allowance for Loan Losses:
 
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Confirmed losses are charged off immediately. Subsequent recoveries, if any, are credited to the allowance.
 
The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the uncollectibility of loans in light of historical experience, the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, current economic conditions that may affect the borrower's ability to pay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
 
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For impaired loans, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the Company's historical loss experience adjusted for other qualitative factors. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.


16


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

 Allowance for Loan Losses (continued):

An unallocated component may be maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. As part of the risk management program, an independent review is performed on the loan portfolio, which supplements management’s assessment of the loan portfolio and the allowance for loan losses. The result of the independent review is reported directly to the Audit Committee of the Board of Directors. Loans, for which the terms have been modified at the borrower's request, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
 
A loan is considered impaired when it is probable, based on current information and events, the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest when due. Loans that experience insignificant payment delays and payment shortfalls are not classified as impaired. Impaired loans are measured by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.
 
The Company's homogeneous loan pools include consumer real estate loans, commercial real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors. The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans in the pool.
 
Troubled Debt Restructurings:
 
The Company designates loan modifications as Troubled Debt Restructurings ("TDRs") when for economic and legal reasons related to the borrower's financial difficulties, it grants a concession to the borrower that it would not otherwise consider. TDRs can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. In circumstances where the TDR involves charging off a portion of the loan balance, the Company typically classifies these restructurings as nonaccrual.
 
In connection with restructurings, the decision to maintain a loan that has been restructured on accrual status is based on a current, well documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. This evaluation includes consideration of the borrower's current capacity to pay, which among other things may include a review of the borrower's current financial statements, an analysis of global cash flow sufficient to pay all debt obligations, a debt to income analysis, and an evaluation of secondary sources of payment from the borrower and any guarantors. This evaluation also includes an evaluation of the borrower's current willingness to pay, which may include a review of past payment history, an evaluation of the borrower's willingness to provide information on a timely basis, and consideration of offers from the borrower to provide additional collateral or guarantor support. The credit evaluation also reflects consideration of the borrower's future capacity and willingness to pay, which may include evaluation of cash flow projections, consideration of the adequacy of collateral to cover all principal and interest, and trends indicating improving profitability and collectability of receivables.
 
Restructured nonaccrual loans may be returned to accrual status based on a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. This evaluation must include consideration of the borrower's sustained historical repayment for a reasonable period, generally a minimum of six months, prior to the date on which the loan is returned to accrual status.
 

17


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Foreclosed Assets:
 
Foreclosed assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less selling costs. Any write-down to fair value at the time of transfer to foreclosed assets is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Costs of improvements are capitalized, whereas costs relating to holding foreclosed assets and subsequent write-downs to the value are expensed. The amount of residential real estate where physical possession had been obtained included within foreclosed assets at December 31, 2018 and 2017 was $400 thousand and $546 thousand, respectively. There was no residential real estate in process of foreclosure at December 31, 2018 and December 31, 2017.
 
Premises and Equipment:
 
Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.
 
Buildings and leasehold improvements
15 - 40 years
Furniture and equipment
3-7 years
 
Goodwill and Intangible Assets:
 
Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as business combinations. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. FASB ASC 350, Goodwill and Other, regarding testing goodwill for impairment provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity does a qualitative assessment and determines that this is the case, or if a qualitative assessment is not performed, it is required to perform additional goodwill impairment testing to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on a qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. The Company performs its annual goodwill impairment test as of December 31 of each year. For 2018, the results of the qualitative assessment provided no indication of potential impairment. Goodwill will continue to be monitored for triggering events that may indicate impairment prior to the next scheduled annual impairment test.
 
Intangible assets consist of core deposit premiums created as a result of Business Combinations by the Company or Bank where deposits are assumed. The core deposit premium is initially recognized based on a valuation performed as of the consummation date. The core deposit premium is amortized over the average remaining life of the acquired customer deposits. Amortization expense relating to these intangible assets was $976 thousand and $346 thousand for the years ended December 31, 2018 and 2017, respectively. The intangible assets were evaluated for impairment as of December 31, 2018, and based on that evaluation it was determined that there was no impairment.
 
Transfer of Financial Assets:
 
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.




18


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Derivative Instruments:

In accordance with ASC Topic 815, Derivatives and Hedging, all derivative instruments are recorded on the accompanying consolidated balance sheet at their respective fair values. The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. If the derivative instrument is not designated as a hedge, changes in the fair value of the derivative instrument are recognized in earnings in the period of change.

For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. The gain or loss on the derivative instrument is presented on the same income statement line item as the earnings effect of the hedged item.
 
Advertising Costs:
 
The Company expenses all advertising costs as incurred. Advertising expense was $873 thousand and $638 thousand for the years ended December 31, 2018 and 2017, respectively.
 
Income Taxes:
 
The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
 
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law by the President of the United States. TCJA is a tax reform act that among other things, reduced corporate tax rates to 21 percent effective January 1, 2018. FASB ASC 740, Income Taxes, requires deferred tax assets and liabilities to be adjusted for the effect of a change in tax laws or rates in the year of enactment, which is the year in which the change was signed into law. Accordingly, the Company adjusted its deferred tax assets and liabilities at December 31, 2017, using the new corporate tax rate of 21 percent. See Note 8.
 
Stock Compensation Plans:
 
At December 31, 2018, the Company had options outstanding under stock-based compensation plans, which are described in more detail in Note 11. The plans have been accounted for under the accounting guidance (FASB ASC 718, Compensation - Stock Compensation) which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and stock or other stock based awards.
 

19


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Stock Compensation Plans(continued):

The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees' service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market value of the Company's common stock at the date of grant is used for restrictive stock awards and stock grants.
 
Employee Benefit Plan:
 
Employee benefit plan costs are based on the percentage of individual employee's salary, not to exceed the amount that can be deducted for federal income tax purposes.
 
Variable Interest Entities:
 
An entity is referred to as a variable interest entity (VIE) if it meets the criteria outlined in ASC Topic 810, which are: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (2) the entity has equity investors that cannot make significant decisions about the entity's operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that has a majority of the expected losses, expected residual returns, or both. At December 31, 2017, the Company had an investment in Community Advantage Fund, LLC that qualified as an unconsolidated VIE.
 
The Company’s investment in a partnership consists of an equity interest in a lending partnership for the purposes of loaning funds to an unrelated entity. This entity will use the funds to make loans through the SBA Community Advantage Loan Initiative. 
 
The Company uses the equity method when it owns an interest in a partnership and can exert significant influence over the partnership’s operations. Under the equity method, the Company’s ownership interest in the partnership’s capital is reported as an investment on its consolidated balance sheets in other assets and the Company’s allocable share of the income or loss from the partnership is reported in noninterest income or expense in the consolidated statements of income. The Company ceases recording losses on an investment in partnership when the cumulative losses and distributions from the partnership exceed the carrying amount of the investment and any advances made by the Company. After the Company’s investment in such partnership reaches zero, cash distributions received from these investments are recorded as income.
 
Comprehensive Income:
 
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. Unrealized gains and losses on available for sale securities are the only component of accumulated other comprehensive loss.
 
Fair Value of Financial Instruments:
 
Fair values of financial instruments are estimates using relevant market information and other assumptions, as more fully disclosed in Note 16. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
 

20


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Business Combinations:
 
Business combinations are accounted for using the acquisition method of accounting. Under the acquisition method of accounting, acquired assets and assumed liabilities are included with the acquirer's accounts as of the date of acquisition at estimated fair value, with any excess of purchase price over the fair value of the net assets acquired (including identifiable intangible assets) capitalized as goodwill. In the event that the fair value of the net assets acquired exceeds the purchase price, an acquisition gain is recorded for the difference in consolidated statements of income for the period in which the acquisition occurred. An intangible asset is recognized as an asset apart from goodwill when it arises from contractual or other legal rights or if it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. In addition, acquisition-related costs and
restructuring costs are recognized as period expenses as incurred. Estimates of fair value are subject to refinement for a period not to exceed one year from acquisition date as information relative to acquisition date fair values becomes available.
 
Earnings Per Common Share:
 
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to restricted stock and outstanding stock options and are determined using the treasury stock method.
 
Segment Reporting:
 
ASC Topic 280, Segment Reporting, provides for the identification of reportable segments on the basis of distinct business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). ASC Topic 280 permits aggregation or combination of segments that have similar characteristics. In the Company’s operations, each bank branch is viewed by management as being a separately identifiable business or segment from the perspective of monitoring performance and allocation of financial resources. Although the branches operate independently and are managed and monitored separately, each is substantially similar in terms of business focus, type of customers, products, and services. Accordingly, the Company’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.
 
Recently Issued Not Yet Effective Accounting Pronouncements:
 
The following is a summary of recent authoritative pronouncements not yet in effect that could impact the accounting, reporting, and/or disclosure of financial information by the Company.
 
In 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 balance sheets, along with our regulatory capital ratios.


21


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Recently Issued Not Yet Effective Accounting Pronouncements (continued):

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.

In July 2018, the FASB issued ASU No. 2018-11, Leases - Targeted Improvements to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU No. 2016-02. Specifically, under the amendments in ASU 2018-11: (1) entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and (2) lessors may elect not to separate lease and non-lease components when certain conditions are met. The amendments have the same effective date as ASU 2016-02 (January 1, 2019 for the Company). The Company expects to elect both transition options.

In December 2018, the FASB also issued ASU 2018-20, Leases (Topic 842) - Narrow-Scope Improvements for Lessors, which provides for certain policy elections and changes lessor accounting for sales and similar taxes and certain lessor costs. Upon adoption of ASU 2016-2, ASU 2018-11 and ASU 2018-20 on January 1, 2019, the Company expects to recognize right-of-use assets and related lease liabilities totaling $2.6 million and $2.7 million, respectively. The Company expects to elect to apply certain practical expedients provided under ASU 2016-02 whereby the Company will not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. The Company also do not expect to apply the recognition requirements of ASU 2016-02 to any short-term leases (as defined by related accounting guidance). The Company expect to account for lease and non-lease components separately because such amounts are readily determinable under our lease contracts and because we expect this election will result in a lower impact on our balance sheet. The Company expect to utilize the modified-retrospective transition approach prescribed by ASU 2018-11.

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.


22


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Recently Issued Not Yet Effective Accounting Pronouncements (continued):

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.

The guidance of ASU 2016-13 was recently amended by ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, which changed the effective date for non-public companies and clarified that operating lease receivables are not within the scope of the standard.

In January 2017, FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

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 financial statements.

As part of its Simplification Initiative, the FASB has issued ASU 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.


23


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Recently Issued Not Yet Effective Accounting Pronouncements (continued):

In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair
Value Measurement. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. As ASU No. 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s consolidated financial statements.

ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 will be effective for us on January 1, 2020, with early adoption permitted, and is not expected to have a significant impact on our financial statements.

ASU 2018-16, “Derivatives and Hedging (Topic 815) - Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this update permit use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct U.S. Treasury obligations, the LIBOR swap rate, the OIS rate based on the Fed Funds Effective Rate and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. ASU 2018-16 will be effective for the Company on January 1, 2019 and is not expected to have a significant impact on our financial statements.

Recently Issued and Adopted Accounting Pronouncements:

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

24


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 1. Summary of Significant Accounting Policies, Continued

Recently Issued and Adopted Accounting Pronouncements (continued):

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 twelve months period ended December 31, 2018, gross interchange and debit card transaction fees totaled $1.6 million while related network costs totaled $1.0 million. On a net basis, we reported $573 thousand as interchange and debit card transaction fees in the accompanying Consolidated Statement of Income for the twelve months period ended December 31, 2018.

For the twelve months period ended December 31, 2017 we reported interchange and debit card transaction fees totaling $952 thousand on a gross basis in the accompanying Consolidated Statement of Income while related network costs totaling $595 thousand 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, 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 e xisting 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 16 - Fair Value Disclosures.

ASU 2017-09, Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting. ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under ASU 2017-09, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the award's fair value, (ii) the award's vesting conditions and (iii) the award's classification as an equity or liability instrument. ASU 2017-09 became effective for us on January 1, 2018 and did not have a significant impact on our financial statements.

ASU 2017-12, Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 amends the hedge accounting recognition and presentation requirements in ASC 815 to improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities to better align the entity’s financial reporting for hedging relationships with those risk management activities and to reduce the complexity of and simplify the application of hedge accounting. The Company early adopted the standard and it does not have a significant impact on our financial statements.

Reclassifications:

Certain captions and amounts in the 2017 consolidated financial statements were reclassified to conform to the 2018 presentation. Such reclassifications had no effect on net income and shareholders’ equity.
 

25


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 2. Business Combinations


Pending Merger with Entegra Financial, Corp.

On January 15, 2019, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Entegra Financial, Corp., a North Carolina corporation (“Entegra”). The Merger Agreement was approved and adopted by the board of directors of SmartFinancial and the board of directors of Entegra. Under the terms and subject to the conditions of the Merger Agreement each outstanding share of Entegra common stock (other than certain excluded) will be converted into the right to receive 1.215 shares of SmartFinancial common stock. As of January 15, 2019, Entegra had 6,917,703 (unaudited) shares of common stock outstanding.

Acquisition of Foothills Bancorp, Inc.

On November 1, 2018, the Company completed it's merger with Foothills Bancorp, Inc., a Tennessee corporation ("Foothills Bancorp"), pursuant to an Agreement and Plan of Merger dated June 27, 2018 (the "Foothills Bancorp merger agreement"), by and among SmartFinancial, FootHills Bancorp, and Foothills Bank, a Tennessee-chartered commercial bank and wholly owned subsidiary of Foothills Bancorp. Foothills Bancorp merged with and into SmartFinancial, with SmartFinancial continuing as the surviving corporation. Immediately following the merger, Foothills Bank merged with and into the Bank continuing as the surviving banking corporation.
Pursuant to the Foothills Bancorp merger agreement, each outstanding share of Foothills Bancorp common stock was converted into and cancelled in exchange to the right to receive $1.75 in cash and 0.666 shares of SmartFinancial common stock. SmartFinancial issued 1,183,232 shares of SmartFinancial common stock and paid $3.1 million in cash as consideration for the merger plus $3.0 million in consideration for Foothills Banccorp Director and management stock options. 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) October 31, 2018 (calculated as $22.46).
After the merger, shareholders of SmartFinancial owned approximately 91 percent of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.

The merger was effected by the issuance of shares of SmartFinancial stock along with cash consideration to the shareholders of Foothills Bancorp. The assets and liabilities of Foothills Bancorp 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 $7.5 million, none of which is deductible for income tax purposes.

In periods following the Foothills Bancorp merger, the financial statements of the combined entity will include the results
attributable to Foothills Bank beginning on the date the merger was completed. In the twelve months period ended December 31, 2018, the revenues and net income attributable to Foothills Bank were approximately $1.5 million and $876 thousand, respectively.

The pro-forma impact to 2018 revenues and net income if the merger had occurred on January 1, 2018 would have been $11.0 million and $1.6 million for the twelve months period ending December 31, 2018, 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 Foothills Bank's provision for credit losses or any adjustments to estimate any additional income that would have been recorded as a result of fair value adjustments for 2018 that may have occurred had the acquired loans been recorded at fair value as of the beginning of 2018. In addition there are no adjustments to reflect any expenses that potentially could have been reduced for 2018 had the merger occurred on January 1, 2018. There were $2.3 million nonrecurring pro forma adjustments to expense included in the reported proforma earnings for twelve month period ending December 31, 2018.

The fair value estimates of Foothills Bancorp 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 December 31, 2018 there were no adjustments initially recorded as part of the business combination.

26


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

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 Foothills Bancorp shareholders as of November 1, 2018
1,183,232

Market price of SMBK common stock on November 1, 2018
$
20.34

Estimated fair value of SMBK common stock issued (in thousands)
24,067

Cash consideration paid (in thousands)
6,069

Total consideration (in thousands)
$
30,136

Allocation of Purchase Price (in thousands)
 
Total consideration above
$
30,136

Fair value of assets acquired and liabilities assumed:
 

Cash and cash equivalents
4,882

Investment securities available-for-sale
48,091

Restricted investments
551

Loans
153,692

Premises and equipment
3,622

Core deposit intangible
3,670

Prepaid and other assets
3,944

Deposits
(185,259
)
FHLB advances and other borrowings
(10,257
)
Payables and other liabilities
(276
)
Total fair value of net assets acquired
22,660

Goodwill
$
7,476


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. 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 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 89 percent of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.


27


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 2. Business Combination, Continued


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 $15.8 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 twelve months period ended December 31, 2018, the revenues and net income attributable to Southern Community Bank were approximately $8.4 million million and $3.5 million million, respectively.

The pro-forma impact to 2018 revenues and net income if the merger had occurred on January 1, 2018 would have been $14.7 million and $3.6 million for the twelve months period ending December 31, 2018, 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 or any adjustments to estimate any additional income that would have been recorded as a result of fair value adjustments for 2018 that may have occurred had the acquired loans been recorded at fair value as of the beginning of 2018. In addition there are no adjustments to reflect any expenses that potentially could have been reduced for 2018 had the merger occurred on January 1, 2018 . There were $2.0 million nonrecurring pro forma adjustments to expense included in the reported proforma earnings for the twelve months period ending December 31, 2018.

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 December 31, 2018 there was one adjustment for approximately $51 thousand to 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 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 (in thousands)
5

Total consideration (in thousands)
$
34,802



28


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 2. Business Combination, Continued


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
2,207

Deposits
(202,272
)
FHLB advances and other borrowings
(4,000
)
Payables and other liabilities
(586
)
Total fair value of net assets acquired
19,023

Goodwill
$
15,779


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 SmartFinancial common stock, (b) $18.50 in cash, or (c) a combination of 80 percent SmartFinancial common stock and 20 percent cash. Elections were limited by the requirement that 80 percent of the total shares of Capstone common stock be exchanged for SmartFinancial common stock and 20 percent be exchanged for cash. Therefore, the allocation of SmartFinancial 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 percent of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.

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 period ended December 31, 2017, the revenues and net income attributable to Capstone were $5.0 million and $186 thousand, respectively. The pro-forma impact to 2017 revenues and net income if the merger had occurred on December 31, 2016 would have been $24.9 million and $947 thousand, 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 or any adjustments to estimate any additional income that would have been recorded as a result of fair value adjustments for the twelve 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 twelve months of 2017 had the merger occurred on January 1, 2017. There were $4.6 million in nonrecurring pro forma adjustments to expense included in the reported proforma revenue and earnings. For the twelve months period ended December 31, 2018, the revenues and net income attributable to Capstone were $27.8 million and $13.5 million, respectively. For the twelve months period ended December 31, 2018, there was an $11 thousand adjustment to reduce fair values initially recorded as part of the business combination.

29


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

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 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 (in thousands)
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
413,012

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
47,664

Goodwill
$
38,058

 
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 twelve months period ended December 31, 2018, the revenues and net income attributable to the Cleveland branch were $1.6 million and $546 thousand, respectively. For the twelve months period ended December 31, 2017, the revenues and net income attributable to the Cleveland branch were $903 thousand and $63 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. 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:

30


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 2. Business Combination, Continued


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 December 31, 2018 there have not been any changes to the initial fair values recorded as part of the business combination.

Note 3. Securities

The amortized cost and fair value of securities available-for-sale at December 31, 2018 and 2017 are summarized as follow (in thousands): 
 
 
December 31, 2018
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Government-sponsored enterprises (GSEs)
 
$
44,117

 
$
12

 
$
(626
)
 
$
43,503

Municipal securities
 
55,248

 
276

 
(363
)
 
55,161

Other debt securities
 
977

 

 
(67
)
 
910

Mortgage-backed securities
 
103,875

 
153

 
(1,914
)
 
102,114

Total
 
$
204,217

 
$
441

 
$
(2,970
)
 
$
201,688

 
 
 
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
 
117,263

 
136

 
(1,184
)
 
116,215

Total
 
$
153,566

 
$
165

 
$
(1,787
)
 
$
151,944

 
The amortized cost and estimated market value of securities at December 31, 2018, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 

31


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 3. Securities, Continued


 
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$

 
$

Due from one year to five years
 
36,112

 
35,780

Due from five years to ten years
 
14,588

 
14,145

Due after ten years
 
49,642

 
49,649

 
 
100,342

 
99,574

Mortgage-backed securities
 
103,875

 
102,114

Total
 
$
204,217

 
$
201,688

 
The following tables present the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities available-for-sale have been in a continuous unrealized loss position, as of December 31, 2018 and 2017 (in thousands):
 
 
 
As of December 31, 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)
 
$
14,763

 
$
(237
)
 
$
13,728

 
$
(389
)
 
$
28,491

 
$
(626
)
Municipal securities
 
16,455

 
(150
)
 
4,767

 
(213
)
 
21,222

 
(363
)
Other debt securities
 

 

 
910

 
(67
)
 
910

 
(67
)
Mortgage-backed securities
 
10,516

 
(155
)
 
69,884

 
(1,759
)
 
80,400

 
(1,914
)
Total
 
$
41,734

 
$
(542
)
 
$
89,289

 
$
(2,428
)
 
$
131,023

 
$
(2,970
)
 
 
 
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
 
61,332

 
(407
)
 
35,048

 
(777
)
 
96,380

 
(1,184
)
Total
 
$
67,058

 
$
(475
)
 
$
50,580

 
$
(1,312
)
 
$
117,638

 
$
(1,787
)
  
At December 31, 2018, the categories of temporarily impaired securities, and management’s evaluation of those securities, are as follows:
 
U.S. Government-sponsored enterprises: At December 31, 2018, 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 does not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is more likely than not that the Bank will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other-than temporarily impaired at December 31, 2018.


32


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 3. Securities, Continued


Municipal securities: At December 31, 2018, twenty two investments in obligations of municipal securities had unrealized losses. The Bank believes the unrealized losses on those investments were caused by the interest rate environment and do not relate to the underlying credit quality of the issuers. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other than temporarily impaired at December 31, 2018.

Other debt securities: At December 31, 2018, one investment in other debt securities had unrealized losses. The Bank believes the unrealized losses on this investment was caused by the interest rate environment and does not relate to the underlying credit quality of the issuers. 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 their amortized cost basis, which may be maturity, the Bank does not consider this investment to be other than temporarily impaired at December 31, 2018.

Mortgage-backed securities: At December 31, 2018, sixty six investments in residential mortgage-backed securities had unrealized losses.  This impairment is believed to be caused by the current interest rate environment. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Because the decline in market value is attributable to the current interest rate environment and not credit quality, and because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other than temporarily impaired at December 31, 2018.
 
Sales of available-for-sale securities for the years ended December 31, 2018 and 2017, were as follows (in thousands):
 
 
 
2018
 
2017
Proceeds
 
$
2,970

 
$
12,614

Gains realized
 
1

 
145

Losses realized
 

 
2

 
Securities with a carrying value of $103.7 million and $97.2 million at December 31, 2018 and 2017, respectively, were pledged to secure various deposits, securities sold under agreements to repurchase, as collateral for federal funds purchased from other financial institutions and serve as collateral for borrowings at the Federal Home Loan Bank.
 

33


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 4. Loans and Allowance for Loan Losses 


Portfolio Segmentation:
 
At December 31, 2018 and 2017, loans consisted of the following (in thousands):
 
 
 
December 31, 2018
 
December 31, 2017
 
 
PCI 
Loans
 
All Other
Loans
 
Total
 
PCI 
Loans
 
All Other
Loans
 
Total
Commercial real estate
 
$
17,682

 
$
842,345

 
$
860,027

 
$
17,903

 
$
625,085

 
$
642,988

Consumer real estate
 
8,712

 
398,542

 
407,254

 
7,450

 
286,007

 
293,457

Construction and land development
 
4,602

 
183,293

 
187,895

 
5,120

 
130,289

 
135,409

Commercial and industrial
 
2,557

 
305,697

 
308,254

 
858

 
237,229

 
238,087

Consumer and other
 
605

 
13,204

 
13,809

 
1,463

 
11,854

 
13,317

Total loans
 
34,158

 
1,743,081

 
1,777,239

 
32,794

 
1,290,464

 
1,323,258

Less:  Allowance for loan losses
 

 
(8,275
)
 
(8,275
)
 
(16
)
 
(5,844
)
 
(5,860
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net
 
$
34,158

 
$
1,734,806

 
$
1,768,964

 
$
32,778

 
$
1,284,620

 
$
1,317,398

 
For purposes of the disclosures required pursuant to the adoption of ASC 310, the loan portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. There are five loan portfolio segments that include commercial real estate, consumer real estate, construction and land development, commercial and industrial, and consumer and other.
 
The following describe risk characteristics relevant to each of the portfolio segments:
 
Commercial Real Estate: Commercial real estate loans include owner-occupied commercial real estate loans and loans secured by income-producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
 
Consumer Real Estate: Consumer real estate loans include real estate loans secured by first liens, second liens, or open end real estate loans, such as home equity lines. These are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. One to four family first mortgage loans are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
 
Construction and Land Development: Loans for real estate construction and development are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio segment includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
 
Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial, financial, and agricultural loans. These loans include those loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or expansion projects. Loans are repaid by business cash flows. Collection risk in this portfolio is driven by the creditworthiness of the underlying borrower, particularly cash flows from the customers' business operations.
 
Consumer and Other: The consumer loan portfolio segment includes direct consumer installment loans, overdrafts and other revolving credit loans, and educational loans. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.
 

34


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 4. Loans and Allowance for Loan Losses, Continued


Credit Risk Management:
 
The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan portfolio segments. Credit risk management is guided by credit policies that provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Credit Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans are individually underwritten, risk-rated, approved, and monitored.
 
Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer real estate and consumer and other portfolio segments, the risk management process focuses on managing customers who become delinquent in their payments. For the other portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit of the portfolios, including a third party review of the largest credits on an annual basis or more frequently as needed. To ensure problem credits are identified on a timely basis, several specific portfolio reviews occur periodically to assess the larger adversely rated credits for proper risk rating and accrual status.
 
Credit quality and trends in the loan portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by the Senior Credit Officer and the Directors Loan Committee.
 
The allowance for loan losses is a valuation reserve allowance established through provisions for loan losses charged against income. The allowance for loan losses, which is evaluated quarterly, is maintained at a level that management deems sufficient to absorb probable losses inherent in the loan portfolio. Loans deemed to be uncollectible are charged against the allowance for loan losses, while recoveries of previously charged-off amounts are credited to the allowance for loan losses. The allowance for loan losses is comprised of specific valuation allowances for loans evaluated individually for impairment and general allocations for pools of homogeneous loans with similar risk characteristics and trends.
 
The allowance for loan losses related to specific loans is based on management's estimate of potential losses on impaired loans as determined by (1) the present value of expected future cash flows; (2) the fair value of collateral if the loan is determined to be collateral dependent or (3) the loan's observable market price. The Company's homogeneous loan pools include commercial real estate loans, consumer real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors.
 
The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans in the pool.

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.

 

35


SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2018 and 2017

Note 4. Loans and Allowance for Loan Losses, Continued


Credit Risk Management (continued):

The composition of loans by loan classification for impaired and performing loan status at December 31, 2018 and 2017, is summarized in the tables below (amounts in thousands):
 
 
 
December 31, 2018
 
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Construction
and Land
Development
 
Commercial
and
Industrial
 
Consumer
and Other
 
Total
Performing loans
 
$
841,709

 
$
397,306

 
$
182,746

 
$
304,673

 
$
13,088

 
$
1,739,522

Impaired loans
 
636

 
1,236

 
547

 
1,024

 
116

 
3,559

 
 
842,345

 
398,542

 
183,293

 
305,697

 
13,204

 
1,743,081

PCI loans
 
17,682

 
8,712

 
4,602

 
2,557

 
605

 
34,158

Total
 
$
860,027

 
$
407,254

 
$
187,895

 
$
308,254

 
$
13,809

 
$
1,777,239

 
 
 
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 and performing loans as of December 31, 2018 and 2017 (amounts in thousands):

 
 
December 31, 2018
 
 
 
 
 
 
Construction
 
Commercial
 
Consumer
 
 
 
 
Commercial
 
Consumer
 
and Land
 
and
 
and
 
 
 
 
Real Estate
 
Real Estate
 
Development
 
Industrial
 
Other
 
Total
Performing loans
 
$
3,639

 
$
1,763

 
$
795

 
$
1,304

 
$
240

 
$
7,741

PCI loans