Business Context and Reporting Period
The source text is a Form 10-Q for Cornerstone Bancshares, Inc., not SmartFinancial Inc. The report covers the quarter and six months ended June 30, 2014. Cornerstone is a bank holding company whose subsidiary, Cornerstone Community Bank, operates five full-service offices in Hamilton County, Tennessee, and a loan production office in Dalton, Georgia. The interim financial statements are unaudited.
Financial Performance and Position
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Interest income | $4.6 million | $9.1 million |
| Net interest income before provision | $3.9 million | $7.7 million |
| Provision for loan losses | $350,000 | $515,000 |
| Noninterest income | $534,000 | $857,000 |
| Noninterest expense | $3.4 million | $6.7 million |
| Net income | $409,000 | $822,000 |
| Net income available to common shareholders | $17,000 | $36,000 |
| Basic and diluted EPS | $0.00 | $0.01 |
- Net interest margin on a taxable-equivalent basis was 3.89% for the quarter and 3.90% for the six-month period. Net interest spread was 3.71% and 3.72%, respectively.
- At June 30, 2014, total assets were $419.9 million, gross loans were $292.4 million, securities were $83.3 million, deposits were $331.4 million, total liabilities were $379.5 million, and stockholders’ equity was $40.4 million.
- Cash and cash equivalents were $19.0 million, down from $24.9 million at December 31, 2013.
- Federal funds purchased and repurchase obligations totaled $21.9 million; Federal Home Loan Bank advances and other borrowings totaled $25.0 million.
- The allowance for loan losses was $3.3 million, or 1.14% of total loans. Nonperforming assets were $15.8 million, including $13.0 million of foreclosed assets and $2.9 million of nonaccrual loans.
- Capital ratios at June 30, 2014 were 8.96% Tier 1 leverage, 12.19% Tier 1 risk-based capital, and 13.26% total risk-based capital.
- Operating cash flow for the first six months was $2.4 million. Investing activities provided $5.2 million, while financing activities used $13.4 million, resulting in a $5.8 million decrease in cash and cash equivalents.
Material Changes Versus Comparable Periods
- Second-quarter net income increased 3.3% from $396,000 to $409,000, while six-month net income declined 3.1% from $848,000 to $822,000.
- Net interest income before loan-loss provisions increased 5.5% in the quarter and 5.1% year to date, primarily because of lower deposit and Federal Home Loan Bank funding costs.
- The provision for loan losses increased from zero to $350,000 in the quarter and from $300,000 to $515,000 for the six-month period.
- Noninterest income declined 23.4% in the quarter and 18.6% year to date, reflecting lower gains on securities, loans, and other assets.
- Noninterest expense declined 8.8% in the quarter but was essentially flat year to date. Salaries and benefits increased 6.2% in the quarter and 10.2% year to date, partly due to wage increases and $196,000 of stock compensation expense during the first six months.
- Gross loans increased 5.9% from approximately $276 million at June 30, 2013 to $292 million at June 30, 2014. Construction and land-development loans declined to $32.7 million from $41.6 million at December 31, 2013, while commercial real estate loans increased.
- Nonaccrual loans declined approximately 58% year over year, from about $7 million to $2.9 million. Foreclosed assets declined approximately 31%, from about $19 million to $13 million.
- Total deposits declined $10.0 million from year-end. Core funding declined to $241.3 million, while non-core funding increased to $137.0 million, or 36.2% of total funding.
- The bank sold approximately $6.8 million of securities during the second quarter, recognizing a $300,000 gain, and sold approximately $9.2 million during the first six months, recognizing gains of $402,000.
Guidance, Outlook, Risks, and Unusual Items
- Management expected continued loan growth during 2014 but anticipated downward pressure on loan yields from refinancing and market conditions.
- Management expected net interest margin improvement from loan growth and lower Federal Home Loan Bank advance rates as borrowings mature over the following nine months.
- Approximately $15 million of Federal Home Loan Bank advances were scheduled to mature over the next twelve months. Management expected total FHLB borrowings to remain approximately $20 million to $35 million and stated that replacement funding could be obtained at lower cost.
- Management budgeted approximately $1.2 million of foreclosed-asset expense for 2014 and targeted a roughly $3 million net reduction in foreclosed assets during the remainder of the year.
- Key risks include credit deterioration, loan losses, real estate and construction exposure, foreclosed-asset valuations, liquidity needs, interest-rate changes, deposit competition, regulatory requirements, capital availability and potential dilution, realization of deferred tax assets, and local economic conditions.
- At June 30, 2014, off-balance-sheet commitments included $45.9 million of commitments to extend credit and $452,000 of standby letters of credit.
- Management stated that pending legal claims were not expected to have a material effect. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was reported.
- The bank paid approximately $1.7 million of other borrowings on June 30, 2014; management stated the repayment did not affect liquidity because the borrowing was fully secured by cash.
Important Facts for Investors to Verify
- Verify the issuer identity: the supplied filing names Cornerstone Bancshares, Inc., while the request identifies SmartFinancial Inc.
- Assess whether the $15.8 million of nonperforming assets, $13.0 million of foreclosed assets, and planned additional foreclosed-asset write-downs are adequately covered by collateral and capital.
- Review the increase in the loan-loss provision and the adequacy of the $3.3 million allowance as loan balances grow.
- Evaluate liquidity and funding risk in light of declining deposits, 36.2% non-core funding, $15 million of upcoming FHLB maturities, and cash of $19.0 million.
- Separate recurring earnings from the $402,000 year-to-date securities-sale gains and other unusual items.
- Consider the limited earnings available to common shareholders after $750,000 of preferred dividends and $35,691 of preferred-stock accretion for the first six months.
- Confirm the treatment and recoverability of deferred tax assets, foreclosed assets, securities classified as temporarily impaired, and the $45.9 million of unfunded credit commitments.