Business Context and Reporting Period
The source text identifies the registrant as Cornerstone Bancshares, Inc., not SmartFinancial Inc. It is a Tennessee bank holding company whose principal subsidiary, Cornerstone Community Bank, operates five full-service branches in Hamilton County, Tennessee, and a loan production office in Dalton, Georgia. The filing is a Form 10-K for the fiscal year ended December 31, 2013, filed March 31, 2014. The requested “2013 Q4” period is covered only through quarterly data within the annual filing.
The Bank provides commercial, real estate, construction, consumer and asset-based lending services, funded primarily by deposits. It had 107 full-time equivalent employees and approximately $341.4 million of deposits at year-end.
Financial Performance and Condition
| Metric | 2013 | 2012 |
|---|---|---|
| Total assets | $432.2 million | $443.4 million |
| Total loans | $289.4 million | $277.0 million |
| Deposits | $341.4 million | $344.9 million |
| Stockholders’ equity | $40.1 million | $40.9 million |
| Net interest income | $14.9 million | $14.6 million |
| Provision for loan losses | $0.3 million | $0.4 million |
| Noninterest income | $1.9 million | $1.0 million |
| Noninterest expense | $13.8 million | $13.2 million |
| Net income | $1.7 million | $1.4 million |
| Net income available to common shareholders | $0.1 million | $0.1 million |
| Basic and diluted EPS | $0.02 | $0.02 |
| Net interest margin | 3.80% | 3.85% |
| Return on average assets | 0.39% | 0.34% |
| Return on average equity | 4.12% | 3.78% |
Fourth-quarter 2013 net income was $404,000, compared with $371,000 in fourth-quarter 2012. Fourth-quarter net income available to common shareholders was $11,000, compared with a $22,000 loss in fourth-quarter 2012.
Cash provided by operating activities was $4.4 million. Investing activities used $27.1 million, primarily because purchases of available-for-sale securities exceeded sales, maturities and paydowns. Financing activities used $11.9 million, reflecting deposit reductions, repayment of $10.0 million of FHLB advances and preferred dividends. Cash and cash equivalents declined from $59.4 million to $24.9 million.
At year-end, borrowings included $22.97 million of federal funds purchased and repurchase agreements and $26.74 million of FHLB advances and other borrowings. The Bank reported a 19.8% liquidity ratio, $15 million of correspondent-bank federal funds lines and approximately $5 million of Federal Reserve discount-window borrowing capacity.
The Bank was categorized as well capitalized by the FDIC. Its year-end ratios were 12.82% total risk-based capital, 11.78% Tier 1 risk-based capital and 8.57% Tier 1 leverage. The filing also reports consolidated ratios of 11.3%, 10.3% and 7.5%, respectively.
Material Changes Versus Prior Comparable Period
- Net income increased 19.9% to $1.7 million, while net interest income increased 2.5%.
- Interest income declined $0.9 million, but interest expense declined $1.3 million as deposit pricing improved and $10 million of fixed-rate FHLB advances were repaid.
- Net interest margin contracted five basis points to 3.80%; average loan yield declined to 5.99% from 6.43%.
- Noninterest income increased $0.9 million, primarily from a $652,000 gain on securities sales and a $404,000 gain on sales of loans and other assets.
- Noninterest expense increased $668,000, largely because foreclosed-assets expense increased to $2.0 million from $1.1 million and salaries increased.
- Total loans increased 4.5%, while total assets declined 2.5% and deposits declined 1.0%. The loan portfolio remained concentrated in commercial real estate and construction lending.
- Asset quality improved: nonaccrual loans declined to $3.6 million from $6.0 million, nonperforming assets declined to 3.82% of assets from 5.94%, and substandard loans declined to $15.0 million from $19.4 million.
- The allowance for loan losses declined to $3.2 million from $6.1 million despite $3.2 million of net charge-offs, producing an allowance-to-average-loans ratio of 1.15% versus 2.28%.
- Foreclosed assets declined to $12.9 million from $20.3 million, but related expense remained elevated.
Guidance, Outlook, Risks and Unusual Items
- Management expected to increase loan balances during 2014 to offset continued pressure on loan yields and interest-rate compression. It expected liquidity for growth to come from foreclosed-asset sales and mortgage-backed-security cash flows.
- Management anticipated that foreclosed-asset expense would remain elevated until foreclosed balances were reduced and that the investment portfolio would decline modestly as mortgage-backed securities prepaid.
- The Bank remained subject to regulatory restrictions requiring prior approval for dividends from the Bank to Cornerstone. Cornerstone also required Federal Reserve approval before paying dividends, incurring debt, redeeming stock or reducing capital. No common-stock dividends were paid in 2012 or 2013.
- The 600,000 shares of Series A preferred stock carry a 10% annual dividend. Preferred dividends and accretion reduced 2013 net income available to common shareholders to $109,000; $750,000 of preferred dividends were accumulated but not declared at December 31, 2013.
- Key risks include commercial real estate and residential construction exposure, local Chattanooga-area economic conditions, real estate values, loan losses, foreclosed assets, interest-rate movements, deposit and liquidity pressures, regulatory requirements and potential future capital needs or dilution.
- The company reported a $2.3 million net deferred tax asset without a valuation allowance; realization depends on future taxable income and remains judgmental.
- Off-balance-sheet commitments included approximately $33.7 million of undisbursed loan commitments and $396,000 of standby letters of credit. Management reported no material litigation and no material off-balance-sheet arrangements in the MD&A.
- The independent auditor issued an unqualified opinion on the 2013 consolidated financial statements. Management concluded that internal control over financial reporting and disclosure controls were effective.
Important Facts to Verify
- Confirm the issuer identity: the supplied filing is for Cornerstone Bancshares, Inc. and Cornerstone Community Bank, not SmartFinancial Inc.
- Reconcile the requested quarterly period with the annual filing and review the unaudited fourth-quarter figures separately from full-year results.
- Assess whether the sharply lower allowance for loan losses adequately covers remaining credit risk, including $13.8 million of impaired loans, $15.0 million of substandard loans and $10.6 million of special-mention loans.
- Review the sustainability of earnings after the $1.5 million preferred dividend requirement and the impact of any accumulated preferred dividends.
- Evaluate liquidity and refinancing needs, including $6.7 million of borrowings scheduled to mature in 2014 and the restriction on upstream dividends from the Bank.
- Test management’s assumptions supporting the $2.3 million deferred tax asset and valuations of foreclosed real estate.