Business Context and Reporting Period
The provided filing is a Form 10-Q for the quarter ended September 30, 2012, filed November 14, 2012. The filing identifies the registrant as Cornerstone Bancshares, Inc., a Tennessee bank holding company, rather than SMARTFINANCIAL INC. This entity discrepancy should be verified. Its wholly owned bank operated five full-service offices in Hamilton County, Tennessee, and a loan production office in Dalton, Georgia.
The interim financial statements are unaudited and cover the three and nine months ended September 30, 2012, with comparisons to the corresponding 2011 periods.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2012 | Nine Months Ended September 30, 2012 |
|---|---|---|
| Total interest income | $4.735 million | $14.179 million |
| Net interest income before provision | $3.563 million | $10.475 million |
| Provision for loan losses | $0.100 million | $0.100 million |
| Noninterest income | $0.259 million | $0.778 million |
| Noninterest expense | $3.203 million | $9.701 million |
| Net income | $0.364 million | $1.031 million |
| Net income available to common shareholders | $0.039 million | $0.130 million |
| Basic and diluted EPS | $0.01 | $0.02 |
- Tax-equivalent net interest margin was 3.70% for the quarter and 3.73% for the first nine months.
- Tax-equivalent net interest spread was 3.53% for the quarter and 3.55% year to date.
- Total assets were $425.2 million at September 30, 2012, versus $422.7 million at December 31, 2011.
- Total loans were $273.8 million, with loans net of the allowance at $268.5 million.
- Total deposits were $329.0 million, compared with $314.0 million at year-end 2011.
- Cash and cash equivalents were $34.8 million, compared with $38.9 million at December 31, 2011.
- Federal funds purchased and repurchase obligations were $19.4 million; Federal Home Loan Bank advances and other borrowings were $37.2 million.
- Stockholders’ equity was $38.1 million, including $12.2 million of preferred stock.
- The Bank reported a Tier 1 leverage ratio of 8.30%, a Tier 1 risk-based capital ratio of 11.59%, and a total risk-based capital ratio of 12.84%.
Cash Flow, Credit Quality, and Liquidity
- Operating activities provided $3.6 million of cash during the first nine months of 2012.
- Investing activities used $8.2 million, primarily reflecting net loan originations and purchases of available-for-sale securities.
- Financing activities provided $0.6 million, including a $2.2 million preferred-stock issuance, partially offset by reductions in repurchase obligations and FHLB borrowings.
- Cash and cash equivalents decreased $4.1 million during the period, ending at $34.8 million.
- The allowance for loan losses declined to $5.3 million from $7.4 million at year-end 2011. The allowance-to-loans ratio declined to 1.93% from 2.76%.
- Nonperforming assets increased to $30.3 million, or 2.91% of total loans, from $26.4 million, or 2.94%, at December 31, 2011. Foreclosed assets were $22.4 million.
- Nonaccrual loans increased to $8.0 million from $7.1 million at June 30, 2012. Management stated that a majority was concentrated in three loan relationships.
- Off-balance-sheet commitments included $34.9 million of commitments to extend credit and $2.7 million of standby letters of credit.
- Approximately $72 million of securities were pledged as collateral for public funds, repurchase obligations, FHLB borrowings, federal funds, and Federal Reserve borrowings.
Material Changes Versus Prior Comparable Period
- Third-quarter net income declined 30.5% to $364,000 from $524,000; nine-month net income increased 12.5% to $1.031 million from $917,000.
- Net income available to common shareholders declined to $39,000 for the quarter and $130,000 year to date, primarily reflecting higher preferred-stock dividend requirements.
- Interest income declined 7.4% for the quarter and 8.5% year to date, driven mainly by lower loan yields.
- Interest expense declined 22.4% for the quarter and 25.3% year to date as funding costs decreased and the deposit mix shifted toward transactional accounts.
- Net interest margin improved from 3.69% to 3.70% for the quarter and from 3.51% to 3.73% year to date.
- Noninterest income declined 19.9% for the quarter and 14.4% year to date, including the absence of securities-sale gains recorded in 2011 and lower deposit-service charges.
- Quarterly noninterest expense increased 4.1%, largely because salaries and employee benefits increased 7.3%. Year-to-date noninterest expense declined 4.4%, helped by lower foreclosed-asset expense and FDIC insurance expense.
- Total loans increased 2.3% from year-end 2011, while securities available for sale declined to $82.2 million from $86.1 million.
- Deposits increased 4.8%, with savings and money-market balances rising materially and time deposits declining.
- Core funding increased to 60.5% of total funding from 55.3%; non-core funding declined to 39.5% from 44.7%.
- Series A preferred stock increased by approximately $2.2 million during the period. No common dividends were declared.
Outlook, Commentary, Risks, and Unusual Items
- Management expected loan yields to continue declining because of competitive pricing, but expected net interest margin to improve as cash and foreclosed assets were converted into earning assets.
- Management expected additional loan growth and modest increases in employee expenses during 2012-2013.
- Management anticipated elevated foreclosed-asset expense through the remainder of 2012 and 2013, while also expecting foreclosed assets to decline as properties were sold.
- Management expected nonaccrual loans to decrease by year-end 2012 as delinquent relationships were foreclosed upon or upgraded to accruing status.
- The Bank had entered into regulatory action plans with the FDIC and Tennessee Department of Financial Institutions in 2010. Those plans were terminated on August 17, 2012, although certain procedures remained, including regulatory approval requirements for dividends paid by the Bank to its parent.
- A Federal Reserve Bank of Atlanta letter continued to require prior approval for certain indebtedness, dividends, stock redemptions, capital reductions, and certain management changes. The parent was described as being in “troubled condition.”
- The filing identifies continuing risks related to credit losses, residential construction and land-development lending, foreclosed assets, liquidity, capital needs, regulatory enforcement, interest rates, local economic conditions, and realization of deferred tax assets.
- Management stated that additional loan-loss provisions could be required as problem assets move through the collection process.
- The filing states that securities with unrealized losses were not considered other-than-temporarily impaired. The principal unrealized losses were attributed to interest-rate conditions rather than credit deterioration.
- Management reported no material expected loss from pending legal claims and stated that disclosure controls were effective as of September 30, 2012.
Investor Verification Checklist
- Verify the registrant identity: the supplied company name is SMARTFINANCIAL INC., but the filing text identifies Cornerstone Bancshares, Inc.
- Reconcile the sharp decline in net income available to common shareholders with preferred dividends and accretion.
- Assess whether the $30.3 million of nonperforming assets and $22.4 million of foreclosed assets are adequately covered by collateral and the $5.3 million allowance.
- Review regulatory restrictions on dividends, borrowings, capital reductions, and management changes, including the continuing Federal Reserve requirements.
- Evaluate liquidity dependence on time deposits, repurchase obligations, FHLB advances, and pledged securities.
- Confirm the sustainability of margin improvement given declining loan yields and management’s plans for loan growth.
- Review the potential for additional loan-loss provisions and foreclosed-asset expenses in subsequent periods.