Business Context and Reporting Period
This unaudited Form 10-Q covers Cornerstone Bancshares, Inc. and its wholly owned Cornerstone Community Bank for the three months ended March 31, 2015, with comparison to March 31, 2014. The bank operates five full-service offices in Hamilton County, Tennessee, and a loan production office in Dalton, Georgia. The submitted metadata identifies SmartFinancial, Inc.; however, the filing is for Cornerstone Bancshares and discusses its pending merger with SmartFinancial.
On December 8, 2014, Cornerstone announced a definitive merger agreement with SmartFinancial, Inc. Completion remained subject to regulatory and shareholder approvals and other conditions.
Financial Performance and Key Metrics
| Metric | Q1 2015 | Q1 2014 or prior period | Change |
|---|---|---|---|
| Total interest income | $4.551 million | $4.533 million | Up 0.4% |
| Net interest income before provision | $3.957 million | $3.810 million | Up 3.9% |
| Provision for loan losses | $350,000 | $165,000 | Up 112.1% |
| Net interest income after provision | $3.607 million | $3.645 million | Down 1.0% |
| Noninterest income | $373,000 | $323,000 | Up 15.5% |
| Noninterest expense | $3.202 million | $3.301 million | Down 3.0% |
| Net income | $479,530 | $412,151 | Up 16.5% |
| Net income available to common shareholders | $86,684 | $19,305 | Up $67,379 |
| Basic and diluted EPS | $0.01 | $0.00 | Improved |
| Net interest margin, taxable-equivalent basis | 3.98% | 3.90% | Up 8 basis points |
Management attributed the improvement in pre-provision net interest income principally to lower borrowing costs. The bank repriced $18 million of Federal Home Loan Bank advances and renewed $13 million at a lower weighted-average rate. Loan yield declined to 5.64% from 5.69%, while investment securities yield declined to 1.63% from 1.99%.
Balance Sheet, Liquidity, and Capital
- Total assets were $426.0 million at March 31, 2015, up 2.5% from $415.7 million at December 31, 2014.
- Total loans were $296.0 million, compared with $295.4 million at year-end; net loans were $292.4 million.
- Securities available for sale were $85.1 million, down from $87.2 million.
- Total deposits were $333.2 million, up from $308.7 million. The increase was concentrated in time deposits and interest-bearing demand deposits.
- Cash and cash equivalents increased to $25.4 million from $15.5 million.
- Federal funds purchased and repurchase agreements declined to $19.5 million from $29.4 million, and Federal Home Loan Bank advances declined to $31.0 million from $36.0 million.
- Stockholders’ equity was $40.9 million, compared with $40.7 million at December 31, 2014.
- Reported bank capital ratios were 11.81% common equity Tier 1, 11.81% Tier 1, 12.89% total capital, and 9.61% Tier 1 leverage.
Cash Flow and Asset Quality
- Operating activities provided $1.237 million of cash, compared with $845,000 in Q1 2014.
- Investing activities used $613,000, including $1.556 million for bank premises and equipment.
- Financing activities provided $9.295 million, primarily from a $24.543 million increase in deposits, partly offset by reduced repurchase funding, repayment of $5.0 million of FHLB borrowings, and $375,000 of preferred dividends.
- The allowance for loan losses increased to $3.657 million from $3.495 million, equal to 1.24% of loans versus 1.18% at year-end.
- Nonperforming assets declined to $9.973 million from $10.865 million at December 31, 2014. Nonaccrual loans declined to $1.450 million from $2.865 million, while foreclosed assets increased to $8.523 million from $8.000 million.
- Impaired loans declined to $5.788 million from $8.838 million, and troubled debt restructurings declined to approximately $3.288 million from $4.956 million.
Material Changes Versus Comparable Period
- Net income increased $67,379, despite a $185,000 increase in the loan-loss provision.
- Interest expense declined $129,209, primarily due to lower FHLB borrowing costs.
- Noninterest income increased because of higher customer service fees, gains on loan and other asset sales, and a $72,785 gain on foreclosed asset sales. Q1 2014 included $102,272 of securities-sale gains, while Q1 2015 had no securities-sale gains.
- Noninterest expense decreased $98,557. Foreclosed-asset expense fell to $57,615 from $349,370, while other operating expense increased to $965,865 from $661,187.
- Net cash increased $9.918 million in Q1 2015, compared with a $2.935 million decrease in Q1 2014, primarily due to deposit growth and lower short-term funding balances.
Guidance, Outlook, Risks, and Unusual Items
- Management expected loan yields to remain under pressure during 2015 because of refinancing activity and market conditions, and planned to pursue loan growth to offset the expected yield reduction.
- Management believed the net interest margin could remain near 3.98%, but identified local competition for loans and deposits as a significant challenge.
- Management expected nonaccrual loans and overall foreclosed and nonperforming assets to decline, targeting an approximately $3 million net reduction in foreclosed assets during the remainder of 2015.
- Additional loan-loss provisions could be required as problem assets are resolved and the loan portfolio grows.
- Liquidity depends on deposit retention, loan demand, market competition, interest rates, FHLB availability, and broader economic conditions. Non-core funding represented approximately 41% of total funding at March 31, 2015.
- The bank requested Federal Reserve permission to pay a scheduled December 31, 2014 dividend on its Series A convertible preferred stock. The filing does not state whether approval had been received.
- Key risks include credit deterioration, construction and land-development exposure, foreclosed real estate, interest-rate changes, liquidity needs, regulatory approvals, potential capital needs and dilution, deferred tax asset realization, cybersecurity, competition, and the pending merger.
- Available-for-sale securities included approximately $145,000 of unrealized losses, but management concluded that no other-than-temporary impairment existed. Approximately $76 million of securities were pledged as collateral.
- The filing reports no material expected loss from pending legal claims and states that disclosure controls were effective as of March 31, 2015.
Facts Investors Should Verify
- Confirm the correct issuer and transaction status: the filing is Cornerstone Bancshares, while the request metadata names SmartFinancial, Inc.; verify subsequent merger approvals, closing, exchange ratios, and preferred-stock treatment.
- Review the adequacy of the $3.657 million loan-loss allowance, particularly against construction and land-development loans, impaired loans, nonaccrual loans, and foreclosed assets.
- Assess the sustainability of the 3.98% net interest margin given declining loan and securities yields and competitive deposit pricing.
- Monitor the increase in time deposits and the 41% non-core funding mix, as well as continued reliance on FHLB and other wholesale funding.
- Verify regulatory approval and payment status for the Series A preferred dividend and its effect on earnings available to common shareholders.
- Evaluate the $47.6 million of unfunded commitments to extend credit and $339,000 of standby letters of credit, which could create future funding or credit exposure.