Business Context and Reporting Period
The supplied filing is a Form 10-K for the fiscal year ended December 31, 2011, filed March 29, 2012. The filing identifies the registrant as Cornerstone Bancshares, Inc., not SMARTFINANCIAL INC.; investors should verify the issuer identity before relying on this summary.
Cornerstone 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 Bank provides commercial, real estate, construction, consumer, deposit, and asset-based lending services. Eagle Financial was transferred into the Bank and became a division effective December 1, 2011.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Total assets | $422.7 million | $441.5 million | Down 4.3% |
| Total loans | $267.8 million | $285.2 million | Down 6.1% |
| Total deposits | $314.0 million | $335.4 million | Down 6.4% |
| Net interest income | $14.1 million | $16.0 million | Down 11.7% |
| Net interest margin | 3.55% | 3.43% | Up 12 basis points |
| Provision for loan losses | $0.45 million | $7.29 million | Down substantially |
| Noninterest income | $1.18 million | $3.08 million | Down 61.6% |
| Noninterest expense | $13.65 million | $18.04 million | Down 24.3% |
| Net income | $1.03 million | $(4.71) million | Returned to profitability |
| Net income available to common stockholders | $0.34 million | $(4.74) million | Returned to profitability |
| Basic and diluted EPS | $0.05 | $(0.73) | Improved |
| Stockholders’ equity | $35.2 million | $25.8 million | Up 36.4% |
| Cash and cash equivalents | $38.9 million | $23.0 million | Up $15.9 million |
| Nonperforming assets to total assets | 6.26% | 5.99% | Increased |
Cash Flow, Debt, and Liquidity
- Net cash provided by operating activities was $2.7 million, compared with $10.1 million in 2010.
- Investing activities provided $34.4 million, primarily reflecting security transactions, net loan collections, and proceeds from foreclosed assets.
- Financing activities used $21.2 million, including deposit reductions, repayment of $10.0 million of FHLB advances, and preferred dividends.
- Cash and cash equivalents increased to $38.9 million at year-end.
- FHLB advances and other borrowings totaled $43.0 million, including $40.0 million of FHLB advances. Federal funds purchased and repurchase agreements totaled $29.4 million.
- The Bank reported a liquidity ratio of 21.7%, $9 million of correspondent-bank federal funds availability, and approximately $5 million of Federal Reserve discount-window borrowing capacity.
- Approximately $5.9 million of FHLB advances and other borrowings were scheduled to mature in 2012.
Material Changes Versus the Prior Comparable Period
- The company returned to profitability, principally because the loan-loss provision declined from $7.3 million to $0.45 million and noninterest expense declined.
- Net interest income decreased as average earning assets and loan balances contracted, although lower funding costs improved the net interest margin.
- Noninterest income declined because customer service and ACH-related fees fell after the Bank exited its payroll processor ACH business, and 2010 included an atypically large $1.7 million securities gain.
- Loan balances declined as management intensified collections and applied more stringent underwriting standards. Commercial and industrial loans fell to $37.5 million from $51.2 million.
- Foreclosed assets increased to $18.5 million from $12.8 million, despite lower nonaccrual loans, reflecting the movement of problem credits into foreclosed assets.
- Stockholders’ equity increased by approximately $9.4 million, supported by $7.1 million of preferred-stock issuance, positive earnings, and accumulated unrealized securities gains.
- Core funding represented 55.3% of total funding versus 54.1% in 2010. Transactional and savings balances increased while time deposits and FHLB borrowings declined.
Guidance, Outlook, Risks, and Unusual Items
- Management intended to increase the loan portfolio during 2012 using excess cash and cash flow from mortgage-backed securities. It estimated that the net interest margin could increase by approximately 25 basis points by year-end 2012.
- The Bank remained subject to an FDIC consent order and a TDFI written agreement, collectively called the Action Plans. The plans require elevated capital ratios, liquidity and asset-quality improvements, restrictions on lending to certain classified borrowers, quarterly progress reports, and prior approval for Bank dividends.
- As of December 31, 2011, the Bank exceeded the Action Plan targets, reporting a Tier 1 leverage ratio of 8.04%, Tier 1 risk-based capital ratio of 11.73%, and total risk-based capital ratio of 12.99%. Nevertheless, regulators classified the Bank as only “adequately capitalized” because the enforcement action prevents a “well-capitalized” classification until the Action Plans are lifted.
- The holding company’s approximately $3.0 million remaining loan was out of compliance with nonperforming-asset and debt-service-coverage covenants at year-end. The FDIC granted a waiver through December 31, 2012, subject to required payments. Failure to obtain further waivers could permit the lender to declare a default and take possession of the Bank’s common stock, raising substantial going-concern risk.
- The company raised approximately $10 million through a Series A convertible preferred-stock offering, which was extended through June 30, 2012. The preferred stock carries a 10% annual dividend, convertible at the holder’s option into five common shares per preferred share, and reduces income available to common stockholders.
- No common-stock dividends were paid in 2011. Preferred dividends were subject to regulatory approval, and approximately $440,000 of preferred dividends were accumulated but undeclared at year-end.
- Credit risk remains concentrated in commercial real estate and construction lending. Commercial real estate, including commercial construction, represented approximately 54% of the loan portfolio.
- At year-end, nonaccrual loans were $7.9 million, troubled debt restructurings were approximately $5.0 million, impaired loans were $25.4 million, and classified loans included approximately $22.9 million of substandard-impaired loans and $2.5 million of doubtful loans.
- The allowance for loan losses declined to $7.4 million from $9.1 million, while net charge-offs were $2.2 million. Future deterioration in real estate values, borrower performance, or local economic conditions could require additional provisions and capital.
- The company reported a $2.1 million net deferred tax asset without a valuation allowance; realization depends on future taxable income and management forecasts.
- The independent auditor issued an unqualified opinion on the consolidated financial statements. Management concluded that internal control over financial reporting and disclosure controls were effective as of December 31, 2011; the smaller reporting company was not required to obtain an auditor attestation on internal controls.
Important Facts for Investors to Verify
- Confirm the issuer and ticker: the source text is for Cornerstone Bancshares, Inc. and references OTC Bulletin Board symbol CSBQ, while the request identifies SMARTFINANCIAL INC.
- Review whether the FDIC consent order and TDFI agreement were subsequently modified, terminated, or replaced, and whether the Bank achieved “well-capitalized” status.
- Verify the status of the $3.0 million holding-company loan, covenant waiver, collateral pledge, and any later default or restructuring.
- Assess trends in nonperforming assets, foreclosed assets, classified loans, troubled debt restructurings, charge-offs, and allowance coverage.
- Evaluate the maturity and renewal risk of time deposits, FHLB advances, repurchase agreements, and other non-core funding.
- Review the terms, accumulated dividends, conversion features, and potential dilution associated with the Series A preferred stock.
- Reconcile the annual results with the unaudited fourth-quarter results: fourth-quarter 2011 net income was $112,822, while net income available to common stockholders was a loss of $153,970 after preferred dividends and accretion.