Business Context and Reporting Period
The submitted Form 10-Q is for Cornerstone Bancshares, Inc., not SMARTFINANCIAL INC. It covers the unaudited quarter ended March 31, 2012, with comparison to March 31, 2011 and December 31, 2011. Cornerstone is a Tennessee bank holding company whose subsidiary, Cornerstone Community Bank, operates five branches in Hamilton County, Tennessee, and a loan production office in Dalton, Georgia.
Key Financial Metrics
| Metric | March 31, 2012 / Quarter | Comparable Period |
|---|---|---|
| Total assets | $417.5 million | $422.7 million at December 31, 2011 |
| Total loans | $262.8 million | $267.8 million at December 31, 2011 |
| Deposits | $315.8 million | $314.0 million at December 31, 2011 |
| Cash and cash equivalents | $34.9 million | $38.9 million at December 31, 2011 |
| Securities available for sale | $88.2 million | $86.1 million at December 31, 2011 |
| Stockholders’ equity | $35.9 million | $35.2 million at December 31, 2011 |
| Net interest income | $3.31 million | $3.46 million in Q1 2011 |
| Net income | $356,517 | $252,275 in Q1 2011 |
| Net income available to common stockholders | $76,193 | $159,200 in Q1 2011 |
| Basic and diluted EPS | $0.01 | $0.02 in Q1 2011 |
| Net interest margin, taxable-equivalent basis | 3.59% | 3.44% in Q1 2011 |
| Operating cash flow | $1.40 million provided | $50,083 provided in Q1 2011 |
| Ending cash and cash equivalents | $34.9 million | $41.4 million at March 31, 2011 |
Material Changes Versus Prior Comparable Period
- Net income increased 41.3% to $356,517, primarily because noninterest expense declined 10.0% and no loan-loss provision was recorded.
- Net income available to common stockholders declined 52.1% because preferred stock dividend requirements increased to $265,856 from $93,075, with an additional $14,468 of preferred-stock accretion in 2012.
- Interest income decreased 11.4% as average loans declined to approximately $265.8 million from $284.3 million and loan yields fell to 6.27% from 6.62%.
- Interest expense decreased 25.1%, reflecting lower funding costs and reduced average interest-bearing liabilities. The net interest margin improved by 15 basis points despite lower net interest income.
- Total noninterest expense fell $343,000, driven by lower occupancy costs, FDIC insurance expense and foreclosed-asset expense. Salaries and benefits increased 3.1%.
- Total loans declined $5.0 million from year-end, while nonaccrual loans increased to $10.8 million from $7.9 million. Total nonperforming assets increased to $29.7 million from $26.4 million.
- The allowance for loan losses declined to $6.0 million from $7.4 million after $1.4 million of charge-offs and $62,000 of recoveries, with no provision recorded. The allowance-to-loans ratio declined to 2.29% from 2.76%.
- Core funding increased to 58.3% of total funding from 55.3%, while noncore funding declined to 41.7% from 44.7%. Repurchase and federal-funds obligations decreased by $7.9 million during the quarter.
Guidance, Outlook, Risks and Unusual Items
- Management expected the balance sheet to remain approximately at its current level or increase slightly, with cash potentially converted into securities and loans to support net interest margin.
- Management was attempting to increase the loan portfolio but expected no material deposit growth during 2012. It expected additional federal Home Loan Bank advance reductions during 2012 and 2013.
- Management anticipated elevated foreclosed-asset expense through 2012 and 2013. Foreclosed assets were approximately $19.0 million at March 31, 2012.
- The Bank remained subject to an FDIC Consent Order and Tennessee Department of Financial Institutions written agreement. Requirements included capital, liquidity, asset-quality, credit-administration and reporting plans. Management stated that the Bank was in substantial compliance.
- The Bank could not declare or pay cash dividends without regulatory approval and was restricted from extending credit to certain classified borrowers. Cornerstone also required Federal Reserve approval for certain indebtedness, dividends, stock redemptions and capital reductions.
- The company had raised approximately $10.5 million through its Series A convertible preferred-stock offering, which was scheduled to remain effective through June 30, 2012. Preferred stock carried a 10% annual return and reduced earnings available to common stockholders.
- Capital ratios at March 31, 2012 were 8.14% Tier 1 leverage, 11.73% Tier 1 risk-based capital and 12.99% total risk-based capital.
- Off-balance-sheet commitments included $31.8 million of commitments to extend credit and $2.7 million of standby letters of credit.
- Management identified going-concern considerations, regulatory enforcement actions, concentrated residential construction and land-development credit risk, declining asset quality, foreclosures, liquidity needs, capital availability and potential shareholder dilution as material risks.
- The filing states that no securities were considered other-than-temporarily impaired. Unrealized losses on available-for-sale securities totaled $43,050 and were attributed primarily to the interest-rate environment.
- Disclosure controls and procedures were reported effective as of March 31, 2012, with no material changes in internal control over financial reporting during the quarter.
Investor Verification Checklist
- Verify the issuer identity: the source filing identifies Cornerstone Bancshares, Inc., while the request identifies SMARTFINANCIAL INC.
- Review the continuing FDIC and state regulatory action plans, all required approvals and the consequences of noncompliance.
- Assess the increase in nonaccrual loans and nonperforming assets against the reduced allowance for loan losses and the absence of a quarterly provision.
- Evaluate the effect of preferred-stock dividends and accretion on common earnings, EPS and future capital needs.
- Monitor liquidity, noncore funding, pledged securities, borrowings and the scheduled reduction of Federal Home Loan Bank advances.
- Assess the valuation and disposition risk of approximately $19 million of foreclosed assets and the expected elevated related expense.
- Confirm the status of the pending preferred-stock dividend approval and the company’s approximately $2.6 million of borrowings from the FDIC as receiver for Silverton Bank.