Business Context and Reporting Period
The submitted filing is a Form 10-K for the fiscal year ended December 31, 2012, filed March 28, 2013. The filing identifies the registrant as Cornerstone Bancshares, Inc., not SMARTFINANCIAL INC.; this entity mismatch should be verified. 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 primarily gathers deposits and originates commercial, commercial real estate, residential real estate, construction, consumer and asset-based loans. The filing also provides unaudited fourth-quarter 2012 data.
Key Financial Metrics
| Metric | 2012 | 2011 | Change or comment |
|---|---|---|---|
| Total assets | $443.4 million | $422.7 million | Increased 4.9% |
| Total loans | $277.0 million | $267.8 million | Increased 3.4% |
| Total deposits | $344.9 million | $314.0 million | Increased 9.8% |
| Net interest income | $14.6 million | $14.1 million | Increased $0.4 million |
| Provision for loan losses | $0.4 million | $0.4 million | Essentially unchanged |
| Noninterest income | $1.0 million | $1.2 million | Decreased $0.2 million |
| Noninterest expense | $13.2 million | $13.7 million | Decreased $0.5 million |
| Net income | $1.4 million | $1.0 million | Increased 36.1% |
| Net income available to common shareholders | $0.1 million | $0.3 million | Reduced by preferred dividends and accretion |
| Basic earnings per common share | $0.02 | $0.05 | Declined |
| Net interest margin | 3.85% | 3.55% | Increased 30 basis points |
| Return on average assets | 0.34% | 0.24% | Improved |
| Return on average equity | 3.78% | 3.46% | Improved |
| Cash and cash equivalents | $59.4 million | $38.9 million | Increased $20.5 million |
| Shareholders’ equity | $40.9 million | $35.2 million | Increased $5.7 million |
Net cash provided by operating activities was $4.9 million. Investing activities used $3.4 million, primarily reflecting net loan originations and securities activity. Financing activities provided $19.0 million, including deposit growth and $4.9 million of preferred stock issuance. Cash and cash equivalents increased by $20.5 million during the year.
At December 31, 2012, borrowings included $35.0 million of Federal Home Loan Bank advances, $19.6 million of federal funds purchased and repurchase agreements, and $2.2 million of other borrowings. The Bank reported a 28.8% liquidity ratio. Its regulatory capital ratios were 8.37% Tier 1 leverage, 11.65% Tier 1 risk-based capital and 12.91% total risk-based capital; the Bank was categorized as well capitalized.
Material Changes Versus Prior Comparable Period
- Net income increased from $1.0 million to $1.4 million, while income available to common shareholders declined from $342,000 to $108,000 because preferred stock dividend requirements increased to $1.2 million.
- Net interest income improved despite lower interest income, primarily because interest expense declined by $1.6 million as deposit and borrowing costs fell. The net interest margin rose to 3.85% from 3.55%.
- Deposits grew by approximately $30.8 million. The Bank increased demand, NOW, savings and money market balances while reducing time deposits by approximately $27.2 million.
- Loans increased by approximately $9.2 million. Construction and land development loans increased to $38.6 million from $31.0 million, while commercial real estate loans declined modestly.
- Nonperforming assets were 5.94% of total assets, compared with 6.26% in 2011. Nonaccruing loans declined to $6.0 million from $7.9 million, partly because problem loans were transferred to foreclosed assets.
- Foreclosed assets increased to $20.3 million from $18.5 million. Foreclosed asset expense declined to $1.1 million from $1.9 million but management expected elevated costs until these assets were reduced.
- The allowance for loan losses declined to $6.1 million from $7.4 million. Net charge-offs were $1.7 million, compared with $2.2 million in 2011.
- Substandard loans declined to $19.4 million from $29.3 million, although the Bank continued to have material classified and special-mention credits.
- The FDIC and Tennessee Department of Financial Institutions terminated the Bank’s 2010 Action Plans in August 2012. However, regulatory approval remained required for dividends from the Bank to the holding company.
Fourth-Quarter 2012, Outlook and Unusual Items
Fourth-quarter 2012 net income was $370,715, compared with $112,822 in the fourth quarter of 2011. Net income available to common shareholders was a loss of $22,130, compared with a loss of $153,970 in the prior-year quarter, after preferred dividends and accretion. Fourth-quarter net interest income before provision was $4.1 million, and the loan-loss provision was $330,000.
Management stated that it intended to increase the loan portfolio during 2013 using excess cash and cash flow from mortgage-backed securities. Management estimated that the net interest margin could increase by approximately 25 basis points by year-end 2013 and expected further interest expense savings. The filing does not provide formal revenue or earnings guidance.
Key unusual or contingent items include a $2.3 million net deferred tax asset, for which no valuation allowance was recorded; accumulated preferred dividends of approximately $684,000 at December 31, 2012; and preferred stock with a 10% annual dividend and conversion rights into common stock. The Bank had approximately $37.4 million of undisbursed loan commitments and $3.2 million of standby letters of credit.
The holding company’s liquidity depends primarily on dividends from the Bank, but such dividends required prior regulatory approval. The Bank also had $10.0 million of scheduled FHLB maturities in 2013. A $2.175 million FDIC-related borrowing outstanding at year-end was refinanced in March 2013 with a correspondent institution; the new loan had no financial covenants, was secured by approximately $1.7 million of cash collateral and bore interest at 2%.
Principal risks include deterioration in asset quality, losses on construction and land development loans, additional foreclosures and declines in collateral values, local economic weakness, funding and liquidity constraints, interest-rate changes, regulatory requirements, the realization of deferred tax assets, potential capital dilution and the effect of preferred stock on common shareholder returns. Management reported no material litigation and concluded that disclosure controls and internal control over financial reporting were effective.
Investor Verification Items
- Registrant identity: Confirm whether this filing belongs to Cornerstone Bancshares, Inc. rather than SMARTFINANCIAL INC.
- Asset quality: Verify nonperforming assets, nonaccrual loans, troubled debt restructurings, classified loans and the $20.3 million foreclosed-asset balance.
- Capital and liquidity: Confirm regulatory capital classifications, dividend restrictions, available borrowing capacity and the timing of FHLB maturities.
- Common shareholder economics: Review the 600,000 preferred shares, 10% dividend, accumulated dividends, conversion terms and the limited 2012 earnings available to common shareholders.
- Deferred tax asset: Assess the assumptions supporting realization of the approximately $2.3 million net deferred tax asset.
- Credit commitments: Evaluate the potential funding exposure from approximately $37.4 million of undisbursed commitments and $3.2 million of standby letters of credit.
- 2013 outlook: Compare actual loan growth, net interest margin and foreclosed-asset expense with management’s expectations.