Business Context and Reporting Period
The filing is a Form 10-Q for the quarter ended June 30, 2012, filed August 13, 2012. The source text identifies the registrant as Cornerstone Bancshares, Inc., not SMARTFINANCIAL INC.; investors should verify the company identity and filing association. Cornerstone is a Tennessee bank holding company whose wholly owned bank provides commercial, consumer, real estate and construction lending primarily in the Chattanooga, Tennessee market, with a loan production office in Dalton, Georgia. The interim financial statements are unaudited.
Financial Performance and Position
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Interest income | $4.817 million | $5.160 million | $9.443 million | $10.378 million |
| Net interest income before loan-loss provision | $3.600 million | $3.469 million | $6.912 million | $6.932 million |
| Noninterest income | $252 thousand | $316 thousand | $519 thousand | $586 thousand |
| Noninterest expense | $3.423 million | $3.657 million | $6.497 million | $7.074 million |
| Net income | $311 thousand | $141 thousand | $667 thousand | $394 thousand |
| Net income available to common shareholders | $15 thousand | $14 thousand | $92 thousand | $173 thousand |
| Basic EPS | $0.00 | $0.00 | $0.01 | $0.02 |
- Tax-equivalent net interest margin was 3.87% for the second quarter and 3.73% for the first six months, compared with 3.42% and 3.44%, respectively, in the comparable 2011 periods.
- The tax-equivalent net interest spread was 3.70% for the quarter and 3.56% year to date, versus 3.25% and 3.27% in 2011.
- No provision for loan losses was recorded in the second quarter or first six months of 2012. The allowance for loan losses declined to $6.029 million from $7.400 million at December 31, 2011, while total loans declined to $263.749 million from $267.765 million.
- At June 30, 2012, total assets were $420.874 million, loans net of allowance were $257.720 million, securities were approximately $86.6 million, deposits were $321.740 million and stockholders’ equity was $36.759 million.
- Cash and cash equivalents were $36.879 million, compared with $38.883 million at December 31, 2011.
- Borrowings included $23.299 million of federal funds purchased and repurchase agreements and $37.610 million of Federal Home Loan Bank advances and other borrowings.
- Six-month operating cash flow was $3.103 million; investing activities used $1.926 million and financing activities used $3.180 million. Cash declined by $2.004 million during the period.
- Capital ratios at June 30, 2012 were 8.24% Tier 1 leverage, 11.85% Tier 1 risk-based capital and 13.11% total risk-based capital.
Material Changes Versus Prior Comparable Period
- Second-quarter net income increased $170 thousand, or approximately 121%, and first-half net income increased $273 thousand, or approximately 69%.
- Interest income declined 6.7% for the quarter and 9.0% year to date, primarily reflecting lower average earning assets and loan balances.
- Interest expense declined 28.0% for the quarter and 26.6% year to date, driven by lower funding costs and a shift toward lower-cost transactional deposits. The net interest margin consequently improved.
- Noninterest income decreased 20.3% for the quarter and 11.4% year to date, including the absence of 2011 securities-sale gains and lower deposit service charges.
- Noninterest expense decreased 6.4% for the quarter and 8.2% year to date. Foreclosed-asset expense and FDIC insurance expense declined, partially offset by higher salaries and employee benefits.
- Nonperforming assets increased to $29.268 million from $26.406 million at December 31, 2011, primarily because foreclosed assets rose to $22.144 million from $18.524 million. Nonaccrual loans declined to $7.124 million from $7.882 million.
- Impaired loans declined to $19.742 million from $25.417 million at December 31, 2011, but troubled debt restructurings increased to approximately $7.329 million from $5.026 million.
- Total deposits increased to $321.740 million from $314.042 million. Core funding increased to $223.847 million, while noncore funding decreased to $156.192 million.
- Stockholders’ equity increased $1.551 million, reflecting first-half earnings, approximately $1.089 million of additional preferred stock issuance and other comprehensive income, partly offset by preferred dividends.
Guidance, Outlook, Risks and Unusual Items
- Management expects loan yields to continue declining in a competitive market but expects the net interest margin to improve as cash and foreclosed assets are converted into earning assets and funding costs remain low.
- Management does not expect significant deposit growth in 2012 and expects 2013 deposit growth to be concentrated in longer-maturity term deposits.
- Management anticipates elevated foreclosed-asset expense through 2012 and 2013 and does not expect foreclosed assets to decline materially while new foreclosures offset property sales.
- The bank remains subject to an FDIC Consent Order and Tennessee Department of Financial Institutions written agreement. These require capital, liquidity, asset-quality, credit-administration, management and reporting actions. The company states that the bank is in substantial compliance, but noncompliance could result in penalties, including potential loss of deposit insurance in serious cases.
- The Federal Reserve Bank of Atlanta requires prior written approval for certain indebtedness, dividends, stock redemptions, capital reductions and specified management or director changes. Common dividends have not been paid; preferred dividends require regulatory approval.
- The company’s Series A preferred stock offering remained effective through December 31, 2012. Approximately $11 million had been raised, and the preferred stock carried a 10% annual return, materially reducing income available to common shareholders.
- Key risks include continued asset-quality deterioration, residential construction and land-development exposure, additional loan losses, foreclosures, liquidity needs, the ability to raise capital, potential shareholder dilution, regulatory enforcement, local economic conditions, interest-rate changes and the realizability of deferred tax assets.
- Off-balance-sheet commitments at June 30, 2012 included $31.2 million of commitments to extend credit and $2.7 million of standby letters of credit. Management stated that pending legal claims were not expected to have a material effect.
- The company reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Investor Verification Items
- Verify whether this filing belongs to SMARTFINANCIAL INC. or Cornerstone Bancshares, Inc.; the source text consistently identifies Cornerstone.
- Assess the sustainability of earnings available to common shareholders after preferred dividends and accretion.
- Review the FDIC Consent Order, state written agreement and Federal Reserve restrictions, including required capital and liquidity actions and their current status.
- Reconcile nonperforming assets, foreclosed real estate, impaired loans, troubled debt restructurings and the allowance for loan losses.
- Evaluate liquidity dependence on time deposits, repurchase agreements and Federal Home Loan Bank advances, including pledged securities.
- Confirm regulatory capital ratios, the preferred stock offering status and any potential dilution or dividend restrictions.
- Review the full annual filing for deferred tax asset valuation, regulatory examination findings, loan concentrations and future provision requirements.