UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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| ý | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 20142017
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| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For transition period from __________ to __________
Commission
file number 000-30497
File Number: 001-37391
SMARTFINANCIAL, INC.
(Exact Namename of Registrantregistrant as Specifiedspecified in its Charter)charter)
_________________________________________________________
Tennessee | 62-1173944 |
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| Tennessee | 62-1173944 |
(State or other jurisdiction of Incorporation) incorporation or organization) | (I.R.S. Employer Identification No.) |
835 Georgia Avenue,
Chattanooga, TN 37402
(Address of principal executive offices)(Zip Code)
(423) 385-3000
(Registrant’s telephone number, including area code)
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5401 Kingston Pike, Suite 600 Knoxville, Tennessee | 37919 |
| (Address of principal executive offices) | (Zip Code) |
(865) 437-5700 |
| (Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
NoneCommon Stock, $1.00 Par Value
Name of exchange where registered:
The NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 Par Value
Indicate by check mark if Registrant is a well known seasoned issuer, as defined in Rule 405 of the of the Securities Act.
Indicate by check mark if Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
Yesý No ¨ No
¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer ¨ | Accelerated filer¨x | Non-accelerated filer¨ | Smaller reporting companyx |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of June 30, 2017, the aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates was approximately $169.4 million. As of March 1, 2018, there were 11,229,306 shares outstanding of the Registrant on June 30, 2014 was $13 million. The market value calculation was determined using the closing sale price of the Registrant’sregistrant’s common stock, on June 30, 2014, as reported on the OTC Bulletin Board. For purposes of this calculation, the term “affiliate” refers to all directors, executive officers and 10% shareholders of the Registrant. As of the close of business on December 31, 2014, there were 6,627,398 shares of the Registrant’s common stock outstanding.$1.00 par value.
DOCUMENTS INCORPORATED BY REFERENCE
None
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 24, 2018, are incorporated by reference in Part III of this Form 10-K.
TABLE OF CONTENTS
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS
Cornerstone Bancshares,
SmartFinancial, Inc. (“Cornerstone”SmartFinancial”) may from time to time make written or oral statements, including statements contained in this report (including, without limitation, certain statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7), that constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”“Exchange Act”). TheAny statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify some of the forward-looking statements by the use of forward-looking words, “expect,such as “may,” “will,” “could,” “project,” “believe,” “anticipate,” “intend,“expect,” “consider,“estimate,” “continue,” “potential,” “plan,” “believe,” “seek,” “should,” “estimate,“forecast,” and similarthe like, the negatives of such expressions, are intendedor the use of the future tense. Statements concerning current conditions may also be forward-looking if they imply a continuation of a current condition. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, financial condition, or achievements to identifybe materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Cornerstone’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors. Such factors include, without limitation, those specifically describedbut are not limited to:
weakness or a decline in Item 1A of Part I of this Annual Report on Form 10-K, as well as the following: (i) U.S. economy, in particular in Tennessee, and other markets in which we operate;
the possibility that our asset quality would decline or that we experience greater loan losses than anticipated, (ii) high levels of other real estate, primarily as a result of foreclosures, (iii) anticipated;
the impact of liquidity needs on our results of operations and financial condition, (iv) condition;
competition from financial institutions and other financial service providers, (v) economic conditions in the local markets where we operate, (vi) the impact of obtaining regulatory approval prior to the payment of dividends, (vii) the impact of our Series A Preferred Stock on net income available to holders of our Common Stock and earnings per common share, (viii) providers;
the impact of negative developments in the financial industry and U.S. and global capital and credit markets, (ix) markets;
the impact of recently enacted and future legislation and regulation on our business;
negative changes in the real estate markets in which we operate and have our primary lending activities, which may result in an unanticipated decline in real estate values in our market area;
risks associated with our growth strategy, including a failure to implement our growth plans or an inability to manage our growth effectively;
claims and litigation arising from our business (x) activities and from the companies we acquire, which may relate to contractual issues, environmental laws, fiduciary responsibility, and other matters;
expected revenue synergies and cost savings from our recently completed acquisition of Capstone Bancshares, Inc. (“Capstone”) and the proposed acquisition Tennessee Bancshares (“Tennessee Bancshares”) may not be fully realized or may take longer than anticipated to be realized;
disruption from these merger with customers, suppliers or employees or other business partners’ relationships;
the risk of successful integration of the targets’ businesses with our business;
lower than expected revenue following these mergers;
SmartFinancial’s ability to manage the combined company’s growth following the mergers;
the possibility that the Tennessee Bancshares merger may be more expensive to complete than anticipated, including as a result of unexpected factors or events;
the dilution caused by SmartFinancial’s issuance of additional shares of its common stock in connection with the Capstone merger and the Tennessee Bancshares merger;
cyber attacks, computer viruses or other malware that may breach the security of our websites or other systems we operate or rely upon for services to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage our systems and negatively impact our operations and our reputation in the market;
results of examinations by our primary regulators, the Tennessee Department of Financial Institutions (the “TDFI”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for credit losses, write-down assets, require us to reimburse customers, change the way we do business, or limit or eliminate certain other banking activities;
government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve;
our inability to pay dividends at current levels, or at all, because of inadequate future earnings, regulatory restrictions or limitations, and changes in the composition of qualifying regulatory capital and minimum capital requirements (including those resulting from the U.S. implementation of Basel III requirements);
the relatively greater credit risk of residentialcommercial real estate loans and construction and land development loans in our loan portfolio;
unanticipated credit deterioration in our loan portfolio (xi) adverse impact on operations and financial conditionor higher than expected loan losses within one or more segments of our loan portfolio;
unexpected significant declines in the loan portfolio due to the lack of economic expansion, increased competition, large prepayments, changes in interest rates, (xii) our ability to obtain additional capitalregulatory lending guidance or other factors;
unanticipated loan delinquencies, loss of collateral, decreased service revenues, and if obtained, the possible significant dilution to current shareholders, (xiii) the impact of federal and state regulationsother potential negative effects on our operationsbusiness caused by severe weather or other external events;
changes in expected income tax expense or tax rates, including changes resulting from revisions in tax laws, regulations and financial performance, (xiv) whether a significant deferred tax asset we have can be fully realized, (xv) case law;
our ability to retain the services of key personnel, (xvi) personnel; and
the impact of Tennessee’s anti-takeover statutes and certain of our charter and bylaw provisions on potential acquisitions of us.
For a more detailed discussion of some of the
holding company, (xvii) our ability to adapt to technological changes, and (xviii)risk factors, see the
impact of business combinations. Many of such factors are beyond Cornerstone’s ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Cornerstone doessection entitled “Risk Factors” below. We do not intend to update
any factors, except as required by SEC rules, or
reissueto publicly announce revisions to any
of our forward-looking
statements. Any forward-looking statement speaks only as of the date that such statement was made. You should consider any forward looking statements
contained in
light of this
report as a result of new information or other circumstances that may become known to Cornerstone.explanation, and we caution you about relying on forward-looking statements.
PART I
SmartFinancial, Inc. (“SmartFinancial” or the “Company”), formerly “Cornerstone Bancshares, Inc.,” was incorporated on September 19, 1983, under the laws of the State of Tennessee. CornerstoneSmartFinancial is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and was formerly known as East Ridge Bancshares, Inc. It has one wholly-owned subsidiary: Cornerstone Community Bank, a Tennessee banking corporation (the “Bank”), which resulted from the merger of The Bank of East Ridge and Cornerstone Community Bank effective October 15, 1997. The Bank owned and operated a subsidiary, Eagle Financial, Inc. (“Eagle”), a finance and factoring company. On December 1, 2011, the Bank elected to transfer the operations, assets and liabilities of Eagle into the Bank. The transfer allowed the Bank to combine the operations of Eagle with the Bank’s asset based lending department. As a result, the Bank formed Eagle Financial, a division of Cornerstone Community Bank. The Bank maintains the existence of this subsidiary in an inactive status.Cornerstone
amended.
The primary activity of
CornerstoneSmartFinancial currently is,
and is expected to remain for the foreseeable future, the ownership and operation of
the Bank.SmartBank. As a bank holding company,
CornerstoneSmartFinancial intends to facilitate
the Bank'sSmartBank’s ability to serve its
customers'customers’ requirements for financial services. The holding company structure also provides flexibility for expansion through the possible acquisition of other financial institutions and the provision of additional banking-related services, as well as certain non-banking services, which a traditional commercial bank may not provide under present laws.
On December 8, 2014,
SmartFinancial and Cornerstone announcedMerger
In 2015, the signing of a definitive agreement to merge with SmartFinancial, Inc., which would create a combined company that will operateCompany operated under the name Cornerstone Bancshares, Inc., and it merged with legacy SmartFinancial, Inc. (“Legacy SmartFinancial”) (we refer to the merger as the “2015 merger”). Cornerstone Bancshares was the survivor of the 2015 merger, and immediately following that transaction, the company changed its name to “SmartFinancial, Inc.” and relocated its headquarters to Knoxville, Tennessee. Following the 2015 merger, we merged Cornerstone Community Bank with and into SmartBank, with SmartBank surviving the merger.
Capstone Merger
On May 22, 2017, the shareholders of the Company approved a merger with Capstone Bancshares, Inc. ("Capstone"), the one bank holding company of Capstone Bank, which was consummated on November 1, 2017. Capstone shareholders received either stock, cash, or a combination of stock and cash. After the merger, shareholders of SmartFinancial owned approximately 74 percent of the outstanding common stock of the combined entity on a fully diluted basis. The assets and liabilities of Capstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of SmartFinancial. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill, which was approximately $38 million. As a result of the merger Company assets increased approximately $536 million and liabilities increased approximately $466 million. The merger had a significant impact on all aspects of the Company's financial statements, and as a result, financial results after the merger may not be comparable to financial results prior to the merger.
SBLF Preferred Stock
In connection with the 2015 merger, the Company entered into an Assignment and Assumption Agreement (the “Assignment Agreement”) with Legacy SmartFinancial, pursuant to which Legacy SmartFinancial assigned to the Company, and the Company assumed, all of Legacy SmartFinancial’s rights, responsibilities, and obligations under that certain Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of August 4, 2011, by and between The United States Secretary of the Treasury (“Treasury”) and Legacy SmartFinancial. The Securities Purchase Agreement was entered into by Legacy SmartFinancial in connection with its participation in Treasury’s Small Business Lending Fund Program.
Under the terms of the agreement, each outstandingSecurities Purchase Agreement, Legacy SmartFinancial sold 12,000 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series A (“Legacy SmartFinancial SBLF Stock”), to Treasury for a purchase price of $12 million. Each share of common stock ofLegacy SmartFinancial will beSBLF Stock was converted into 4.20 shares of Cornerstone common stock, subject to adjustment based on an anticipated reverse stock split of Cornerstone’s common stock, which is expected to adjust the ratio to 1.05 shares of Cornerstone common stock for eachone share of SmartFinancial common stock. Additionally, each outstandingthe Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series B, having a liquidation preference of $1,000 per share (the “SBLF Preferred Stock”). On March 6, 2017, the Company redeemed the $12 million of SmartFinancial preferred stock willand paid $195 thousand in accrued dividends. More details about the SBLF Preferred Stock can be converted into a share of Cornerstone preferred stock with similar rights and preferences. Current holders of Cornerstone’s preferred stock will be askedfound in Note 16 in the “Notes to vote on an amendment to Cornerstone’s charter to allow Cornerstone to redeem its outstanding preferred stock prior to the completion of the merger. Completion of the merger is subject to a number of conditions, including approval by bank regulatory authorities and both SmartFinancial’s and Cornerstone’s shareholders.
The Consolidated Financial Statements.”
SmartBank
SmartBank (the "BankThe Bank
") is a Tennessee-chartered commercial bank established in 19852007 which has its principal executive offices in Chattanooga,Pigeon Forge, Tennessee. The principal business of the Bank consists of attracting deposits from the general public and investing
those funds, together with funds generated from operations and from principal and interest payments on loans, primarily in commercial loans, commercial and residential real estate loans, consumer loans and residential and commercial construction loans. Funds not invested in the loan portfolio are invested by the Bank primarily in obligations of the U.S. Government, U.S. Government agencies, and various states and their political subdivisions. In addition to deposits, sources of funds for the Bank’s loans and other investments include amortization and prepayment of loans, sales of loans or participations in loans, sales of its investment securities and borrowings from other financial institutions. The principal sources of income for the Bank are interest and fees collected on loans, fees collected on deposit accounts and interest and dividends collected on other investments. The principal expenses of the Bank are interest paid on deposits, employee compensation and benefits, office expenses and other overhead expenses.At December 31, 2014, the Bank2017, SmartBank had fivetwenty-two full-service banking officesbranches located in Hamilton County, Tennessee, Alabama, and Florida, one loan production office, located in Dalton, Georgia.
Eagle Financial, a Division of Cornerstone Community Bank
Eagle’s business concentrates on the purchase of accounts receivable from small businessestwo mortgage loan production offices, and commercial loan placement on a conduit basis. The principal sources of Eagle’s income are fees derived from the collection of accounts receivable and fees generated from the placement of loans with conduit financial institutions. Eagle’s principal expenses are employee compensation and benefits, office expenses and other overhead expenses.
two service centers.
As of December 31,
2014, Cornerstone2017, SmartFinancial had
104343 full-time equivalent employees and SmartBank had 343 full-time equivalent employees. The employees are not represented by a collective bargaining unit.
CornerstoneSmartFinancial believes that its relationship with its employees is good.
Competition
All phases of the Bank’s banking activities are highly competitive. The Bank competes actively with over 20 commercial banks,
Merger and Acquisition Strategy
Our strategic plan involves growing a high performing community bank through organic loan and deposit growth as well as finance companies, credit unions,disciplined merger and otheracquisition activity. We are continually evaluating business combination opportunities and may conduct due diligence activities in connection with these opportunities. As a result, business combination discussions and, in some cases, negotiations, may take place, and transactions involving cash, debt or equity securities could be expected. Any future business combinations or series of business combinations that we might undertake may be material in terms of assets acquired, liabilities assumed, or equity issued.
Competition
The markets in which we currently operate are very competitive. The Sevier County, Tennessee banking market, which is not in a MSA, is comprised of 10 financial institutions
locatedwith approximately $2.4 billion in
its service area, which includes Hamilton County, Tennessee.The Bank’s deposits totaled approximately $309 millionin the market as of December 31, 2014. TheJune 30, 2017, up from $2.2 billion at June 30, 2016. As of June 30, 2017, approximately 79 percent of this deposit base representswas controlled by four local community banks which are headquartered in the county. At June 30, 2017, SmartBank had approximately 4%19.8 percent of the deposit basemarket share in the Chattanooga, Tennessee Metropolitan Statistical Area (MSA). Three major regional banks representcounty.
The Knoxville MSA banking market consists of 46 financial institutions with approximately 57% of the$16.3 billion in deposits in the Chattanooga,market as of June 30, 2017, unchanged from June 30, 2016. As of June 30, 2017, approximately 57 percent of this deposit base was controlled by four financial institutions. At June 30, 2017, SmartBank had approximately 0.7 percent of the deposit market share in the MSA.
The Bradley County, Tennessee MSA. These largerbanking market, which is not in a MSA, is comprised of 15 financial institutions have greater resources and higher lending limits thanwith approximately $1.7 billion in deposits in the Bank, and eachmarket as of June 30, 2017, which was unchanged from June 30, 2016. As of June 30, 2017, approximately 67 percent of this deposit base was controlled by five financial institutions. At June 30, 2017, SmartBank had approximately 1.4 percent of the three institutions has over 20 branchesdeposit market share in the county.
The Chattanooga TennesseeMSA banking market consists of 28 financial institutions with approximately$9.7 billion in deposits in the market as of June 30, 2017, up from $9.2 billion at June 30, 2016. As of June 30, 2017, approximately 56 percent of this deposit base was controlled by three large, multi-state banks headquartered outside of Chattanooga. At June 30, 2017, SmartBank had approximately 3.1 percent of the deposit market share in the MSA. There are also several credit unions located
The Tuscaloosa MSA banking market consists of 24 financial institutions with approximately $4.0 billion in Hamiltondeposits in the market as of June 30, 2017, up from $3.8 billion at June 30, 2016. As of June 30, 2017, approximately 45 percent of this deposit base was controlled by three financial institutions. At June 30, 2017, SmartBank had approximately 8.2 percent of the deposit market share in the MSA.
The Washington County, Tennessee. Credit unions areAlabama banking market, which is not subject toin a MSA, is comprised of two financial institutions with approximately $167.9 million in deposits in the same income tax structuremarket as commercial banks. This advantage enables credit unions to offer competitive rates to potential customers. of June 30, 2017, which was up from $161.0 million on June 30, 2016. At June 30, 2017, SmartBank had approximately 28.0 percent of the deposit market share in the county.
The Bank also faces competitionClarke County, Alabama banking market, which is not in certain areasa MSA, is comprised of its business5 financial institutions with approximately $482 million in deposits in the market as of June 30, 2017, down from mortgage$485 million at June 30, 2016. As of June 30, 2017, approximately 73 percent of this deposit base was controlled by two financial institutions. At June 30, 2017, SmartBank had approximately 3.5 percent of the deposit market share in the county.
The Daphne-Fairhope-Foley MSA banking companies, consumer finance companies, insurance companies, money market mutual funds and investmentconsists of 22 financial institutions with approximately $4.3 billion in deposits in the market as of June 30, 2017, up from $4.0 billion at June 30, 2016. As of June 30, 2017, approximately 51 percent of this deposit base was controlled by five financial institutions. At June 30, 2017, SmartBank had approximately 0.5 percent of the deposit market share in the MSA.
The Pensacola-Ferry Pass-Brent MSA banking firms, somemarket consists of which are not subject to19 financial institutions with approximately $5.6 billion in deposits in the same degreemarket as of regulationJune 30, 2017, up from $5.4 billion at June 30, 2016. As of June 30, 2017, approximately 65 percent of this deposit base was controlled by five financial institutions. At June 30, 2017, SmartBank had approximately 0.3 percent of the deposit market share in the MSA.
The Crestview-Fort Walton Beach-Destin MSA banking market is comprised of 18 financial institutions with approximately $5.2 billion in deposits in the market as
of June 30, 2017, up from $4.9 billion at June 30, 2016. As of June 30, 2017, approximately 28 percent of this deposit base was controlled by two financial institutions. At June 30, 2017, SmartBank had approximately 1.1 percent of the
Bank.deposit market share in the MSA.
The Panama City MSA banking market is comprised of 25 financial institutions with approximately $3.0 billion in deposits in the market as of June 30, 2017, up from $2.7 billion at June 30, 2016. As of June 30, 2017, approximately 67 percent of this deposit base was controlled by five financial institutions. At June 30, 2017, SmartBank had approximately 0.3 percent of the deposit market share in the MSA.
The Bank competes for deposits principally by offering depositors a variety of deposit programs with competitive interest rates, quality service and convenient locations and hours. The Bank focuses its resources in seeking out and attracting small business relationships and taking advantage of the Bank’s ability to provide flexible service that meets the needs of this customer class. Management feels this market niche is the most promising business area for the future growth of the Bank.
Supervision
SUPERVISON AND REGULATION
General
The U.S. banking industry is highly regulated under federal and
RegulationCornerstone and the Bank are subject to state and federal banking laws and regulations that impose specific requirements and restrictions and provide for general regulatory oversight over virtually all aspects of our operations. These laws and regulations generally are intended to protect depositors, not shareholders.law. The following discussion is only a general summary of somethe material aspects of certain statutes and regulations applicable to SmartFinancial and SmartBank. This supervisory framework could materially impact the more significant statutoryconduct and regulatory provisions. This summary is qualified by reference to the particular statutory and regulatory provisions. Anyprofitability of our activities. A change in applicable laws and regulations, or in the manner such laws or regulations are interpreted by regulatory agencies or courts, may have a material effect on our business, operations and prospects.
General
Cornerstoneearnings.
SmartFinancial is a bank holding company
within the meaning ofregistered under the Bank Holding Company Act of 1956, as amended,
(the “Act”),or the BHC Act. As a result, we are subject to supervision, regulation, and
is registered with and regulatedexamination by
the Board of Governors of the Federal Reserve,
System (the “Federal Reserve Board”). Cornerstone isand we are required to file with the Federal Reserve
Board annual reports and such additional information as the Federal Reserve
Board may require pursuant to the
BHC Act.
SmartFinancial is required to file with the Federal Reserve annual reports and such additional information as the Federal Reserve may require pursuant to the BHC Act and other applicable regulations. The Federal Reserve
Board may also make examinations of
CornerstoneSmartFinancial and its subsidiary.
The Bank We are also under the jurisdiction of the SEC for matters relating to the offering and sale of our securities and are subject to the SEC’s rules and regulations relating to periodic reporting, reporting to shareholders, proxy solicitations, and insider-trading regulations.
SmartBank is a Tennessee-chartered commercial bank and is a member of the Federal Reserve System. As a Tennessee bank, SmartBank is subject to supervision, regulation and examination by the supervision and regulationTDFI. As a member of the Tennessee Department of Financial Institutions (the “TDFI”).Federal Reserve System, SmartBank is also subject to supervision, regulation and examination by the Federal Reserve. In addition, the Bank’sSmartBank’s deposit accounts are insured up to applicable limits by the Deposit Insurance Fund (the “DIF”)of the FDIC, and SmartBank is subject to regulation by the FDIC as the insurer of its deposits.
The bank and bank holding company regulatory scheme has two primary goals: to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. This comprehensive system of supervision and regulation is intended primarily for the protection of the FDIC’s Deposit Insurance Fund, bank depositors and the public, rather than our shareholders or creditors. To this end, federal and state banking laws and regulations control, among other things, the types of activities in which we and
SmartBank may engage, permissible investments that we and SmartBank may make, the level of reserves that SmartBank must maintain against deposits, minimum equity capital levels, the nature and amount of collateral required for loans, maximum interest rates that can be charged, the manner and amount of the dividends that may be paid, and corporate activities regarding mergers, acquisitions and the establishment and closing of branch offices. In addition, federal and state laws impose substantial requirements on SmartBank in the areas of consumer protection and detection and reporting of potential or suspected money laundering and terrorist financing.
The description below summarizes certain elements of the bank regulatory framework applicable to us and SmartBank. This summary is not, however, intended to describe all laws, regulations and policies applicable to us and SmartBank, and you should refer to the full text of the statutes, regulations, and corresponding guidance for more information. These statutes and regulations are subject to change, and additional statutes, regulations, and corresponding guidance may be adopted. Proposals to change the laws and regulations governing the banking industry are frequently raised at both the state and federal level. We are unable to predict these future changes or the effects, if any, that these changes could have on our business, revenues, and financial results.
Regulation of SmartFinancial
As a regulated bank holding company, we are subject to various laws and regulations that affect our business. These laws and regulations, among other matters, prescribe minimum capital requirements, limit transactions with affiliates, impose limitations on the business activities in which we can engage, restrict our ability to pay dividends to our shareholders, restrict the ability of institutions to guarantee our debt and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than generally accepted accounting principles, among other things.
Permitted activities
Under the BHC Act, a bank holding company that is not a financial holding company, as discussed below, is generally permitted to engage in, or acquire direct or indirect control of more than five percent of any class of the voting shares of any company that is not a bank or bank holding company and that is engaged in, the following activities (in each case, subject to certain conditions and restrictions and prior approval of the Federal Deposit Insurance Corporation (the “FDIC”)Reserve):
banking or managing or controlling banks;
furnishing services to or performing services for its subsidiaries; and consequently,
any activity that the Federal Reserve determines by regulation or order to be so closely related to banking as to be a proper incident to the business of banking, including, for example factoring accounts receivable, making, acquiring, brokering or servicing loans and usual related activities, leasing personal or real property, operating a nonbank depository institution, such as a savings association, performing trust company functions, conducting financial and investment advisory activities, underwriting and dealing in government obligations and money market instruments, performing selected insurance underwriting activities, issuing and selling money orders and similar consumer-type payment instruments, and engaging in certain community development activities.
While the Federal Reserve has found these activities in the past acceptable for other bank holding companies, the Federal Reserve may not allow us to conduct any or all of these activities, which are reviewed by the Federal Reserve on a case by case basis upon application by a bank holding company.
Acquisitions subject to prior regulatory approval
The BHC Act requires the prior approval of the Federal Reserve for a bank holding company to acquire substantially all the assets of a bank or to acquire direct or indirect ownership or control of more than 5 percent of any class of the voting shares of any bank, bank holding company, savings and loan holding company or savings association, or to increase any such non-majority ownership or control of any bank, bank holding company, savings and loan holding company or savings association, or to merge or consolidate with any bank holding company.
Under the BHC Act, a bank holding company that is located in Tennessee and is “well capitalized” and “well managed”, as such terms are defined under the BHC Act and implementing regulations, may purchase a bank located outside of Tennessee. Conversely, a well-capitalized and well-managed bank holding company located outside of Tennessee may purchase a bank located inside Tennessee. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in concentrations of deposits exceeding limits specified by statute.
Federal and state laws, including the BHC Act and the Change in Bank Control Act, impose additional prior notice or approval requirements and ongoing regulatory requirements on any investor that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank holding company. “Control” of a depository institution is a facts and circumstances analysis, but generally an investor is deemed to control a depository institution or other company if the investor owns or controls 25 percent or more of any class of voting securities. Ownership or control of 10 percent or more of any class of voting securities, where either the depository institution or company is a public company, as we are, or no other person will own or control a greater percentage of that class of voting securities after the acquisition, is also presumed to result in the investor controlling the depository institution or other company, although this is subject to rebuttal.
The BHC Act was substantially amended through the Financial Services Modernization Act of 1999, commonly referred to as the Gramm-Leach Bliley Act, or the GLBA. The GLBA eliminated long-standing barriers to affiliations among banks, securities firms, insurance companies and other financial services providers. A bank holding company whose subsidiary deposit institutions are “well capitalized” and “well managed” may elect to become a “financial holding company” and thereby engage without prior Federal Reserve approval in certain banking and non-banking activities that are deemed to be financial in nature or incidental to financial activity. These “financial in nature” activities include securities underwriting, dealing and market making; organizing, sponsoring and managing mutual funds; insurance underwriting and agency; merchant banking activities; and other activities that the Federal Reserve has determined to be closely related to banking. No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve. We have not elected to become a financial holding company.
A dominant theme of the GLBA is functional regulation of financial services, with the primary regulator of a company or its subsidiaries being the agency which traditionally regulates the activity in which the aompany or its subsidiaries wish to engage. For example, the SEC will regulate bank holding company securities transactions, and the various banking regulators will oversee banking activities.
Bank holding company obligations to bank subsidiaries
Under current law and Federal Reserve policy, a bank holding company is expected to act as a source of financial and managerial strength to its depository institution subsidiaries and to maintain resources adequate to support such subsidiaries, which could require us to commit resources to support SmartBank in situations where additional investments may not otherwise be warranted. As a result of these obligations, a bank holding company may be required to contribute additional capital to its subsidiaries.
Bank holding company dividends
The Federal Reserve’s policy regarding dividends is that a bank holding company should not declare or pay a cash dividend which would impose undue pressure on the capital of any bank subsidiary or would be funded only through borrowing or other arrangements that might adversely affect a bank holding company’s financial position. As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer, or significantly reduce the bank holding company’s dividends if:
its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;
its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or
it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.
Should an insured member bank controlled by a bank holding company be “significantly undercapitalized” under the applicable federal bank capital ratios, or if the bank subsidiary is “undercapitalized” and has failed to submit an acceptable capital restoration plan or has materially failed to implement such a plan, the Federal Reserve may require prior approval for any capital distribution by the bank holding company. For more information, see “Capitalization levels and prompt corrective action” below.
In addition, since our legal entity is separate and distinct from SmartBank and does not conduct stand-alone operations, our ability to pay dividends depends on the ability of SmartBank to pay dividends to us, which is also subject to regulatory restrictions as described below in “Bank dividends.”
Under Tennessee law, we are not permitted to pay cash dividends if, after giving effect to such payment, we would not be able to pay our debts as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus any amounts needed to satisfy any preferential rights if we were dissolving.
Dodd-Frank Act
On July 21, 2010, the President signed into law the Dodd-Frank Act. The Dodd-Frank Act has imposed new restrictions on and expanded regulatory oversight for financial institutions, including depository institutions like SmartBank. Although the Dodd-Frank Act is primarily aimed at the activities of investment banks and large commercial banks, many of the provisions of the legislation impact operations of community banks like SmartBank. In addition to the Volcker Rule, which is discussed in more detail below, the following aspects of the Dodd-Frank Act are related to our operations:
Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated, subject to various grandfathering and transition rules.
The deposit insurance assessment base calculation now equals the depository institution’s average consolidated total assets minus its average tangible equity during the assessment period. Previously, the deposit insurance assessment was calculated based on the insured deposits held by the institution.
The ceiling on the size of the Deposit Insurance Fund was removed and the minimum designated reserve ratio of the Deposit Insurance Fund increased 20 basis points to 1.35 percent of estimated annual insured deposits or assessment base. The FDIC also was directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.
Bank holding companies and banks must be “well capitalized” and “well managed” in order to acquire banks located outside of their home state, which codified long-standing Federal Reserve policy. Any bank holding company electing to be treated as a financial holding company must be and remain “well capitalized” and “well managed.”
Capital requirements for insured depository institutions are now countercyclical, such that capital requirements increase in times of economic expansion and decrease in times of economic contraction.
The Federal Reserve established interchange transaction fees for electronic debit transactions under a restrictive “reasonable and proportional cost” per transaction standard.
The “opt in” provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1997 have been eliminated, which allows state banks to establish de novo branches in states other than the bank’s home state if the law of such other state would permit a bank chartered in that state to open a branch at that location.
The Durbin Amendment limits interchange fees payable on debit card transactions for financial institutions with more than $10 billion in assets. While the Durbin Amendment does not directly apply to SmartBank, competitive market forces related to the reduction mandated by the Durbin Amendment may result in a decrease in revenue from interchange fees for smaller financial institutions.
The prohibition on the payment of interest on demand deposit accounts was repealed effective one year after enactment, thereby permitting depository institutions to pay interest on business checking and other accounts.
A new federal agency was created, the Consumer Financial Protection Bureau, or CFPB, which has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB is also responsible for examining large financial institutions (i.e., those with more than $10 billion in assets) and enforcing compliance with federal consumer financial protection.
The regulation of consumer protections regarding mortgage originations, addressing loan originator compensation, minimum repayment standards including restrictions on variable-rate lending by requiring the ability to repay be determined based on the maximum rate that will apply during the first five years of a variable-rate loan term, prepayment consideration, and new disclosures, has been expanded.
The foregoing provisions may have the consequence of increasing our expenses, decreasing our revenues and changing the activities in which we choose to engage. The environment in which banking organizations will now operate, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, changes in fiscal policy and steps to eliminate government support for banking organizations, may have long-term effects on the profitability of banking organizations that cannot now be foreseen. The ultimate effect of the Dodd-Frank Act and its implementing regulations on the financial services industry in general, and on us in particular, is uncertain at this time.
The Volcker Rule
On December 10, 2013, the Federal Reserve and the other federal banking regulators as well as the SEC each adopted a final rule implementing Section 619 of the Dodd-Frank Act, commonly referred to as the “Volcker Rule.” Generally speaking, the final rule prohibits a bank and its affiliates from engaging in proprietary trading and from sponsoring certain “covered funds” or from acquiring or retaining any ownership interest in such covered funds. Most private equity, venture capital, and hedge funds are considered “covered funds” as are bank trust preferred collateralized debt obligations. The final rule required banking entities to divest disallowed securities by July 21, 2015, subject to extension upon application. The Volcker Rule did not impact any of our
activities nor do we hold any securities that we were required to sell under the rule, but it does limit the scope of permissible activities in which we might engage in the future.
U.S. Basel III capital rules
The U.S. Basel III capital rules, effective January 1, 2015, apply to all national and state banks and savings associations and most bank holding companies, which we collectively refer to herein as “covered banking organizations.” The requirements in the U.S. Basel III capital rules started to phase in on January 1, 2015, for many covered banking organizations, including SmartFinancial and SmartBank. The requirements in the U.S. Basel III capital rules will be fully phased in by January 1, 2019.
The U.S. Basel III capital rules impose higher risk-based capital and leverage requirements than those previously in place. Specifically, the rules impose the following minimum capital requirements:
a new common equity Tier 1 risk-based capital ratio of 4.5 percent;
a Tier 1 risk-based capital ratio of 6 percent (increased from the then-current 4 percent requirement);
a total risk-based capital ratio of 8 percent (unchanged from the then-current requirements);
a leverage ratio of 4 percent; and
a new supplementary leverage ratio of 3 percent applicable to advanced approaches banking organizations, resulting in a leverage ratio requirement of 7 percent for such institutions.
Under the U.S. Basel III capital rules, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, or CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as non-cumulative perpetual preferred stock.
The rules permit bank holding companies with less than $15.0 billion in total consolidated assets, such as us, to continue to include trust-preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in CET1 capital, subject to certain restrictions. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment.
In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a capital conservation buffer on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital, and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5 percent of risk-weighted assets.
The U.S. Basel III capital standards require certain deductions from or adjustments to capital. As a result, deductions from CET1 capital will be required for goodwill (net of associated deferred tax liabilities); intangible assets such as non-mortgage servicing assets and purchased credit card relationships (net of associated deferred tax liabilities); deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities); any gain on sale in connection with a securitization exposure; any defined benefit pension fund net asset (net of any associated deferred tax liabilities) held by a bank holding company (this provision does not apply to a bank or savings association); the aggregate amount of outstanding equity investments (including retained earnings) in financial subsidiaries; and identified losses. Other deductions will be necessary from different levels of capital. The U.S. Basel III capital rules also increase the risk weight for certain assets, meaning that more capital must be held against such assets. For example, commercial real estate loans that do not meet certain underwriting requirements must be risk-weighted at 150 percent rather than the 100 percent that was the case prior to these rules becoming effective.
Additionally, the U.S. Basel III capital standards provide for the deduction of three categories of assets: (i) deferred tax assets arising from temporary differences that cannot be realized through net operating loss carrybacks (net of related valuation allowances and of deferred tax liabilities), (ii) mortgage servicing assets (net of associated deferred tax liabilities) and (iii) investments in more than 10 percent of the issued and outstanding common stock of unconsolidated financial institutions (net of associated deferred tax liabilities). The amount in each category that exceeds 10 percent of CET1 capital must be deducted from CET1 capital. The remaining, non-deducted amounts are then aggregated, and the amount by which this total amount exceeds 15 percent of CET1 capital must be deducted from CET1 capital. Amounts of minority investments in consolidated subsidiaries that exceed certain limits and investments in unconsolidated financial institutions may also have to be deducted from the category of capital to which such instruments belong.
Accumulated other comprehensive income, or AOCI, is presumptively included in CET1 capital and often would operate to reduce this category of capital. The U.S. Basel III capital rules provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We elected to opt out. The rules also have the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, mortgage servicing rights not includable in CET1 capital, equity exposures, and claims on securities firms, which are used in the denominator of the three risk-based capital ratios.
When fully phased in on January 1, 2019, the U.S. Basel III capital rules will require us and SmartBank to maintain (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.5 percent, plus the 2.5 percent capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7 percent, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus the capital conservation buffer, effectively resulting in a minimum Tier 1 capital ratio of 8.5 percent, (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0 percent, plus the capital conservation buffer, effectively resulting in a minimum total capital ratio of 10.5 percent and (iv) a minimum leverage ratio of 4 percent, calculated as the ratio of Tier 1 capital to average assets. Management believes that we and SmartBank would meet all capital adequacy requirements under the U.S. Basel III capital rules on a fully phased-in basis if such requirements were currently effective.
The U.S. Basel III capital rules also make important changes to the “prompt corrective action” framework discussed below in “Regulation of SmartBank-Capitalization levels and prompt corrective action.”
Anti-tying restrictions.
Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other nonbanking services offered by a bank holding company or its affiliates.
Executive compensation and corporate governance
The Dodd-Frank Act requires public companies to include, at least once every three years, a separate non-binding “say on pay” vote in their proxy statement by which shareholders may vote on the compensation of the public company’s named executive officers. In addition, if such public companies are involved in a merger, acquisition, or consolidation, or if they propose to sell or dispose of all or substantially all of their assets, shareholders have a right to an advisory vote on any golden parachute arrangements in connection with such transaction (frequently referred to as “say-on-golden parachute” vote). Other provisions of the act may impact our corporate governance. For instance, the act requires the SEC to adopt rules prohibiting the listing of any equity security of a company that does not have an independent compensation committee; and requiring all exchange-traded companies to adopt clawback policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements.
Regulation of SmartBank
As a Tennessee-chartered commercial bank, SmartBank is subject to supervision, regulation, and
supervisionexamination by the
FDIC. The Bank is notTDFI, and, as a member of the Federal Reserve
System.System, SmartBank is also subject to supervision, regulation, and examination by the Federal Reserve. Federal and state banking lawslaw and regulations governregulation affect virtually all areas of SmartBank’s activities including capital requirements, the operations of Cornerstoneability to pay dividends, mergers and the Bank, including reserves, loans, mortgages, capital, issuance of securities, payment of dividends and establishment of branches. Federal and state banking agencies also have the general authority to limit the dividends paid by insured banks if such payments should be deemed to constitute an unsafe or unsound banking practice. In accordance with and as a result of the exercise of this general authority, the Bank is currently prohibited from paying dividends without prior regulatory approval. The TDFI, FDIC and Federal Reserve Board have the authority to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound practices.
On April 2, 2010, the Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the FDIC. Pursuant to the Stipulation, the Bank consented, without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulations, to the issuance of a Consent Order (the “Order”) by the FDIC, also effective as of April 2, 2010. On April 8, 2010, the Bank also executed a written agreement (the “Agreement”) with the TDFI.
The Order and the Agreement (collectively, the “Action Plans”) contained substantially similar terms and were basedacquisitions, limitations on the findings of the FDIC and TDFI during their joint examination of the Bank commenced on October 8, 2009 (the “Examination”), as disclosed in the Joint Report of Examination (the “Report”). The Order and the Agreement represented agreements between the Bank, on the one hand, and the FDIC and the TDFI, respectively, on the other hand, as to areas of the Bank’s operations that warranted improvement and presented plans for making those improvements. The Action Plans imposed no fines or penalties on the Bank.
The Action Plans required the Bank to implement several governance, budgeting, credit management, risk management and reporting procedures. The Bank substantially complied with the terms of the Action Plans. As a result, on August 17, 2012, the FDIC and the TDFI issued written confirmation to the Bank’s Board of Directors that the Action Plans had been terminated. Some of the procedures established by the Action Plans, however, remain in place, including the requirement for approval by the Regional Director of the FDIC and the Commissioner of the TDFI of any dividends declared or paid by the Bank to Cornerstone.
Cornerstone received a letter dated March 30, 2010, from its primary banking regulator, the Federal Reserve Bank of Atlanta (the “FRBA”), directing Cornerstone to obtain the FRBA’s written approval before Cornerstone (i) incurs any indebtedness; (ii) declares or pays any dividends; (iii) redeems any corporate stock; or (iv) makes any other payment representing a reduction in its capital, except for the payment of normal and routine operating expenses. As required by the letter, Cornerstone continues to seek and receive the FRBA’s approval for payment of dividends on its preferred stock. To date, Cornerstone is in compliance with the requirements of the FRBA letter.
The most significant impact of the FRBA’s letter relates to the payment of dividends on Cornerstone’s preferred stock. However, Cornerstone has been able to consistently raise additional capital and the company generated positive earnings during 2013 and 2014. These two elements coupled with the Bank’s stabilization of asset quality have, in Cornerstone’s estimation, led to the approval of dividend payments on the preferred stock.
FDIC Insurance of Deposit Accounts
The FDIC insures the deposit accounts of the Bank up to the maximum amount provided by law. The general insurance limit is $250,000. The FDIC assesses deposit insurance premiums on each insured institution quarterly based on annualized rates for one of four risk categories. Under the rules in effect through March 31, 2011, these rates were applied to the institution’s deposits. Each institution was assigned to one of four risk categories based on its capital, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses were assigned to Risk Category I. Risk Categories II, III and IV presented progressively greater risks to the DIF. A range of initial base assessment rates applied to each risk category, subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits.
As required by the Dodd-Frank Act, the FDIC adopted rules effective April 1, 2011, under which insurance premium assessments are based on an institution’s total assets minus its tangible equity (defined as Tier 1 capital) instead of its deposits. Under these rules, an institution with total assets of less than $10 billion is assigned to a risk category as described above, and a range of initial base assessment rates apply to each category, subject to adjustment downward based on unsecured debt issued by the institution and, except for an institution in Risk Category I, adjustment upward if the institution’s brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates. Total base assessment rates range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV, all subject to further adjustment upward if the institution holds more than a de minimis amount of unsecured debt issued by another FDIC-insured institution. The FDIC may increase or decrease its rates by 2 basis points without further rulemaking. In an emergency, the FDIC may also impose a special assessment.
Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (“DRR”), which is the ratio of the DIF to insured deposits. The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the statutory minimum DRR to 1.35% on institutions with assets of less than $10 billion from the former statutory minimum of 1.15%.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of the Financing Corporation (the “FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly. In 2014, it was 0.62 cents per $100 of assessable deposits. These assessments will continue until the debt matures in 2017 through 2019.
State of Tennessee Supervision and Regulation
As a commercial bank chartered and regulated by the TDFI, the Bank is subject to various state laws and regulations which limit the amount that can be loaned to a single borrower and the borrower’s related interests, the types of permissible investments, and geographic and new product expansion, among other things. The BankSmartBank must submit an application to, and receive the approval of, the TDFI and Federal Reserve before opening a new branch office or merging with another financial institution. The Commissioner of the TDFI hasand the Federal Reserve have the authority to enforce state laws and regulations by ordering SmartBank or a director, officer, or employee of the BankSmartBank to cease and desist from violating a law or regulation or from engaging in unsafe or unsound banking practices.
practices and by imposing other sanctions including civil money penalties.
Tennessee law contains limitations on the interest rates that may be charged on various types of loans and restrictions on the nature and amount of loans that may be granted and on the type of investments which may be made. The operations of banks are also affected by various consumer laws and regulations, including those relating to equal credit opportunity and regulation of consumer lending practices.
All Tennessee banks, includingSmartBank’s deposits are insured by the
Bank, must become and remain insuredFDIC under the Federal Deposit Insurance Act.
State banks are subject to regulation by the TDFI with regard to capital requirements and the payment of dividends. Tennessee has adopted the provisions of the Federal Reserve Board’sReserve’s Regulation O with respect to restrictions on loans and other extensions of credit to bank “insiders”.“insiders.” Further, under Tennessee law, state banks are prohibited from lending to any one person, firm, or corporation amounts more than fifteen15 percent (15%) of the bank’s equity capital accounts, except (i) in the case of certain loans secured by
negotiable title documents covering readily marketable nonperishable staples, or (ii) with the prior approval of the bank’s board of directors or finance committee (however titled), the bank may make a loan to any person, firm or corporation of up to twenty-five25 percent (25%) of its equity capital accounts.
Various state and federal consumer laws and regulations also affect the operations of SmartBank, including state usury laws, consumer credit and equal credit opportunity laws, and fair credit reporting. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, generally prohibits insured state chartered institutions from conducting activities as principal that are not permitted for national banks.
Capitalization levels and prompt corrective action
Federal law and regulations establish a capital-based regulatory scheme designed to promote early intervention for troubled banks and require the FDIC to choose the least expensive resolution of bank failures. The capital-based regulatory framework contains five categories of regulatory capital requirements, including “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To qualify as a “well capitalized” institution for these purposes, a bank must have a leverage ratio of no less than 5 percent, a Tier 1 capital ratio of no less than 6 percent, and a total risk-based capital ratio of no less than 10 percent, and a bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.
Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the Federal Deposit Insurance Act, or FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. Bank holding companies controlling financial institutions can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; (iv) requiring the institution to change and improve its management; (iv) prohibiting the acceptance of deposits from correspondent banks; (v) requiring prior Federal Reserve approval for any capital distribution by a bank holding company controlling the institution; and (vi) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Notably, the thresholds for each of the five categories for regulatory capital requirements were revised pursuant to the U.S. Basel III capital rules. See the discussion under the heading “U.S. Basel III capital rules” above. Under these rules, which started to phase in on January 1, 2015, a well-capitalized insured depository institution is one (i) having a total risk-based capital ratio of 10 percent or greater, (ii) having a Tier 1 risk-based capital ratio of 8 percent or greater, (iii) having a CET1 capital ratio of 6.5 percent or greater, (iv) having a leverage capital ratio of 5 percent or greater and (v) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. A state member bank is considered “adequately capitalized” if it has a leverage ratio of at least 4 percent, a CET1 capital ratio of 4.5 percent or better, a Tier 1 risk-based capital ratio of at least 6.0 percent, a total risk-based capital ratio of at least 8.0 percent and does not meet the definition of a well-capitalized bank.
It should be noted that the minimum ratios referred to above in this section are merely guidelines, and the bank regulators possess the discretionary authority to require higher capital ratios.
Bank reserves
The Federal Reserve requires all depository institutions, even if not members of the Federal Reserve System, to maintain reserves against some transaction accounts (primarily negotiable order of withdrawal (NOW) and Super NOW checking accounts). The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. An institution may borrow from the Federal Reserve Bank “discount window” as a secondary source of funds, provided that the institution meets the Federal Reserve Bank’s credit standards.
Bank dividends
The Federal Reserve prohibits any distribution that would result in the bank being “undercapitalized” (<4 percent leverage ratio, <4.5 percent CET1 capital ratio, <6 percent Tier 1 risk-based capital ratio, or <8 percent total risk-based capital ratio). Tennessee law
requiresplaces restrictions on the declaration of dividends by state chartered banks to their shareholders, including, but not limited to, that
the board of directors of a Tennessee-chartered bank may only make a dividend from the surplus profits arising from the business of the bank, and may not declare dividends
be paid only fromin any calendar year that exceeds the total of its retained
earnings (or undivided profits) exceptnet income of that
dividends may be paid from capital surplusyear combined with
its retained net income of the preceding two years without the prior
written consentapproval of the commissioner of the TDFI. Tennessee laws regulating banks require certain charges against and transfers from an institution’s undivided profits account before undivided profits can be made available for the payment of dividends.
Federal Supervision Furthermore, the TDFI also has authority to prohibit the payment of dividends by a Tennessee bank when it determines such payment to be an unsafe and Regulation
Cornerstoneunsound banking practice.
Insurance of accounts and other assessments
SmartBank pays deposit insurance assessments to the Deposit Insurance Fund, which is
regularly examineddetermined through a risk-based assessment system. SmartBank’s deposit accounts are currently insured by the
Federal Reserve Board, and the Bank is supervised and examined by the FDIC. Cornerstone is requiredDeposit Insurance Fund, generally up to
file with the Federal Reserve Board annual reports and other information regarding its business operations and the business operationsa maximum of
the Bank. Approval of the Federal Reserve Board is required before Cornerstone may acquire, directly or indirectly, ownership or control of the voting shares of any bank, if, after such acquisition, Cornerstone would own or control, directly or indirectly, more than 5% of the voting stock of the bank. In addition, pursuant$250,000 per separately insured depositor. SmartBank pays assessments to the
provisions of the Act and the regulations promulgated thereunder, Cornerstone may only engage in, or own or control companies that engage in, activities deemed by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.The Bank and Cornerstone are “affiliated” within the meaning of the Act. Certain provisions of the Act establish standards for the terms of, limit the amount of, and establish collateral requirements with respect to, any loans or extensions of credit to, and investments in, affiliates by the Bank, as well as set arms-length criteriaFDIC for such transactionsdeposit insurance. Under the current assessment system, the FDIC assigns an institution to a risk category based on the institution’s most recent supervisory and for certain other transactions (including payment bycapital evaluations, which are designed to measure risk. Under the Bank for services under any contract) betweenFDIA, the Bank and its affiliates. In addition, related provisions of the Act and the regulations promulgated under the Act limit the amounts of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors, and principal shareholders of the Bank, Cornerstone and any other subsidiary of Cornerstone, and to related interests of such persons.
Bank holding companies are required to serve asFDIC may terminate a source of financial strength to their subsidiary banks. Most bank holding companies are required to give the Federal Reserve Board prior written notice of any purchase or redemption of their outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the bank holding company’s consolidated net worth. The Federal Reserve Board may disapprove suchbank’s deposit insurance upon a purchase or redemption if it determinesfinding that the proposal constitutes an unsafe or unsound practice that would violate any law, regulation, Federal Reserve Board order or directive or any condition imposed by, or written agreement with, the Federal Reserve Board. The prior notice requirement does not apply to certain “well-capitalized” bank holding companies that meet specified criteria.
In November 1985, the Federal Reserve Board adopted its Policy Statement on Cash Dividends Not Fully Covered by Earnings. The Policy Statement sets forth various guidelines that the Federal Reserve Board believes that a bank holding company should follow in establishing its dividend policy. In general, the Federal Reserve Board stated that bank holding companies should not pay dividends except out of current earnings and unless the prospective rate of earnings retention by the holding company appears consistent with its capital needs, asset quality and overall financial condition.
The FDIC may impose sanctions on any insured bank that does not operate in accordance with FDIC regulations, policies and directives. Proceedings may be instituted against any insured bank or any director, officer or employee of the bank that is believed by the FDIC to beinstitution has engaged in unsafe orand unsound practices, including violation of applicable laws and regulations. The FDIC is also empowered to assess civil penalties against companies or individuals who violate certain federal statutes, orders or regulations. In addition, the FDIC has the authority to terminate insurance of deposit accounts, after notice and hearing, upon a finding by the FDIC that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, or is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, or order, of,agreement or condition imposed by the FDIC. Neither Cornerstone nor
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, or FICO, a federal government corporation established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the FICO bonds mature in 2017 through 2019.
Restrictions on transactions with affiliates
SmartBank is also subject to federal laws that restrict certain transactions between it and its nonbank affiliates. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank, including in the case of SmartBank, SmartFinancial. Under sections 23A and 23B of the Federal Reserve Act, or FRA, and the Federal Reserve’s Regulation W, covered transactions by SmartBank with a single nonbank affiliate are generally limited to 10 percent of SmartBank’s capital and surplus and 20 percent of capital and surplus for all covered transactions with all nonbank affiliates. The definition of “covered transactions” includes transactions like a loan by a bank to an affiliate, an investment by a bank in an affiliate, or a purchase by a bank of assets from an affiliate. A loan by a bank to a nonbank affiliate must be secured by collateral valued at 100 percent to 130 percent of the loan amount, depending on the type of collateral and certain low quality assets and any securities of an affiliate may not serve as collateral.
All such transactions must generally be consistent with safe and sound banking practices and must be on terms that are no less favorable to the bank than those that would be available from nonaffiliated third parties. Moreover, state banking laws impose restrictions on affiliate transactions similar to those imposed by federal law. Federal Reserve policies also forbid the payment by bank subsidiaries of management fees which are unreasonable in amount or exceed the fair market value of the services rendered or, if no market exists, actual costs plus a reasonable profit.
Loans to insiders
Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10 percent of any class of voting securities of a bank, or to any related interest of those persons, including any company controlled by that person, are subject to Sections 22(g) and 22(h) of the FRA and their corresponding regulations, which is referred to as Regulation O. Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Regulation O prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15 percent of an institution’s unimpaired capital and surplus plus an additional 10 percent of unimpaired capital and surplus in the case of loans that are fully secured by certain readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the bank’s unimpaired capital and unimpaired surplus. Section 22(g) identifies limited circumstances in which the bank is permitted to extend credit to executive officers.
Community Reinvestment Act
The Community Reinvestment Act, or CRA, and its corresponding regulations are intended to encourage banks to help meet the credit needs of their service areas, including low and moderate-income neighborhoods, consistent with safe and sound operations. These regulations provide for regulatory assessment of a bank’s record in meeting the credit needs of its service area. Federal banking agencies are required to make public a rating of a bank’s performance under the CRA. The federal banking agencies consider a bank’s CRA rating when a bank submits an application to establish banking centers, merge, or acquire the assets and assume the liabilities of another bank. In the case of a bank holding company, the CRA performance record of all banks involved in the merger or acquisition are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other financial holding company. An unsatisfactory record can substantially delay, block or impose conditions on the transaction. SmartBank received a satisfactory rating on its most recent CRA assessment.
Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or Riegle-Neal Act, provides that adequately capitalized and managed bank holding companies are permitted to acquire banks in any state. Previously, under the Riegle-Neal Act, a bank’s ability to branch into a particular state was largely dependent upon whether the state “opted in” to de novo interstate branching. Many states did not “opt-in,” which resulted in branching restrictions in those states. The Dodd-Frank Act amended the Riegle-Neal legal framework for interstate branching to permit national banks and state banks to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state. Under current Tennessee law, our bank may open branch offices throughout Tennessee with the prior approval of the TDFI. All branching remains subject to applicable regulatory approval and adherence to applicable legal requirements.
Bank Secrecy Act
The Currency and Foreign Transactions Reporting Act of 1970, better known as the Bank knowsSecrecy Act, or BSA, requires all United States financial institutions to assist United States government agencies to detect and prevent money laundering. Specifically, BSA requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding a daily aggregate amount of $10,000, and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities.
Anti-money laundering and economic sanctions
The USA PATRIOT Act provides the federal government with additional powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. By way of amendments to the BSA, the USA PATRIOT Act imposed new requirements that obligate financial institutions, such as banks, to take certain steps to control the risks associated with money laundering and terrorist financing.
Among other requirements, the USA PATRIOT Act and implementing regulations require banks to establish anti-money laundering programs that include, at a minimum:
internal policies, procedures and controls designed to implement and maintain the bank's compliance with all of the requirements of the USA PATRIOT Act, the BSA and related laws and regulations;
systems and procedures for monitoring and reporting of suspicious transactions and activities;
designated compliance officer;
employee training;
an independent audit function to test the anti-money laundering program;
procedures to verify the identity of each customer upon the opening of accounts; and
heightened due diligence policies, procedures and controls applicable to certain foreign accounts and relationships.
Additionally, the USA PATRIOT Act requires each financial institution to develop a customer identification program, or CIP, as part of the bank's anti-money laundering program. The key components of the CIP are identification, verification, government list comparison, notice and record retention. The purpose of the CIP is to enable the financial institution to determine the true identity and anticipated account activity of each customer. To make this determination, among other things, the financial institution must collect certain information from customers at the time they enter into the customer relationship with the financial institution. This information must be verified within a reasonable time through documentary and non-documentary methods. Furthermore, all customers must be screened against any CIP-related government lists of known or suspected terrorists. Financial institutions are also required to comply with various reporting and recordkeeping requirements. The Federal Reserve and the FDIC consider an applicant's effectiveness in combating money laundering, among other factors, in connection with an application to approve a bank merger or acquisition of control of a bank or bank holding company.
Likewise, the Treasury's Office of Foreign Assets Control, or OFAC, is responsible for helping to ensure that United States entities do not engage in transactions with the subjects of U.S. sanctions, as defined by various Executive Orders and Acts of Congress. Currently, OFAC administers and enforces comprehensive U.S. economic sanctions programs against certain specified countries/regions. In addition to the country/region-wide sanctions programs, OFAC also administers complete embargoes against individuals and entities identified on OFAC's list of Specially Designated Nationals and Blocked Persons, or SDN List. The SDN List includes over 7,000 parties that are located in many jurisdictions throughout the world, including in the United States and Europe. SmartBank is responsible for determining whether any potential and/or existing customers appear on the SDN List or are owned or controlled by a person on the SDN List. If any customer appears on the SDN List or is owned or controlled by a person or entity on the SDN List, such customer's account must be placed on hold and a blocking or rejection report, as appropriate and if required, must be filed within 10 business days with OFAC. In addition, if a customer is a citizen of, has provided an address in, or is organized under the laws of any pastcountry or current practice, conditionregion for which OFAC maintains a comprehensive sanctions program, the Bank must take certain actions with respect to such customers as dictated under the relevant OFAC sanctions program. SmartBank must maintain compliance with OFAC by implementing appropriate policies and procedures and by establishing a recordkeeping system that is reasonably appropriate to administer the Bank's compliance program. SmartBank has adopted policies, procedures and controls to comply with the BSA, the USA PATRIOT Act and OFAC regulations.
Privacy and data security
Under the GLBA, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The GLBA also directed federal regulators, including the FDIC, to prescribe standards for the security of consumer information. SmartBank is subject to such standards, as well as standards for notifying customers in the event of a security breach.
Consumer laws and regulations
SmartBank is also subject to other federal and state consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, or
violation that might lead to termination of its deposit insurance.Specific Legislation Affecting CornerstoneTILA, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Check Clearing for the 21st Century Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Equal Credit Opportunity Act,
the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair and Accurate Transactions Act, the Servicemembers Civil Relief Act, the Military Lending Act, the Mortgage Disclosure Improvement Act, and the
BankThe following information summarizesReal Estate Settlement Procedures Act, among others. These laws and regulations mandate certain statutorydisclosure requirements and regulatory provisions affecting Cornerstoneregulate the manner in which financial institutions must deal with consumers when offering consumer financial products and services.
Rulemaking authority for these and other consumer financial protection laws transferred from the prudential regulators to the CFPB on July 21, 2011. In some cases, regulators such as the Federal Trade Commission, the U.S. Department of Housing and Urban Development, and the BankU.S. Department of Justice also retain certain rulemaking or enforcement authority. The CFPB also has broad authority to prohibit unfair, deceptive and abusive acts and practices, or UDAAP, and to investigate and penalize financial institutions that violate this prohibition. While the statutory language of the Dodd-Frank Act sets forth the standards for acts and practices that violate the prohibition on UDAAP, certain aspects of these standards are untested, and thus it is currently not possible to predict how the CFPB will exercise this authority. In addition, consumer compliance examination authority remains with the prudential regulators for smaller depository institutions ($10 billion or less in total assets). The possibility of changes in the authority of the CFPB going forward after President-elect Trump is sworn into office is uncertain, and we cannot ascertain the impact, if any, changes to the CFPB may have on our business, revenues, operations, or results.
The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” On January 10, 2013, the CFPB published final rules to, among other things, specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. Since then the CFPB made certain modifications to these rules. The rules extend the requirement that creditors verify and document a borrower’s “income and assets” to include all “information” that creditors rely on in determining repayment ability. The rules also provide further examples of third-party documents that may be relied on for such verification, such as government records and check-cashing or funds-transfer service receipts. The new rules were effective beginning on January 10, 2014. The rules also define “qualified mortgages,” imposing both underwriting standards-for example, a borrower’s debt-to-income ratio may not exceed 43 percent-and limits on the terms of their loans. Points and fees are subject to a relatively stringent cap, and the terms include a wide array of payments that may be made in the course of closing a loan. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.
On October 3, 2015, the CFPB implemented a final rule combining the mortgage disclosures consumers previously received under TILA and the Real Estate Settlement Procedures Act, or RESPA. For more than 30 years, the TILA and RESPA mortgage disclosures had been administered separately by, respectively, the Federal Reserve and the U.S. Department of Housing and Urban Development. The final rule requires lenders to provide applicants with the new Loan Estimate and Closing Disclosure and generally applies to most closed-end consumer mortgage loans for which the creditor or mortgage broker receives an application on or after October 3, 2015.
Volcker Rule
The Volcker Rule generally prohibits a “banking entity” (which includes any insured depository institution, such as SmartBank, or any affiliate or subsidiary of such depository institution, such as SmartFinancial) from engaging in proprietary trading and acquiring or retaining any ownership interest in, sponsoring, or engaging in certain transactions with, a “covered fund”. Both the proprietary trading and covered fund-related prohibitions are subject to a number of exemptions and exclusions. The Volcker Rule became effective by statute in July 2012, and on December 10, 2013, five federal regulators including the FDIC and the Federal Reserve jointly adopted the final regulations to implement the Volcker Rule. The final regulations contain exemptions for, among others, market making, risk-mitigating hedging, underwriting, and trading in U.S. government and agency obligations and also permit certain ownership interests in certain types of funds to be retained. They also permit the offering and sponsoring of funds under certain conditions. In addition, the final regulations impose significant compliance and reporting obligations on banking entities.
The final regulations became effective on April 1, 2014, and banking entities were required to conform their proprietary trading activities and investments in and relationships with covered funds that were in place after December 31, 2013 by July 21, 2015. For those banking entities whose investments in and relationships with covered funds were in place prior to December 31, 2013 (“legacy covered funds”), the Volcker Rule conformance period was recently extended by the Federal Reserve to July 21, 2017 for such legacy covered funds. In addition, the Federal Reserve has also indicated its entiretyintention to grant two additional one-year extensions of the conformance period to July 21, 2017, for banking entities to conform ownership interests in and sponsorship of
activities of collateralized loan obligations, or CLOs, that are backed in part by
reference to such statutorynon-loan assets and
regulatory provisions.that were in place as of December 31, 2013.
Far-reaching legislation, including the Financial Institutions Reform, Recovery and Enforcement Act of 1989,
(“FIRREA”)or FIRREA, and the Federal Deposit Insurance Corporation Improvement Act of 1991,
(“FDICIA”)or FDICIA, have
for years impacted the business of
banking.banking for years. FIRREA primarily affected the regulation of savings institutions rather than the regulation of commercial banks and bank holding companies like
the BankSmartBank and
Cornerstone,SmartFinancial, but did include provisions affecting deposit insurance premiums, acquisitions of thrifts by banks and bank holding companies, liability of commonly controlled depository institutions, receivership and conservatorship rights and procedures and substantially increased penalties for violations of banking statutes, regulations and orders.
FDICIA resulted in extensive changes to the federal banking laws. The primary purpose of FDICIA was to authorize additional borrowings by the FDIC in order to assist in the resolution of failed and failing financial institutions. However, the law also instituted certain changes to the supervisory process and contained various provisions affecting the operations of banks and bank holding companies.
The additional supervisory powers and regulations mandated by FDICIA include a “prompt corrective action” program based upon five regulatory zones for banks, in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank’s financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank’s ratio of tangible equity to total assets reaches two percent. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital.
The Federal Reserve has adopted regulations implementing the prompt corrective action provisions of the FDICIA, which place financial institutions into one of the following five categories based upon capitalization ratios as these ratios have been amended following regulations implementing the requirements of Basel III: (1) a “well capitalized” institution has a total risk-based capital ratio of at least 10 percent, a Tier 1 risk-based capital ratio of at least 8 percent, a leverage ratio of at least 5 percent and a CET1 capital ratio of at least 6.5 percent; (2) an “adequately capitalized” institution has a total risk-based ratio of at least 8 percent, a Tier 1 risk-based ratio of at least 6 percent, a leverage ratio of at least 4 percent and a CET1 capital ratio of at least 4.5 percent; (3) an “undercapitalized” institution has a total risk-based capital ratio of under 8 percent, a Tier 1 risk-based capital ratio of under 6 percent, a leverage ratio of under 4 percent or a CET1 capital ratio of less than 4.5 percent; (4) a “significantly undercapitalized” institution has a total risk-based capital ratio of under 6 percent, a Tier 1 risk-based ratio of under 4 percent, a leverage ratio of under 3 percent or a CET1 capital ratio of less than 3 percent; and (5) a “critically undercapitalized” institution has a ratio of tangible equity to total assets of 2 percent or less. Institutions in any of the three undercapitalized categories would generally be prohibited from declaring dividends or making capital distributions. The regulations also establish procedures for “downgrading” an institution to a lower capital category based on supervisory factors other than capital.
Various other sections of the FDICIA impose substantial audit and reporting requirements and increase the role of independent accountants and outside directors. Set forth below is a list containing certain other significant provisions of the FDICIA:
| § | annual on-site examinations by regulators (except for smaller, well-capitalized banks with high management ratings, which must be examined every 18 months); |
| § | mandated annual independent audits by independent public accountants and an independent audit committee of outside directors for institutions with more than $500,000,000 in assets; |
| § | uniform disclosure requirements for interest rates and terms of deposit accounts; |
| § | a requirement that the FDIC establish a risk-based deposit insurance assessment system; |
| § | authorization for the FDIC to impose one or more special assessments on its insured banks to recapitalize the Bank Insurance Fund (now called the Deposit Insurance Fund); |
| § | a requirement that each institution submit to its primary regulators an annual report on its financial condition and management, which report will be available to the public; |
| § | a ban on the acceptance of brokered deposits except by well capitalized institutions and by adequately capitalized institutions with the permission of the FDIC, and the regulation of the brokered deposit market by the FDIC; |
| § |
annual on-site examinations by regulators (except for smaller, well-capitalized banks with high management ratings, which must be examined every 18 months); mandated annual independent audits by independent public accountants and an independent audit committee of outside directors for institutions with more than $500,000,000 in assets; uniform disclosure requirements for interest rates and terms of deposit accounts; a requirement that the FDIC establish a risk-based deposit insurance assessment system; authorization for the FDIC to impose one or more special assessments on its insured banks to recapitalize the bank insurance fund (now called the Deposit Insurance Fund); a requirement that each institution submit to its primary regulators an annual report on its financial condition and management, which report will be available to the public; a ban on the acceptance of brokered deposits except by well capitalized institutions and by adequately capitalized institutions with the permission of the FDIC, and the regulation of the brokered deposit market by the FDIC; restrictions on the activities engaged in by state banks and their subsidiaries as principal, including insurance underwriting, to the same activities permissible for national banks and their subsidiaries unless the state bank is well capitalized and a determination is made by the FDIC that the activities do not pose a significant risk to the insurance fund; |
| § | a review by each regulatory agency of accounting principles applicable to reports or statements required to be filed with federal banking agencies and a mandate to devise uniform requirements for all such filings; |
| § | the institution by each regulatory agency of noncapital safety and soundness standards for each institution it regulates which cover (1) internal controls, (2) loan documentation, (3) credit underwriting, (4) interest rate exposure, (5) asset growth, (6) compensation, fees and benefits paid to employees, officers and directors, (7) operational and managerial standards, and (8) asset quality, earnings and stock valuation standards for preserving a minimum ratio of market value to book value for publicly traded shares (if feasible); |
| § | uniform regulations regarding real estate lending; and |
| § | a review by each regulatory agency of the risk-based capital rules to ensure they take into account adequate interest rate risk, concentration of credit risk, and the risks of non-traditional activities. |
Capital Regulations
The federal bank regulatory authorities have adopted risk-based capital guidelines for banks that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and account for off-balance sheet items. The guidelines are minimums, and the federal regulators have noted that banks contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain such ratios in excess of the minimums.
In December 2010, the Basel Committee on Banking Supervision (“BCBS”), an international forum for cooperation on banking supervisory matters, announced the “Basel III” capital standards, which substantially revised the existing capital requirements for banking organizations. On July 2, 2013, the Federal Reserve adopted a final rule for the Basel III capital framework and, on July 9, 2013, the OCC also adopted a final rule and the FDIC adopted the same provisions in the form of an “interim” final rule. The rule applies to all national and state banks and savings associationstheir subsidiaries as principal, including insurance underwriting, to the same activities permissible for national banks and mosttheir subsidiaries unless the state bank is well capitalized and a determination is made by the FDIC that the activities do not pose a significant risk to the insurance fund;
a review by each regulatory agency of accounting principles applicable to reports or statements required to be filed with federal banking agencies and a mandate to devise uniform requirements for all such filings;
the institution by each regulatory agency of noncapital safety and soundness standards for each institution it regulates which cover (1) internal controls, (2) loan documentation, (3) credit underwriting, (4) interest rate exposure, (5) asset growth, (6) compensation, fees and benefits paid to employees, officers and directors, (7) operational and managerial standards, and (8) asset quality, earnings and stock valuation standards for preserving a minimum ratio of market value to book value for publicly traded shares (if feasible);
uniform regulations regarding real estate lending; and
a review by each regulatory agency of the risk-based capital rules to ensure they take into account adequate interest rate risk, concentration of credit risk, and the risks of non-traditional activities.
Jumpstart Our Business Startups Act of 2012
The Jumpstart Our Business Startups Act, or JOBS Act, increased the threshold under which a bank or bank holding company may terminate registration of a security under the Securities Exchange Act of 1934, as amended, to 1,200 shareholders of record from 300. The JOBS Act also raised the threshold requiring companies to register to 2,000 shareholders from 500. Since the JOBS Act was signed, numerous banks or bank holding companies
and savings and loan holding companies, which we collectively referhave filed to
herein as “covered” banking organizations. Bank holding companies with less than $500 million in total consolidated assets are not subject to the final rule, nor are savings and loan holding companies substantially engaged in commercial activities or insurance underwriting. In certain respects, the rule imposes more stringent requirements on “advanced approaches” banking organizations, which are those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. The requirements in the rule began to phase in on January 1, 2014, for advanced approaches banking organizations, and began to phase in on January 1, 2015 for other covered banking organizations. The requirements in the rule will be fully phased in by January 1, 2019.The rule imposes higher risk-based capital and leverage requirements than those previously in place. Specifically, the rule imposes the following minimum capital requirements:
| · | a new common equity Tier 1 risk-based capital ratio of 4.5%; |
| · | a Tier 1 risk-based capital ratio of 6% (increased from the current 4% requirement); |
| · | a total risk-based capital ratio of 8% (unchanged from current requirements); |
| · | a leverage ratio of 4%; and |
| · | a new supplementary leverage ratio of 3% applicable to advanced approaches banking organizations, resulting in a leverage ratio requirement of 7% for such institutions. |
Under the rule, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form ofderegister their common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. The rule permits bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities
Future legislative developments
Legislative acts that impact SmartFinancial and
cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in common equity Tier 1 capital, subject to certain restrictions. Tier 2 capital consists of instruments that previously qualified as Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment.In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets.
The prior capital rules required certain deductions from or adjustments to capital. The final rule retains many of these deductions and adjustments and also provides for new ones. As a result, deductions from common equity Tier 1 capital will be required for goodwill (net of associated deferred tax liabilities), intangible assets such as non-mortgage servicing assets and purchased credit card relationships (net of associated deferred tax liabilities), deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities), any gain on sale in connection with a securitization exposure, any defined benefit pension fund net asset (net of any associated deferred tax liabilities) held by a bank holding company (this provision does not apply to a bank or savings association), the aggregate amount of outstanding equity investments (including retained earnings) in financial subsidiaries, and identified losses. Other deductions will be necessary from different levels of capital.
Additionally, the final rule provides for the deduction of three categories of assets: (i) deferred tax assets arising from temporary differences that cannot be realized through net operating loss carrybacks (net of related valuation allowances and of deferred tax liabilities), (ii) mortgage servicing assets (net of associated deferred tax liabilities) and (iii) investments in more than 10% of the issued and outstanding common stock of unconsolidated financial institutions (net of associated deferred tax liabilities). The amount in each category that exceeds 10% of common equity Tier 1 capital must be deducted from common equity Tier 1 capital. The remaining, nondeducted amountsSmartBank are then aggregated, and the amount by which this total amount exceeds 15% of common equity Tier 1 capital must be deducted from common equity Tier 1 capital. Amounts of minority investments in consolidated subsidiaries that exceed certain limits and investments in unconsolidated financial institutions may also have to be deducted from the category of capital to which such instruments belong.
Accumulated other comprehensive income (AOCI) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital. The final rule provides a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. The final rule also has the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, mortgage servicing rights not includable in common equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.
Prompt Corrective Action
As an insured depository institution, the Bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations under it, which set forth five capital categories, each with specific regulatory consequences. Beginning January 1, 2015, the minimum capital levels for each prompt corrective action category were enhanced pursuant to recently adopted new capital regulations, described above under “Capital Regulations”. The following is a list of the newly revised criteria (as currently in effect) for each prompt corrective action category:
| · | Well Capitalized- A well-capitalized institution: |
| o | has total risk-based capital ratio of 10% or greater; |
| o | has a Tier 1 risk-based capital ratio of 8% or greater; |
| o | has a common equity Tier 1 risk-based ratio of 6.5% or greater; and |
| o | has a Tier 1 leverage ratio of 5% or greater. |
| · | Adequately Capitalized - An adequately capitalized institution: |
| o | has a total risk-based capital ratio of 8% or greater; |
| o | has a Tier 1 risk-based capital ratio of 6% or greater; |
| o | has a common equity Tier 1 risk-based capital ratio of 4.5% or greater; |
| o | has a Tier 1 leverage ratio of 4% or greater; and |
| o | does not meet the definition of a well capitalized bank. |
| · | Undercapitalized– An undercapitalized institution: |
| o | has total risk-based capital ratio of less than 8%; |
| o | has a Tier 1 risk-based capital ratio of less than 6%; |
| o | has a common equity Tier 1 risk-based capital ratio of less than 4.5%; or |
| o | has a Tier 1 leverage ratio of less than 4%. |
| · | Significantly Undercapitalized - A significantly undercapitalized institution: |
| o | has a total risk-based capital ratio of less than 6%; |
| o | has a Tier 1 risk-based capital ratio of less than 4%; |
| o | has a common equity Tier 1 risk-based capital ratio of less than 3%; or |
| o | has a Tier 1 leverage ratio of less than 3%. |
| · | Critically Undercapitalized - A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%. |
If the FDIC determines, after notice and an opportunity for hearing, that an institution is in an unsafe or unsound condition, the FDIC is authorized to reclassify the institution to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.
If the institution is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, rate restrictions will govern the rate the institution may pay on the brokered deposits. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the “national rate” paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity. The “national rate” is defined as a simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly by the FDIC. Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area. Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market areas.
If the institution becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The institution also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless it is determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and the loss of its charter to conduct banking activities.
An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital, to the owners of the institution if following such a distribution the institution would be undercapitalized.
Gramm-Leach-Bliley Act
The activities permissible to Cornerstone and the Bank were substantially expanded by the Gramm-Leach-Bliley Act of 1999 (the “Gramm Act”). The Gramm Act repealed the anti-affiliation provisions of the Glass-Steagall Act to permit the common ownership of commercial banks, investment banks and insurance companies. The Gramm Act amended the Act to permit a financial holding company to engage in any activity and acquire and retain any company that the Federal Reserve Board determines to be (i) financial in nature or incidental to such financial activity, or (ii) complementary to a financial activity and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. The Gramm Act also modified existing law relating to financial privacy and community reinvestment. The new financial privacy provisions generally prohibit financial institutions, including the Bank and Cornerstone, from disclosing nonpublic personal financial information to third parties unless customers have the opportunity to “opt out” of the disclosure.
The Dodd-Frank Act
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The impact of the Dodd-Frank Act on the financial services industry will be broad, with enhanced regulatory oversight and compliance, including, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the FDIC for federal deposit insurance; and (v) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector. In addition, the Dodd-Frank Act established a new framework for systemic risk and oversight in the industry which has resulted and will continue to result in sweeping changes in the regulation of financial institutions aimed at strengthening safety and soundness for the financial services sector. A summary of certain provisions of the Dodd-Frank Act is set forth below:
| · | Increased Capital Standards and Enhanced Supervision. The federal banking agencies were required to establish minimum leverage and risk-based capital requirements for banks and bank holding companies (see “Capital Regulations” above). The Dodd-Frank Act also increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency. |
| · | Federal Deposit Insurance. The Dodd-Frank Act made permanent the $250,000 deposit insurance limit for insured deposits. The Dodd-Frank Act also changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling on the size of the DIF and increased the floor of the size of the DIF. |
| · | The Consumer Financial Protection Bureau (“Bureau”). The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the Bureau, responsible for implementing, examining and, for large financial institutions (i.e., those with more than $10 billion in assets), enforcing compliance with federal consumer financial laws. The Bureau has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. On July 21, 2011, the Dodd-Frank Act transferred the responsibility for implementation of a wide variety of existing consumer protection rules and regulations to the Bureau. In addition, the Dodd-Frank Act tasks the Bureau with implementation of many new consumer protection initiatives required by that law. While the exact impact of any future changes is unknown, the Bank expects that it will incur additional expense related to the implementation of those rules. Another provision of the Dodd-Frank Act, commonly known as the Durbin Amendment, became effective October 1, 2011. The Durbin Amendment limits interchange fees payable on debit card transactions for financial institutions with more than $10 billion in assets. While the Durbin Amendment does not directly apply to the Bank, competitive market forces related to the reduction mandated by the Durbin Amendment may result in a decrease in revenue from interchange fees for smaller financial institutions. |
| · | Interest on Demand Deposit Accounts. The Dodd-Frank Act repeals the prohibition on the payment of interest on demand deposit accounts effective one year after the date of enactment, thereby permitting depository institutions to pay interest on business checking and other accounts. |
| · | Mortgage Reform. The Dodd-Frank Act provides for mortgage reform addressing a customer’s ability to repay, restricts variable-rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and makes more loans subject to requirement for higher-cost loans, new disclosures and certain other restrictions. |
We expect that many of the requirements called for in the Dodd-Frank Act will be implemented over time, and most will be subject to implementing regulations over the course of several years. Given the continued uncertainty associated with the manner in which many of the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations remains unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Future Legislation
Legislation is regularly introduced in both the United States Congress and the Tennessee General Assembly that contains wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions. Suchlegislature from time to time. This legislation may change banking statutes and the operating environment of Cornerstone and/or the Bankin which we operate in substantial and unpredictable waysways. Due to the outcome of the 2016 presidential election, changes to legislation surrounding taxes, consumer protection laws, regulation of financial institutions, and could increase or decreaseother topics relevant to our company will likely be considered in Congress in the cost of doing business, limit or expand permissible activities or affectcoming four years. We cannot determine the competitive balance, depending upon whether any of thisultimate effect that potential changes to legislation, will be enacted and, if enacted, the effect that it or any implementing regulations and interpretations with respect thereto, would have on theour financial condition or resultresults of operations of Cornerstone and/or the Bank.
Investing in our common stock involves various risks which are particular to
Cornerstone,SmartFinancial, its industry, and its market area. Several risk factors regarding investing in our securities are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct our business as currently planned and our financial condition or operating results could be negatively impacted. These matters could cause the trading price of our securities to decline in future periods.
If our asset quality were
Risks Related to decline or if we experienced greater loan losses than anticipated,Our Industry
Our net interest income could be negatively affected by interest rate adjustments by the Federal Reserve Board.
As a financial institution, our earnings
are dependent upon our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and
overall financial condition would be adversely affected.loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve Board’s policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets are primarily comprisedand liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of loans. The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loanour assets and liabilities. As a result, an increase or decrease in the case ofmarket interest rates could have a collateralized loan, the value and marketability of the collateral for the loan. While the risk of nonpayment of loans is inherent in banking, in recent years we have experienced higher nonpayment levels than anticipated, which has had a significantmaterial adverse effect on our earningsnet interest margin and overall financial condition. We have taken actions to prevent future problems,results of operations. Actions by monetary and fiscal authorities, including the creation of a special asset committee to develop and review action plans for minimizing loan losses and the dedication of resources to assist in the collection and recovery process. The Bank has also established a loan review committee comprised of a majority of non-employee directors to periodically review the Bank’s loan portfolio and identify and categorize problem credits. To minimize the likelihood of a substandard loan portfolio, we assess the credit worthiness of customers and perform collateral valuations. Management also maintainsFederal Reserve Board, could have an allowance for loan losses based upon, among other things, historical experience and an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and takes a charge against earnings with respect to specific loans when their ultimate collectability is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if regulatory authorities require us to increase our allowance for loan losses as a part of their examination process, additional provision expense would be incurred and our earnings and capital could be significantly and adversely affected. Moreover, additions to the allowance may be necessary based on changes in economic and real estate market conditions, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of management’s control. These additions may require increased provision expense which would negatively impact our results of operations.
We have high levels of foreclosed assets, primarily as a result of foreclosures.
We have continued to resolve non-performing real estate loans and as a result we continue to have high levels of foreclosed assets. Foreclosed real estate expense consists of three types of charges: maintenance costs, valuation adjustments due to new appraisal values and gains or losses on disposition. Although levels of foreclosed assets have decreased in 2014 compared to recent years and local real estate values have improved, these charges will likely continue to negatively affect our results of operations.
Liquidity needs could adversely affect our results of operations and financial condition.
We rely on dividends from the Bank as our primary source of funds. However, in November 2009, following the conclusion of a joint examination of the Bank by the FDIC and the TDFI, the FDIC placed restrictions on the Bank’s ability to pay cash dividends, requiring that the Bank first obtain a non-objection from the FDIC. Furthermore, the majority of the Bank’s funds are comprised of customer deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The repayment of loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Accordingly, we currently are, and may from time to time in the future be, required to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Alternative sources include advances from the Federal Home Loan Bank and federal funds lines of credit from correspondent banks. These sources might not be sufficient to meet future liquidity demands. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets if these alternative sources are not adequate.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with other commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other community banks and super-regional and national financial institutions that operate offices in our primary market areas and elsewhere.
Additionally, we face competition from de novo community banks, including those with senior management who were previously affiliated with other local or regional banks or those controlled by investor groups with strong local business and community ties. These de novo community banks may offer higher deposit rates or lower cost loans in an effort to attract our customers, and may attempt to hire our management and employees.
We compete with these other financial institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.
Our success depends significantly upon economic conditions in the local markets where we operate.
Substantially all of our loan and deposit customers live, work and bank in the Chattanooga, Tennessee MSA. As a result, our success depends upon a sound local economy to provide opportunities for new business ventures, increased loan demand and the need for deposit services. Our profitability is impacted by these local factors as well as general economic conditions and interest rates. For example, our earnings may be negatively impacted by increases in unemployment rates or reductions in population, income levels, deposits and housing starts and home prices. In recent years, adverse economic conditions have inhibited our growth and diminished the ability of some of our customers to service their loan obligations. If economic conditions in our local markets deteriorate again, we could experience any of the following consequences, each of which could further adversely affect our business:
| · | demand for our products and services could decline; |
| · | loan delinquencies could increase; and |
| �� | nonperforming assets and foreclosures could increase. |
A prolonged economic downturn could also negatively impact collateral values or cash flows of borrowing businesses, and as a result our primary source of repayment could be insufficient to service the debt. In addition, adverse consequences to us in the event of a prolonged economic downturn in our local markets could be compounded by the fact that many of our commercial and real estate loans are secured by real estate located in those market areas. Significant decline in real estate values in these market areas would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. Adverse economic conditions in our local markets, including sustained periods of increased payment delinquencies, foreclosures or losses in the State of Tennessee or the State of Georgia, could impair our ability to collect loans and could otherwise have a negative effect on our assets, revenues,deposit levels, loan demand, business and results of operations and financial condition.
Cornerstone is required to obtain regulatory approval prior to the payment of dividends.
Cornerstone’s Series A Convertible Preferred Stock requires annual dividend payments that equal ten percent of the original issue price of $25.00 per share. operations.
The
dividends are scheduled to be paid at the end of each quarter. However, prior to the payment of the quarterly dividend Cornerstone must first obtain approval from the Federal Reserve
Bank (“FRB”). Cornerstone provides information toBoard raised interest rates by 100 basis points since December 2016 after having held interest rates at almost zero over recent years. However, the
FRB which includes an evaluation of asset quality, earnings quarter and year to date and liquidity. Prior approval would also be required before common stock dividends could be paid.
Our Series A Convertible Preferred Stock will reduce net income available to holders of our Common Stock and earnings per common share.
The cash dividends paid or accumulated on our Series A Convertible Preferred Stock, and any future capital stock we may issue which is senior to our Common Stock, will reduce any net income available to holders of Common Stock and our earnings per common share. The preferred stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of our Company. To date, we have received regulatory approval first and have made seventeen dividend payments on the Series A Convertible Preferred Stock. However, because of the need for regulatory approval to pay future dividends on the Series A Convertible Preferred Stock, dividends could accumulate and become quite substantial. The higher these accumulated dividends, the higher the preference payable in the event of liquidation, dissolution or winding up of our Company and the less likely the holders of our Common Stock will be able to realize any proceeds in such event.
Negative developments in the financial services industry and U.S. and global capital and credit markets may lead to additional regulation and further deterioration of our results of operations and financial condition.
Negative developments in the capital and credit markets in recent years have resulted in uncertainty in the financial markets. Financial institutions across the United States, including the Bank, have experienced deteriorating asset quality. Loan portfolios include impaired loans to businesses struggling to stay in operation or achieve adequate cash flow. Further, a decline in collateral values supporting these loansconsistently low rate environment has also impacted the ability of a business or consumer to obtain loans or increased financial institutions losses in the event of foreclosure and liquidation. At the same time, financial institutions have become concerned about liquidity. This concern has increased the competition for deposits in our local market as well as wholesale funding options. These events havenegatively impacted our stock price, as well as the stock price of other bank holding companies. The potential impact of these events may be an expansion of existing or creation of new federal or state lawsnet interest margin, notwithstanding decreases in nonperforming loans and regulations regarding lending and funding practices, liquidity standards and compliance issues. Continued negative developments below, as well as our ability to respond to these new operating and regulatory requirements, could furtherimprovements in deposit mix. Any reduction in net interest income will negatively impact our results of operations. The negative consequences could limit our ability to originate new loans or obtain adequate funding or increase costs associated with regulatory compliance. Ultimately, these changes could result in modifications to our existing or future strategic plans, capital requirements, compensation, financial performance and stock performance.
Recently enacted legislation might not stabilize the U.S. financial system.
The U.S. Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”) in response to the impact of the volatility and disruption in the capital and credit markets on the financial sector. The Treasury and the federal banking regulators implemented a number of programs under this legislation to address these conditions and the asset quality, capital and liquidity issues they have caused for certain financial institutions and to improve the general availability of credit for consumers and businesses. In addition, the U.S. Congress enacted the American Recovery and Reinvestment Act of 2009 (“ARRA”) in an effort to save and create jobs, stimulate the U.S. economy and promote long-term growth and stability. The EESA and ARRA have been followed by numerous actions by the Federal Reserve, the U.S. Congress, the U.S. Treasury, the FDIC, the Commission and others to address the liquidity and credit crisis that followed the sub-prime meltdown. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. financial system. The Temporary Liquidity Guarantee Program (“TLGP”), the EESA, the ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen,affect our business, financial condition, liquidity, results of operations, and/or access to credit, as well as the trading price of our common stock, could be materially and adversely affected.
Our loan portfolio includes residential construction and land development loans, which have a greater credit risk than residential mortgage loans.
We engage in residential construction and land development loans to developers. This type of lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful operation of the related real estate project. Consequently, these loans are more sensitive to the current adverse conditions in the real estate market and the general economy. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline. Furthermore, during adverse general economic conditions, which were experienced in residential real estate construction nationwide, borrowers involved in the residential real estate construction and development business suffer above normal financial strain. As the residential real estate development and construction market in our markets previously deteriorated, our borrowers in this segment experienced difficulty repaying their obligations to us. If additional charge-offs or foreclosures relating to these loans are necessary in the future, our results of operations would be negatively impacted. Additionally, to the extent repayment is dependent upon the sale of newly constructed homes or lots, such sales are likely to be at lower prices or at a slower rate than was expected when the loan was made, which may result in such loans being placed on non-accrual status and subject to higher loss estimates even if the borrower keeps interest payments current. These adverse economic and real estate market conditions may lead to further increases in non-performing loans and other real estate owned, increased charge-offs from the disposition of non-performing assets, and increases in provision for loan losses, all of which would negatively impact our financial condition and results of operations.
Changes in interest rates could adversely affect our results of operations and financial condition.
Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities. Accordingly, changes in interest rates could decrease our net interest income.
Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets, and theour ability to realize gains from the sale of our assets, all of which ultimately affectsaffect our earnings. Economic events prompted the Federal Reserve, beginning in September 2007, to reduce its federal funds rate. Due to the rapidA decline in interest rates, we were unablethe market value of our assets may limit our ability to recalibrate our liabilities at the same rate at which loan rates declined.borrow additional funds. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized costs of the investments, we will incur losses.
The primary tool that management uses to measure short-term interest rate risk is a net interest margin was impacted negatively during 2009. Ifincome simulation model prepared by an independent third party provider. As of December 31, 2017, SmartFinancial is considered to be in an asset-sensitive position, meaning income is generally expected to increase with an increase in short-term interest rates and, conversely, to decrease with a decrease in short-term interest rates. Based on the Federal Reserve’s federal fundsresults of this simulation model, which assumed a static environment with no contemplated asset growth or changes in our balance sheet management strategies, if short-term interest rates immediately increased by 200 basis points, we could expect net income to increase by approximately $4.0 million over a 12-month period. This result is primarily due to the floating rate remainssecurities and loans which we anticipate would reprice at extremely low levels or does not increase abovea quicker rate than our interest rate floors,bearing liabilities. The actual amount of any increase or decrease may be higher or lower than predicted by our funding costs maysimulation model.
The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.
In July 2013, the federal banking agencies published new regulatory capital rules based on the international standards, known as Basel III, that had been developed by the Basel Committee on Banking Supervision. The new rules raised the risk-based capital requirements and revised the methods for calculating risk-weighted assets, usually resulting in higher risk weights. The new rules became effective on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019.
The Basel III-based rules increase whichcapital requirements and include two new capital measurements that will negatively impactaffect us, a risk-based common equity Tier 1 ratio and a capital conservation buffer. As an example, the Tier 1 capital ratio minimum requirement of 4 percent on January 1, 2015 will increase to 8.5 percent by 2019. SmartFinancial has approximately $157.8 million of Tier 1 capital. Under the previous standard, we could have grown SmartBank's total asset size to approximately $3.9 billion with our current capital but will be limited to $1.9 billion in assets under the new Basel III standards to be fully phased in by 2019. In 2017, 91 percent of our average assets were earning assets and over 90 percent of our revenue was generated from net interest marginincome. Therefore, a future reduction of potential earning assets by approximately 53 percent could drastically reduce our future income. More details about the new capital requirements can be found in Note 13 in the “Notes to Consolidated Financial Statements.”
We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions or breaches of security could have an adverse effect on our financial condition and results of operations.
Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify these systems as circumstances warrant, the security of our computer systems, software and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. We outsource many of our major systems, such as data processing, loan servicing and deposit processing systems. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
In addition, we provide our customers the ability to bank remotely, including over the Internet or through their mobile device. The secure transmission of confidential information is a critical element of remote and mobile banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches (including breaches of security of customer systems and networks) and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation, results of operations and ability to attract and maintain customers and businesses. In addition, a security breach could also subject us to additional regulatory scrutiny, expose us to civil litigation and possible financial liability and cause reputational damage.
Risks Related to Our Company
If our allowance for loan and lease losses and fair value adjustments with respect to acquired loans is not sufficient to cover actual loan losses, our earnings will be adversely affected.
Our success depends significantly on the quality of our assets, particularly loans. Like other financial institutions, we are exposed to the risk that our borrowers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. As a result, we may experience significant loan losses that may have a material adverse effect on our operating results and financial condition.
We maintain an allowance for loan and lease losses with respect to our loan portfolio, in an attempt to cover loan losses inherent in our loan portfolio. In determining the size of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. We also make various assumptions and judgments about the collectability of our loan portfolio, including the diversification in our loan portfolio, the effect of changes in the economy on real estate and other collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic conditions and their probable impact on borrowers, the amount of charge-offs for the period and the amount of nonperforming loans and related collateral security.
The application of the acquisition method of accounting in our acquisitions has impacted our allowance for loan and lease losses. Under the acquisition method of accounting, all acquired loans were recorded in our consolidated financial
performance.
We may require additional capitalstatements at their fair values at the time of acquisition and the related allowance for loan and lease losses was eliminated because credit quality, among other factors, was considered in the determination of fair value. To the extent that our estimates of fair values are too high, we will incur losses associated with the acquired loans. The allowance, if any, associated with our purchased credit impaired loans reflects deterioration in cash flows since acquisition resulting from our quarterly re-estimation of cash flows which involves complex cash flow projections and significant judgment on timing of loan resolution.
If our analysis or assumptions prove to be incorrect, our current allowance may not be
ablesufficient, and adjustments may be necessary to
be obtainedallow for different economic conditions or
if obtained, may cause significant dilutionadverse developments in our loan portfolio. Material additions to
current shareholders.Wethe allowance for loan and lease losses would materially decrease our net income and adversely affect our general financial condition. As an example, an increase in the amount of the reserve to organic loans of 0.05 percent in 2017 would have resulted in a reduction of approximately 3 percent to pre-tax income.
In addition, federal and state regulators periodically review our allowance for loan and lease losses and may require
capital from sources otherus to increase our allowance for loan and lease losses or recognize further loan charge-offs, based on judgments different than
earnings generation. Such other sources may include an offeringthose of
equity-based securities, which could significantly dilute your investmentour management. Any increase in
the event of conversion. We may need to pursue additional sources of capital, which may include additional equity investments, additional offerings of equity-based securities, borrowed fundsour allowance for loan and lease losses or
any combination ofloan charge-offs required by these
sources. Our ability to access these alternative capital sources may be limited to the condition of the capital markets. Therefore, we may have difficulty rebuilding the Bank’s capital reserves and we may provide new investors in the future certain rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders.
Recently enacted legislationregulatory agencies could have a negativematerial adverse effect on our operating results and financial condition.
Our success depends significantly on economic conditions in our market areas.
Unlike larger organizations that are more geographically diversified, our branches are currently concentrated in Eastern Tennessee and the Florida Panhandle. As a result of this geographic concentration, our financial results will depend largely upon economic conditions in these market areas. If the communities in which we operate do not grow or if prevailing economic conditions, locally or nationally, deteriorate, this may have a significant impact on the amount of loans that we originate, the ability of our business.The impactborrowers to repay these loans and the value of the Dodd-Frank Act on the financial services industry will be broad, with enhanced regulatory oversight and compliance, including, amongcollateral securing these loans. A return to economic downturn conditions caused by inflation, recession, unemployment, government action, natural disasters or other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paidfactors beyond our control would likely contribute to the FDIC for federal deposit insurance;deterioration of the quality of our loan portfolio and (v) numerous other provisions designed to improve supervision and oversightreduce our level of and strengthening safety and soundness for,deposits, which in turn would have an adverse effect on our business. As an example, the financial services sector. In addition, the Dodd-Frank Act established a new framework for systemic risk and oversight in the industry whichFlorida Panhandle area has resultedbeen and will continue to resultbe susceptible to major hurricanes, floods, and tropical storms. In 2016, certain of our markets in sweepingEastern Tennessee were disrupted by wildfires which damaged homes and businesses.
In addition, some portions of our target market are in areas which a substantial portion of the economy is dependent upon tourism. The tourism industry tends to be more sensitive than the economy as a whole to changes in the regulation ofunemployment, inflation, wage growth, and other factors which affect consumer’s financial institutions aimed at strengthening safetycondition and soundness for the financial services sector.We expect thatsentiment.
Our organic loan growth may be limited by regulatory constraints
During 2017 many of the requirements calledregulatory agencies, including ours, increased their focus on the application of an interagency guidance issued in 2006, titled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.” The 2006 interagency guidance focuses on the risks of high levels of concentration in CRE lending at banking institutions, and specifically addresses two supervisory criteria:
Construction concentration criterion: Loans for construction, land, and land development (CLD or “construction”) represent 100 percent or more of a banking institution’s total risk-based capital, commonly referred to as the "100 ratio"
Total CRE concentration criterion: Total nonowner-occupied CRE loans (including CLD loans), as defined in the Dodd-Frank Act2006 guidance (“total CRE”), represent 300 percent or more of the institution’s total risk-based capital, and growth in total CRE lending has increased by 50 percent or more during the previous 36 months, commonly referred to as the "300 ratio"
The guidance states that banking institutions exceeding the concentration levels mentioned in the two supervisory criteria should have in place enhanced credit risk controls, including stress testing of CRE portfolios. The guidance also states that institutions with CRE concentration levels above those specified in the two supervisory criteria may be identified for further supervisory analysis. Under the guidance for every $1 in increased capital only $1 can be leveraged to construction lending and only $3 can be lent to total CRE lending. In comparison $1 of capital can be leveraged into about $10 other types of lending. At the end of 2017 our loan portfolio was below both the 100 and 300 ratio as laid out in the guidance, but given the guidance our ability to grow those loan types could well be constrained by the amount we are also able to grow capital.
To the extent that we are unable to identify and consummate attractive acquisitions, or increase loans through organic loan growth, we may be unable to successfully implement our growth strategy, which could materially and adversely affect us.
A substantial part of our historical growth has been a result of acquisitions and we intend to continue to grow our business through strategic acquisitions of banking franchises coupled with organic loan growth. Previous availability of attractive acquisition targets may not be indicative of future acquisition opportunities, and we may be unable to identify any acquisition targets that meet our investment objectives. To the extent that we are unable to find suitable acquisition candidates, an important component of our strategy may be lost. If we are able to identify attractive acquisition opportunities, we must generally satisfy a number of conditions prior to completing any such transaction, including certain bank regulatory approvals, which have become substantially more difficult, time-consuming and unpredictable as a result of the recent financial crisis. Additionally, any future acquisitions may not produce the revenue, earnings or synergies that we anticipated. As our purchased credit impaired loan portfolio, which produces substantially higher yields than our organic and purchased non-credit impaired loan portfolios, is paid down, we expect downward pressure on our income. If we are unable to replace our purchased credit impaired loans and the related accretion with a significantly higher level of new performing loans and other earning assets due to our inability to identify attractive acquisition opportunities, a decline in loan demand, competition from other financial institutions in our markets, stagnation or continued deterioration of economic conditions, or other conditions, our financial condition and earnings may be adversely affected.
Our strategic growth plan contemplates additional acquisitions, which could expose us to additional risks.
We periodically evaluate opportunities to acquire additional financial institutions. As a result, we may engage in negotiations or discussions that, if they were to result in a transaction, could have a material effect on our operating results and financial condition, including short and long-term liquidity. Our acquisition activities could be material and could require us to use a substantial amount of common stock, cash, other liquid assets, and/or incur debt.
Our acquisition activities could involve a number of additional risks, including the risks of:
incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in management's attention being diverted from the operation of our existing business;
using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets;
incurring time and expense required to integrate the operations and personnel of the combined businesses, creating an adverse short-term effect on results of operations; and
losing key employees and customers as a result of an acquisition that is poorly received.
Our recent acquisition and future expansion may result in additional risks.
Over the last three years we have completed the acquisitions of Legacy SmartFinancial and Capstone, and we anticipate consummating our proposed merger with Tennessee Bancshares in the second quarter of 2018, subject to customary closing conditions. We expect to continue to expand in our current markets and in other select markets through additional branches or through additional acquisitions of all or part of other financial institutions. These types of expansions involve various risks, including the risks detailed below.
Growth. As a result of our merger activity, we may be unable to successfully:
maintain loan quality in the context of significant loan growth;
obtain regulatory and other approvals;
attract sufficient deposits and capital to fund anticipated loan growth;
maintain adequate common equity and regulatory capital;
avoid diversion or disruption of our existing operations or management as well as those of the acquired institution;
maintain adequate management personnel and systems to oversee and support such growth;
maintain adequate internal audit, loan review and compliance functions; and
implement additional policies, procedures and operating systems required to support such growth.
Results of Operations. There is no assurance that existing offices or future offices will maintain or achieve deposit levels, loan balances or other operating results necessary to avoid losses or produce profits. Our growth strategy necessarily entails growth in overhead expenses as we routinely add new offices and staff. Our historical results may not be indicative of future results or results that may be achieved as we continue to increase the number and concentration of our branch offices in our newer markets.
Development of offices. There are considerable costs involved in opening branches, and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, any new branches we establish can be expected to negatively impact our earnings for some period of time until they reach certain economies of scale. The same is true for our efforts to expand in these markets with the hiring of additional seasoned professionals with significant experience in that market. Our expenses could be further increased if we encounter delays in opening any of our new branches. We may be unable to accomplish future branch expansion plans due to a lack of available satisfactory sites, difficulties in acquiring such sites, failure to receive any required regulatory approvals, increased expenses or loss of potential sites due to complexities associated with zoning and permitting processes, higher than anticipated merger and acquisition costs or other factors. Finally, we have no assurance any branch will be implemented over time,successful even after it has been established or acquired, as the case may be.
Regulatory and most willeconomic factors. Our growth and expansion plans may be subjectadversely affected by a number of regulatory and economic developments or other events. Failure to implementingobtain required regulatory approvals, changes in laws and regulations over the course of several years. Given the uncertainty associated with the manneror other regulatory developments and changes in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Actprevailing economic conditions or other unanticipated events may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirementsprevent or otherwise adversely affect our business. These changescontinued growth and expansion. Such factors may also requirecause us to invest significant management attentionalter our growth and resourcesexpansion plans or slow or halt the growth and expansion process, which may prevent us from entering into or expanding in our targeted markets or allow competitors to evaluategain or retain market share in our existing markets.
Failure to successfully address these and
make necessary changes in orderother issues related to
comply with new statutoryour expansion could have a material adverse effect on our financial condition and
regulatory requirements.We are subject to federal and state regulations that may negatively impact our operations and financial performance.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies, including the Federal Reserve, the FDIC and the TDFI. Many of the banking regulations we are governed by are intended to protect depositors, the public or the insurance funds maintained by the FDIC, not shareholders. Compliance with the numerous banking regulations is costly and requires investment in human and information technology resources. Certain of our activities, such as the payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices, are impacted by these regulations. We are also subject to capitalization guidelines established by banking authorities, which require us to maintain adequate capital to support our growth. To be categorized as “well capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios.
The laws and regulations applicable to the banking industry are subject to change at any time. We cannot predict the events that will result in regulatory changes nor their impact on the banking industry in general and us in particular. Because government regulation greatly affects the business and financial results of all commercial banksoperations, and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably.
The Sarbanes-Oxley Actsuccessfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our results of 2002operations and financial condition could be materially adversely affected.
Integrating Capstone Bank and, if our pending merger with Tennessee Bancshares is completed, Southern Community Bank into SmartBank’s may be more difficult, costly, or time-consuming than anticipated.
We are still in the related rulesprocess of integrating Capstone Bank’s business with that of SmartBank, and regulations promulgated byif the Commission have increasedmerger with Tennessee Bancshares is completed as planned, we will begin the scope, complexityprocess of integrating Southern Community Bank with that of SmartBank as well. A successful integration of these businesses with ours will depend substantially on our ability to consolidate operations, corporate cultures, systems and costprocedures and to eliminate redundancies and costs. We may not be able to combine our business with one or both of corporate governance, reportingthe targets’ businesses without encountering difficulties, such as:
the loss of key employees;
disruption of operations and disclosure practices. These regulations are applicablebusiness;
inability to us. We have experienced,maintain and may continue to experience, increasing compliance costsincrease competitive presence;
loan and deposit attrition, customer loss and revenue loss, including as a result of any decision we may make to close one or more locations;
possible inconsistencies in standards, control procedures and policies;
unexpected problems with costs, operations, personnel, technology and credit; and/or
problems with the Sarbanes-Oxley Act. These necessary costs are proportionately higherassimilation of new operations, sites or personnel, which could divert resources from regular banking operations.
Additionally, general market and economic conditions or governmental actions affecting the financial industry generally may inhibit our successful integration of one or both of the targets’ businesses. Further, we acquired Capstone and intend to acquire Tennessee Bancshares with the expectation that the acquisitions will result in various benefits including, among other things, benefits relating to enhanced revenues, a strengthened market position for the combined company, cross selling opportunities, technological efficiencies, cost savings and operating efficiencies. Achieving the anticipated benefits of this acquisition is subject to a companynumber of uncertainties, including whether we integrate Capstone’s and/or Southern Community Bank’s businesses, including
its organizational culture, operations, technologies, services and products, in an efficient and effective manner, our ability to achieve the estimated noninterest expense savings we believe we can achieve, and general competitive factors in the marketplace. Failure to achieve these anticipated benefits on the anticipated timeframe, or at all, could result in a reduction in the price of our sizeshares as well as in increased costs, decreases in the amount of expected revenues and diversion of management’s time and energy and could materially and adversely affect our business, results of operations and financial condition. Additionally, we made fair value estimates of certain assets and liabilities in recording our acquisition of Capstone and will affectmake fair value estimates of certain assets and liabilities in recording our acquisition of Southern Community Bank. Actual values of these assets and liabilities could differ from our estimates, which could result in our not achieving the anticipated benefits of the acquisition. Finally, any cost savings that are realized may be offset by losses in revenues or other charges to earnings.
We may face risks with respect to future acquisitions.
When we attempt to expand our business through mergers and acquisitions (as we have done over the last three years), we seek targets that are culturally similar to us, have experienced management and possess either market presence or have potential for improved profitability more thanthrough economies of scale or expanded services. In addition to the general risks associated with our growth plans which are highlighted above, in general acquiring other banks, businesses or branches, particularly those in markets with which we are less familiar, involves various risks commonly associated with acquisitions, including, among other things:
the time and costs associated with identifying and evaluating potential acquisition and merger targets;
inaccuracies in the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution;
the time and costs of evaluating new markets, hiring experienced local management, including as a result of de novo expansion into a market, and opening new bank locations, and the time lags between these activities and the generation of sufficient assets and deposits to support the significant costs of the expansion that we may incur, particularly in the first 12 to 24 months of someoperations;
our ability to finance an acquisition and possible dilution to our existing shareholders;
the diversion of our
larger competitors.U.S. Banking agenciesmanagement’s attention to the negotiation of a transaction and integration of an acquired company’s operations with ours;
the incurrence of an impairment of goodwill associated with an acquisition and adverse effects on our results of operations;
entry into new markets where we have finalized revisionslimited or no direct prior experience;
closing delays and increased expenses related to their risk-basedthe resolution of lawsuits filed by our shareholders or shareholders of companies we may seek to acquire;
the inability to receive regulatory approvals timely or at all, including as a result of community objections, or such approvals being restrictively conditional; and leverage
risks associated with integrating the operations, technologies and personnel of the acquired business.
We expect to continue to evaluate merger and acquisition opportunities that are presented to us in our current markets as well as other markets throughout the region and conduct due diligence activities related to possible transactions with other financial institutions. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash or equity securities and related capital requirements consistentraising transactions may occur at any time. Generally, acquisitions of financial institutions involve the payment of a premium over book and market values, and, therefore, some dilution of our book value and fully diluted earnings per share may occur in connection with agreements reached byany future transaction. Failure to realize the Basel Committee on Banking Supervision (Basel III). The final rules establish tougher capital standards through more restrictive capital definitions, higher risk-weighted assets, additional capital buffers, and higher requirements for minimum capital ratios. These reformsexpected revenue increases, cost savings, increases in product presence and/or other projected benefits from an acquisition could have a material negative impactadverse effect on our financial condition and results of operations.
In addition, we may face significant competition from numerous other financial services institutions, many of which may have greater financial resources than we do, when considering acquisition opportunities. Accordingly, attractive acquisition opportunities may not be available to us. There can be no assurance that we will be successful in identifying or completing any potential future acquisitions.
Our concentration in loans secured by real estate, particularly commercial real estate and construction and development, is subject to risks that could adversely affect our results of operations and financial condition.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market areas. Consequently, declines in economic conditions in these market areas may have a greater effect on our earnings and capital than on the profitabilityearnings and returnscapital of larger financial institutions whose real estate loan portfolios are more geographically diverse.
At December 31, 2017, approximately 81 percent of our loans had real estate as a primary or secondary component of collateral, with 11 percent of our loans secured by construction and development collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Real estate values declined significantly during the recent economic crisis and may decline similarly in future periods. Although real estate prices in most of our markets have stabilized or are improving, a renewed decline in real estate values would expose us to further deterioration in the value of the collateral for all loans secured by real estate and may adversely affect our results of operations and financial condition.
Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans, particularly when there is a downturn in the business cycle. They are also typically larger than residential real estate loans and consumer loans and depend on
equitycash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions and a downturn in the local economy or in occupancy rates in the local economy where the property is located, each of
U.S. banks, includingwhich could increase the
Bank.
We havelikelihood of default on the loan. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant deferred tax asset that might not be fully realized.
We have net deferred tax assetsincrease in the percentage of $1.8 million asnonperforming loans. An increase in nonperforming loans could result in a loss of December 31, 2014. We did not establish a valuation allowance against our net deferred tax assets as of December 31, 2013 or December 31, 2014 because we believe that it is more likely than not thatearnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of these assets will be realized. In evaluating the need for a valuation allowance, we estimated future taxable income based on management prepared forecasts. This process required significant judgment by management about matters that are by nature uncertain. If future events differ significantly from our current forecasts, we may need to establish a valuation allowance, which could have a material adverse effect on our results of operations and financial condition.
We rely heavilycondition, which could negatively affect our stock price.
If a commercial real estate loan did default there would be legal expenses associated with obtaining the real estate which is typically collateral for the loan. In the last several years the amount of these legal expenses has been low, compared to periods when the defaults of commercial real estate loans have been higher. Once we obtain the collateral for the commercial real estate loan it is put into foreclosed assets. Foreclosed assets generally do not produce income but do have the costs associated with the ownership of real estate, principally real estate taxes and maintenance costs. Since these assets have a cost to maintain our goal is to keep costs at a minimum by liquidating the assets as soon as possible. Generally, in spite of our best efforts and intentions, foreclosed assets are sold at a loss. Among other reasons the rate of loan defaults increase as the economy worsens and declining economic environment and political turmoil generally results in downward pressure on foreclosed asset values and increased marketing periods. In simple terms for banks like ours who have a large amount of commercial real estate loans a worsening economy will typically lead to higher loan delinquencies, followed by increases in loan defaults and greater legal expenses, leading to higher foreclosed asset levels with an increased expense to maintain the servicesproperties, ending in a sale of key personnel and the unexpected lossforeclosed assets - most likely at a loss.
Our largest loan relationships currently make up a significant percentage of our total loan portfolio.
As of December 31, 2017, our 10 largest borrowing relationships totaled approximately $149 million in commitments (including unfunded commitments), or approximately 11 percent of our total loan portfolio. The concentration risk associated with having a small number of relatively large loan relationships is that, if one or more of these relationships were to become delinquent or suffer default, we could be at risk of material losses. The allowance for loan losses may not be adequate to cover losses associated with any of those personnelthese relationships, and any loss or increase in the allowance could have a material adverse effect on our business, financial condition, results of operations and prospects.
Our corporate structure provides for decision-making authority by our regional presidents and banking teams. Our business, financial condition, results of operations and prospects could be negatively affected if our employees do not follow our internal policies or are negligent in their decision-making.
We attract and retain our management talent by empowering them to make certain business decisions on a local level. Lending authorities are assigned to relationship managers, regional and presidents and regional credit officers to make credit decisions based on their experience. Additionally, all loans not in full compliance with the bank’s loan policy must be approved by an additional level of authority with adequate credit authority for the exposure and any exposure in excess of $2.8 Million in Total Relationship Exposure with some sample loans below this amount are reviewed by our Chief Credit Officer in Knoxville, Tennessee. Moreover, for decisions that fall outside of the assigned individual authorities at every level, our teams are required to obtain approval from our. Officer Loan Committee and/or Directors Loan Committee. Our local bankers may not follow our internal procedures or otherwise act in our best interests with respect to their decision-making. A failure of our employees to follow our internal policies, or actions taken by our employees that are negligent could have a material adverse effect on our business, financial condition, results of operations and prospects.
Declines in the businesses or industries of our customers could cause increased credit losses and decreased loan balances, which could adversely affect our financial results.
The small to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan, and such impairment could have an adverse effect on our business, financial condition and results of operations.
A substantial focus of our marketing and business strategy is to serve small to medium-sized businesses in our market areas. As a result, a relatively high percentage of our loan portfolio consists of commercial loans to such businesses. We further anticipate an increase in the amount of loans to small to medium-sized businesses during 2018.
Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have an adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact the markets in which we operate and small to medium-sized businesses are adversely affected or our borrowers are otherwise harmed by adverse business developments, this, in turn, could have an adverse effect on our business, financial condition and results of operations.
Certain of our deposits and other funding sources may be volatile and impact our liquidity.
In addition to the traditional core deposits, such as demand deposit accounts, interest checking, money market savings and certificates of deposits less than $250,000, we utilize or in the past have utilized several noncore funding sources, such as brokered certificates of deposit, Federal Home Loan Bank (FHLB) of Cincinnati advances, federal funds purchased and other sources. We utilize these noncore funding sources to fund the ongoing operations and growth of SmartBank. The availability of these noncore funding sources is subject to broad economic conditions and to investor assessment of our financial strength and, as such, the cost of funds may fluctuate significantly and/or be restricted, thus impacting our net interest income, our immediate liquidity and/or our access to additional liquidity. We have somewhat similar risks to the extent high balance core deposits exceed the amount of deposit insurance coverage available.
We impose certain internal limits as to the absolute level of noncore funding we will incur at any point in time. Should we exceed those limitations, we may need to modify our growth plans, liquidate certain assets, participate loans to correspondents or execute other actions to allow for us to return to an acceptable level of noncore funding within a reasonable amount of time.
We face additional risks due to our increase in mortgage banking activities that have and could negatively impact our net income and profitability.
We have established mortgage banking operations which expose us to risks that are different from our retail and commercial banking operations. During higher and rising interest rate environments, the demand for mortgage loans and the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues, which could negatively impact our earnings. While we have been experiencing historically low interest rates, the low interest rate environment likely will not continue indefinitely. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking operations also depends in large part on our ability to aggregate a high volume of loans and sell them in the secondary market at a gain. Thus, in addition to our dependence on the interest rate environment, we are dependent on certain key officers who have important customer relationships or are instrumentalupon (a) the existence of an active secondary market and (b) our ability to profitably sell loans into that market. Our mortgage banking operations incurred additional expenses over $2.1 million in 2017 and generated noninterest income of $1,058 thousand. Profitability of our lending, depository and bank operations. We believe that our future resultsmortgage operations will also depend upon our ability to increase production and thus income while holding or reducing costs. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third-party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, we may be required to charge such shortfall to earnings.
Any expansion into new lines of business might not be successful.
As part of our ongoing strategic plan, we will continue to consider expansion into new lines of business through the acquisition of third parties, or through organic growth and development. There are substantial risks associated with such efforts, including risks that (a) revenues from such activities might not be sufficient to offset the development, compliance, and other implementation costs, (b) competing products and services and shifting market preferences might affect the profitability of such activities, and (c) our internal controls might be inadequate to manage the risks associated with new activities. Furthermore, it is possible that our unfamiliarity with new lines of business might adversely affect the success of such actions. If any such expansions into new product markets are not successful, there could be an adverse effect on our financial condition and results of operations.
We may need additional access to capital, which we may be unable to obtain on attractive terms or at all.
We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our stock price negatively affected.
Any deficiencies in our financial reporting or internal controls could materially and adversely affect us, including resulting in material misstatements in our financial statements, and could materially and adversely affect the market price of our common stock.
If we fail to maintain effective internal controls over financial reporting, our operating results could be harmed and it could result in a material misstatement in our financial statements in the future. Inferior controls and procedures or the identification of accounting errors could cause our investors to lose confidence in our internal controls and question our reported financial information, which, among other things, could have a negative impact on the trading price of our common stock. Additionally, we could become subject to increased regulatory scrutiny and a higher risk of shareholder litigation, which could result in significant additional expenses and require additional financial and management resources.
We incur increased costs as a result of being a public company.
As a public company, we incur significant legal, accounting and other expenses, including costs associated with public company reporting requirements. We also incur costs associated with the Sarbanes-Oxley Act, the Dodd-Frank Act and related rules implemented or to be implemented by the SEC and the NASDAQ Stock Market. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to continue to invest resources to comply with evolving laws, regulations and standards and this continued investment may result in increased general and administrative expenses and a diversion of management's time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected. In 2017 we incurred over $530 thousand in direct external costs associated with being a public company, which does not include the increased internal costs of the personnel needed to comply with being a public company.
Inability to retain senior management and key employees or to attract new experienced financial services professionals could impair our relationship with our customers, reduce growth and adversely affect our business.
We have assembled a senior management team which has substantial background and experience in banking and financial services. Moreover, much of our organic loan growth in 2012 through 2017 was the result of our ability to attract experienced financial services professionals who have been able to attract customers from other financial institutions. Inability to retain
highly skilledthese key personnel or to continue to attract experienced lenders with established books of business could negatively impact our growth because of the loss of these individuals' skills and
qualified personnel.
customer relationships and/or the potential difficulty of promptly replacing them.
We may be subject to losses due to fraudulent and negligent conduct of our loan customers, deposit customers, third party service providers and employees.
When we make loans to individuals or entities, we rely upon information supplied by borrowers and other third parties, including information contained in the applicant’s loan application, property appraisal reports, title information and the borrower’s net worth, liquidity and cash flow information. While we attempt to verify information provided through available sources, we cannot be certain all such information is correct or complete. Our reliance on incorrect or incomplete information could have a material adverse effect on our financial condition or results of operations.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2017, we had $50.8 million of goodwill and other intangible assets. A significant decline in our financial condition, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations. Future acquisitions could result in additional goodwill.
Risks Related to Our Stock
Our ability to declare and pay dividends is limited.
There can be no assurance of whether or when we may pay dividends on our common stock in the future. Future dividends, if any, will be declared and paid at the discretion of our board of directors and will depend on a number of factors. Our principal source of funds used to pay cash dividends on our common stock will be dividends that we receive from SmartBank. Although the Bank’s asset quality, earnings performance, liquidity and capital requirements will be taken into account before we declare or pay any future dividends on our common stock, our board of directors will also consider our liquidity and capital requirements and our board of directors could determine to declare and pay dividends without relying on dividend payments from the Bank.
Federal and state banking laws and regulations and state corporate laws restrict the amount of dividends we may declare and pay. For example, Federal Reserve Board regulations implementing the capital rules required under Basel III do not permit dividends unless capital levels exceed certain higher levels applying capital conservation buffers that began to apply on January 1, 2016 and are being phased in over three years.
Further, in connection with the Capstone merger, we entered into a loan agreement for a revolving line of credit of up to $15 million. Under the terms of the loan agreement, we may not pay dividends on our common stock if we do not satisfy certain financial covenants and capital ratio requirements.
Even though our common stock is currently traded on the Nasdaq Capital Market, it has less liquidity than many other stocks quoted on a national securities exchange.
The trading volume in our common stock on the Nasdaq Capital Market has been relatively low when compared with larger companies listed on the Nasdaq Capital Market or other stock exchanges. Although we have experienced increased liquidity in our stock, we cannot say with any certainty that a more active and liquid trading market for our common stock will continue to develop. Because of this, it may be more difficult for stockholders to sell a substantial number of shares for the same price at which stockholders could sell a smaller number of shares.
We cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock. We can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our future ability to raise capital through sales of our common stock.
The market price of our common stock has fluctuated significantly, and may fluctuate in the future. These fluctuations may be unrelated to our performance. General market or industry price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.
We may issue additional shares of stock or equity derivative securities, including awards to current and future executive officers, directors and employees, which could result in the dilution of shareholders’ investment.
Our authorized capital includes 40,000,000 shares of common stock and 2,000,000 shares of preferred stock. As of December 31, 2017, we had 11,152,561 shares of common stock and no shares of preferred stock outstanding, and had reserved or otherwise set aside for issuance 316,574 shares underlying outstanding options and 2,478,030 shares that are available for future grants of stock options, restricted stock or other equity-based awards pursuant to our equity incentive plans. Subject to NASDAQ rules, our board of directors generally has the authority to issue all or part of any authorized but unissued shares of common stock or preferred stock for any corporate purpose. We anticipate that we will issue additional equity in connection with the acquisition of other strategic partners and that in the future we likely will seek additional equity capital as we develop our business and expand our operations, depending on the timing and magnitude of any particular future acquisition. These issuances would dilute the ownership interests of existing shareholders and may dilute the per share book value of the common stock. New investors also may have rights, preferences and privileges that are senior to, and that adversely affect, our then existing shareholders.
In addition, the issuance of shares under our equity compensation plans will result in dilution of our shareholders’ ownership of our Common Stock. The exercise price of stock options could also adversely affect the terms on which we can obtain additional capital. Option holders are most likely to exercise their options when the exercise price is less than the market price for our Common Stock. They may profit from any increase in the stock price without assuming the risks of ownership of the underlying shares of Common Stock by exercising their options and selling the stock immediately.
We are subject to Tennessee’s anti-takeover statutes and certain charter provisions that could decrease our chances of being acquired even if the acquisition is in the best interest of our shareholders.
As a Tennessee corporation, we are subject to various legislative acts that impose restrictions on and require compliance with procedures designed to protect shareholders against unfair or coercive mergers and acquisitions. These statutes may delay or prevent offers to acquire us and increase the difficulty of consummating any such offers, even if the acquisition would be in our shareholders’ best interests. Our charter also contains provisions which may make it difficult for another entity to acquire us without the approval of a majority of the disinterested directors on our board of directors. Secondly, the amount of common stock owned by, and other compensation arrangements with, certain of our officers and directors may make it more difficult to obtain shareholder approval of potential takeovers that they oppose. Agreements with our senior management also provide for significant payments under certain circumstances following a change in control. These compensation arrangements, together with the common stock and option ownership of our board of directors and management, could make it difficult or expensive to obtain majority support for shareholder proposals or potential acquisition proposals that the board of directors and officers oppose.
The success and growth of our operations will depend on our ability to adapt to technological changes.
The banking industry and the ability to deliver financial services is becoming more dependent on technological advancement, such as the ability to process loan applications over the Internet, accept electronic signatures, provide process status updates instantly, reliable on-line banking capabilities and other customer expected conveniences that are cost efficient to our business processes. As these technologies are improved in the future, we may, in order to remain competitive, be required to make significant capital expenditures.
If we engage in business combination transactions, we may face risks associated with integration of operations or undiscovered losses or other problems.
Such negotiated acquisitions will be accompanied by the risks commonly encountered in acquisitions, including, among other things:
credit risk associated with the other bank’s loans and leases and investments;
difficulty of integrating operations and personnel;potential disruption of the our ongoing business; and
potential loss of key employees, customers and deposits of the other bank.
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber attacks, could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.
We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions have generally increased in recent years. Our operating systems and infrastructure must continue to be protected. Our operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including electrical or telecommunication outages; natural disasters such as earthquakes, tornadoes, and floods; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and cyber attacks.
Our technologies, systems and networks, those of third parties with whom we do business, and our customers’ devices may become the target of cyber attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of confidential information. As threats of cyber attacks continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities.
Any of these events could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
None.
As of December 31,
2014,2017, the principal offices of
CornerstoneSmartFinancial are located at
835 Georgia Avenue, Chattanooga,5401 Kingston Pike, #600, Knoxville, Tennessee
37402.37919. This property is owned by SmartBank and also serves as a branch location for the Bank’s customers. In addition, the Bank operates
fivetwenty one full-service branches,
and one loan production office,
thattwo mortgage loan production offices, and two service centers which are located at:
|
| |
| Owned | |
| Banking Branches | 1011 Parkway, Sevierville, Tennessee 37862 |
| | Banking Branches570 East Parkway, Gatlinburg, Tennessee 37738 |
| 202 Advantage Place, Knoxville, Tennessee 37922 |
| 5401 Kingston Pike, #600, Knoxville, Tennessee 37919 |
| 4154 Ringgold Road, East Ridge, Tennessee (owned by the Bank)37412 |
| | 5319 Highway 153, Hixson, Tennessee (owned by the Bank)37343 |
| | 2280 Gunbarrel Road, Chattanooga, Tennessee (owned by the Bank)37421 |
| | 8966 Old Lee Highway, Ooltewah, Tennessee (owned by the Bank)37363 |
| | 835 Georgia Avenue, Chattanooga, Tennessee (leased by the Bank as of December 31, 2014; owned by the Bank as of February 24, 2015)37402 |
| | 201 North Palafox Street, Pensacola, Florida 32502 |
| 4405 Commons Drive East, Destin, Florida 32541 |
| 16780 Jordan Street ,Chatom,, Alabama 36518
|
| 1600 College Avenue, Jackson, Alabama 36545
|
| 158 Commerce Street,McIntosh, Alabama 36553
|
| 33219 Hwy 43,Thomasville, AL 36784
|
| 2301 University Blvd, Tuscaloosa, AL 35401 |
|
| |
| Leased | |
| Banking Branches | 2430 Teaster Lane, #205, Pigeon Forge, Tennessee 37863 |
| 2000 Lurleen B Wallace Blvd, Northport, AL 35476 |
| 230 McFarland Circle North, Tuscaloosa, AL 35406 |
| 103 Ecor Rouge Place, Fairhope, AL 36532 |
| 2411 Jenks Avenue, Panama City, Florida 32405 |
| Loan Production Office | 202 West Crawford Street, Dalton, Georgia (leased by the Bank)37020 |
| Mortgage Loan Production Offices | 243 Southwood Drive, Panama City, Florida 32405 |
| 28810 Hwy 98, Suite E, Daphne AL 36526 |
| Service Centers | 6413 Lee Highway, #107, Chattanooga, Tennessee 37421 |
| 1732 Newport Highway, Suite 1, Sevierville, Tennessee 37876 |
The Georgia Avenue facility located in downtown Chattanooga, Tennessee serves as a branch location for the Bank’s customers as well as Cornerstone’s executive offices. This property was leased by the Bank as of December 31, 2014 but was purchased subsequent to year end. Additional information regarding this purchase is disclosed under Item 13 Related Party Transactions. The transaction closed on February 24, 2015. Cornerstone leases and operates a service center located at 6401 Lee Highway, Suite 119, Chattanooga, Tennessee to facilitate all of its noncustomer contact functions.
ITEM 3. LEGAL PROCEEDINGS
As of the end of
2014,2017, neither
CornerstoneSmartFinancial nor
the Bankits subsidiary was involved in any material litigation.
The BankSmartBank is periodically involved as a plaintiff or defendant in various legal actions in the ordinary course of its business. Management believes that any claims pending against
CornerstoneSmartFinancial or its
subsidiariessubsidiary are without merit or that the ultimate liability, if any, resulting from them will not materially affect
the Bank’sSmartBank’s financial condition or
Cornerstone’sSmartFinancial’s consolidated financial position.
| ITEM 4. | MINE SAFETY DICLOSURES |
ITEM 4. MINE SAFETY DICLOSURES
| ITEM 5. | MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
On
January 5, 2015, CornerstoneDecember 31, 2017, SmartFinancial had
6,627,39811,152,561 shares of common stock outstanding.
Cornerstone’sSmartFinancial’s common stock is
quotedlisted on
the OTC Bulletin BoardNASDAQ under the symbol
“CSBQ” but is not listed on a national securities exchange. There are ten market makers who provide a market for Cornerstone’s common stock.“SMBK”.
There were approximately
550673 holders of record of the common stock as of
December 31, 2014.March 1, 2018. This number does not include shareholders with shares in nominee name held by the Depository Trust Company (DTC). As of
the end of 2014,March 1, 2018 there were approximately
3,871,0008,130,397 shares held in nominee name by DTC.
Cornerstone
Dividends and Dividend Restrictions
SmartFinancial paid no cash dividends on common stock in 20132016 or 2014. Cornerstone must obtain the approval of the FRBA prior to declaring or paying a dividend2017. In 2016 and 2017, SmartFinancial recognized following dividends on its common or preferred stock. Cornerstone’s board of directors will continue to evaluateSBLF Preferred Stock (including dividends recognized by Legacy SmartFinancial):
|
| | | |
| Year | Total SBLF Preferred Stock Dividends |
| 2016 | $ | 1,022,000 |
|
| 2017 | $ | 195,000 |
|
We redeemed the amount of future dividends, if any, after capital needs required for expected growth of assets are reviewed. Subject to regulatory approval, theSBLF Preferred Stock in full on March 6, 2017.
The payment of dividends is within the discretion of the board of directors, considering Cornerstone’sSmartFinancial’s expenses, the maintenance of reasonable capital and risk reserves, and appropriate capitalization requirements for state banks. Currently,
In connection with the
Bank is undermerger with Capstone we entered into a
restriction fromloan agreement for a revolving line of credit. Under the
FDIC that no dividend can be paid fromterms of the
Bank to the holding company without prior approval.loan agreement, we may not pay dividends on our common stock if we do not satisfy certain financial covenants and capital ratio requirements.
Market Prices for Our Common Stock
Table 1 presents the high and low closing prices of
Cornerstone’sSmartFinancial’s common stock for the periods indicated, as reported
by published sources, andon the Nasdaq Capital Market. Table 1 also presents cash dividends declared on
itsour common stock for the last
twothree fiscal years. The prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
TABLE 1| High and Low Common Stock Price for Cornerstone | | Cash Dividends | |
| 2015 Fiscal Year | | Low | | | High | | | Paid Per Share | |
| First Quarter (through February 2, 2015) | | $ | 3.20 | | | $ | 3.50 | | | | - | |
| | | | | | | | | | | | | |
| 2014 Fiscal Year | | | | | | | | | | | | |
| First Quarter | | $ | 2.30 | | | $ | 2.50 | | | | - | |
| Second Quarter | | $ | 2.35 | | | $ | 2.62 | | | | - | |
| Third Quarter | | $ | 2.46 | | | $ | 3.05 | | | | - | |
| Fourth Quarter | | $ | 2.90 | | | $ | 3.70 | | | | - | |
| | | | | | | | | | | | | |
| 2013 Fiscal Year | | | | | | | | | | | | |
| First Quarter | | $ | 1.73 | | | $ | 2.89 | | | | - | |
| Second Quarter | | $ | 1.75 | | | $ | 2.28 | | | | - | |
| Third Quarter | | $ | 2.01 | | | $ | 2.69 | | | | - | |
| Fourth Quarter | | $ | 2.20 | | | $ | 2.60 | | | | - | |
| | | | | | | | | | | | | |
|
| | | | | | | | | | | |
| High and Low Common Stock Price for SmartFinancial | | Cash Dividends |
| 2017 | | Low | | High | | Paid Per Share |
| First Quarter | | $ | 17.17 |
| | $ | 23.20 |
| | — |
|
| Second Quarter | | $ | 20.35 |
| | $ | 26.26 |
| | — |
|
| Third Quarter | | $ | 22.31 |
| | $ | 25.95 |
| | — |
|
| Fourth Quarter | | $ | 21.10 |
| | $ | 24.98 |
| | — |
|
| | | | | | | |
| 2016 | | |
| | |
| | |
|
| First Quarter | | $ | 14.75 |
| | $ | 18.50 |
| | — |
|
| Second Quarter | | $ | 14.21 |
| | $ | 18.75 |
| | — |
|
| Third Quarter | | $ | 14.41 |
| | $ | 16.79 |
| | — |
|
| Fourth Quarter | | $ | 16.14 |
| | $ | 20.58 |
| | — |
|
| | | | | | | |
For information relating to compensation plans under which our equity securities are authorized for issuance, see
ItemPart III Items 11 and 12.
There were 600,000 shares of our Series A Convertible Preferred Stock outstanding as of December 31, 2014. Table 2 presents information relating to dividends paid on the Series A Convertible Preferred Stock.
TABLE 2
| Series A Convertible Preferred Stock Dividend Payments | | Amount | |
| Year | | Record Date | | Date Payable | | Per Share | |
| 2014 | | March 31, 2014 | | August 26, 2014 | | $ | 0.625 | |
| | | June 30, 2014 | | November 25, 2014 | | $ | 0.625 | |
| | | September 30, 2014 | | February 25,2015 | | $ | 0.625 | |
| | | | | | | | | |
| 2013 | | March 31, 2013 | | August 22, 2013 | | $ | 0.625 | |
| | | June 30, 2013 | | November 7, 2013 | | $ | 0.625 | |
| | | September 30, 2013 | | February 20, 2014 | | $ | 0.625 | |
| | | December 31, 2013 | | May 15, 2014 | | $ | 0.625 | |
ITEM 6.SELECTED6. SELECTED FINANCIAL DATATable 3 presents selected financial data for the periods indicated (amounts in thousands, except per share data).
TABLE 3
| | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| Total interest income | | $ | 18,137 | | | $ | 18,453 | | | $ | 19,353 | | | $ | 20,494 | | | $ | 25,211 | |
| Total interest expense | | | 2,789 | | | | 3,523 | | | | 4,785 | | | | 6,362 | | | | 9,202 | |
| Net interest income | | | 15,348 | | | | 14,930 | | | | 14,568 | | | | 14,132 | | | | 16,009 | |
| Provision for loan losses | | | 515 | | | | 300 | | | | 430 | | | | 445 | | | | 7,291 | |
| Net interest income after provision for loan losses | | | 14,833 | | | | 14,630 | | | | 14,138 | | | | 13,687 | | | | 8,718 | |
| Noninterest income | | | 1,819 | | | | 1,940 | | | | 1,019 | | | | 1,183 | | | | 3,081 | |
| Noninterest expense | | | 14,000 | | | | 13,846 | | | | 13,178 | | | | 13,652 | | | | 18,042 | |
| Income before income taxes | | | 2,652 | | | | 2,724 | | | | 1,979 | | | | 1,218 | | | | (6,243 | ) |
| Income tax expense / (benefit) | | | 1,014 | | | | 1,043 | | | | 577 | | | | 188 | | | | (1,535 | ) |
| Net income (loss) | | $ | 1,638 | | | $ | 1,681 | | | $ | 1,402 | | | $ | 1,030 | | | $ | (4,708 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Per Common Share Data: | | | | | | | | | | | | | | | | | | | | |
| Net income / (loss), basic | | $ | 0.01 | | | $ | 0.02 | | | $ | 0.02 | | | $ | 0.05 | | | $ | (0.73 | ) |
| Net income / (loss), assuming dilution | | | 0.01 | | | | 0.02 | | | | 0.02 | | | | 0.05 | | | | (0.73 | ) |
| Cash dividends paid | | | - | | | | - | | | | - | | | | - | | | | - | |
| Book value | | | 3.88 | | | | 3.86 | | | | 4.01 | | | | 3.89 | | | | 3.55 | |
| Tangible book value(1) | | | 3.88 | | | | 3.85 | | | | 4.01 | | | | 3.89 | | | | 3.55 | |
| | | | | | | | | | | | | | | | | | | | | |
| Financial Condition Data: | | | | | | | | | | | | | | | | | | | | |
| Assets | | $ | 415,740 | | | $ | 432,223 | | | $ | 443,446 | | | $ | 422,655 | | | $ | 441,499 | |
| Loans, net of unearned interest and allowance | | | 291,869 | | | | 286,237 | | | | 270,850 | | | | 260,365 | | | | 276,115 | |
| Cash and investments | | | 105,069 | | | | 119,417 | | | | 137,860 | | | | 127,332 | | | | 133,651 | |
| Federal funds sold | | | - | | | | - | | | | - | | | | - | | | | - | |
| Deposits | | | 308,654 | | | | 341,414 | | | | 344,881 | | | | 314,042 | | | | 355,447 | |
| FHLB advances and other borrowings | | | 36,000 | | | | 26,740 | | | | 37,175 | | | | 43,045 | | | | 54,715 | |
| Federal funds purchased and repurchase agreements | | | 29,410 | | | | 22,974 | | | | 19,587 | | | | 29,391 | | | | 24,325 | |
| Shareholders’ equity | | | 40,662 | | | | 40,134 | | | | 40,889 | | | | 35,208 | | | | 25,819 | |
| Tangible shareholders’ equity(1) | | | 40,662 | | | | 40,131 | | | | 40,878 | | | | 35,186 | | | | 25,782 | |
| | | | | | | | | | | | | | | | | | | | | |
| Selected Ratios: | | | | | | | | | | | | | | | | | | | | |
| Interest rate spread | | | 3.73 | % | | | 3.64 | % | | | 3.67 | % | | | 3.36 | % | | | 3.24 | % |
| Net interest margin(2) | | | 3.90 | % | | | 3.80 | % | | | 3.85 | % | | | 3.55 | % | | | 3.43 | % |
| Return on average assets | | | 0.39 | % | | | 0.39 | % | | | 0.34 | % | | | 0.24 | % | | | (0.94 | )% |
| Return on average equity | | | 4.04 | % | | | 4.12 | % | | | 3.78 | % | | | 3.46 | % | | | (15.79 | )% |
| Return on average tangible equity(1) | | | 4.04 | % | | | 4.12 | % | | | 3.78 | % | | | 3.47 | % | | | (15.81 | )% |
| Average equity to average assets | | | 9.65 | % | | | 9.51 | % | | | 8.94 | % | | | 6.91 | % | | | 5.95 | % |
| Common stock dividend payout ratio | | | N/A | | | | N/A | | | | N/A | | | | N/A | | | | N/A | |
| Ratio of nonperforming assets to total assets | | | 2.61 | % | | | 3.82 | % | | | 5.94 | % | | | 6.26 | % | | | 5.99 | % |
| Ratio of allowance for loan losses to nonperforming loans | | | 121.99 | % | | | 89.83 | % | | | 102.26 | % | | | 93.90 | % | | | 66.98 | % |
| Ratio of allowance for loan losses to total average loans, net of unearned income | | | 1.19 | % | | | 1.15 | % | | | 2.28 | % | | | 2.71 | % | | | 2.93 | % |
| (1) | Tangible shareholders’ equity is shareholders’ equity less goodwill and intangible assets. |
| (2) | Net interest margin is the net yield on interest-earning assets and is the difference between the interest yield earned on interest-earning assets less the interest rate paid on interest-bearing liabilities. |
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Certain financial information included in Cornerstone’s summary of consolidated financial data
This Item is
determined by methods other than in accordance with U.S. generally accepted accounting principles (“GAAP”). These non-GAAP financial measures are “tangible book value per common share,” “tangible shareholders’ equity,” and “return on average tangible equity.” Management uses these non-GAAP measures in its analysis of Cornerstone’s financial performance.“Tangible book value per common share” is defined as total equity reduced by recorded preferred stock, goodwill and other intangible assets divided by total common shares outstanding. This measure is importantnot applicable to investors interested in changes from period-to-period in book value per common share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. For companies, such as Cornerstone, that have engaged in business combinations, purchase accounting can result in the recording of significant amounts of goodwill related to such transactions.
“Tangible shareholders’ equity” is shareholders’ equity less goodwill and other intangible assets.
“Return on average tangible equity” is defined as earnings for the period divided by average equity reduced by average goodwill and other intangible assets.
These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, and are not necessarily comparable to non-GAAP performance measures which may be presented by othersmaller reporting companies. Table 4 presents a reconciliation to provide a more detailed analysis of these non-GAAP performance measures:
TABLE 4
| | | At and for the Fiscal Years Ended December 31, | |
| | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| Number of common shares outstanding | | | 6,627,398 | | | | 6,547,074 | | | | 6,500,396 | | | | 6,500,396 | | | | 6,500,396 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total stockholders’ equity | | $ | 40,662,105 | | | $ | 40,133,728 | | | $ | 40,886,836 | | | $ | 35,208,305 | | | $ | 25,819,153 | |
| Less: preferred stock | | | 14,964,309 | | | | 14,892,927 | | | | 14,821,546 | | | | 9,899,544 | | | | 2,727,424 | |
| Book value | | $ | 25,697,796 | | | $ | 25,240,801 | | | $ | 26,065,290 | | | $ | 25,308,761 | | | $ | 23,091,729 | |
| | | | | | | | | | | | | | | | | | | | | |
| Book value per common share | | $ | 3.88 | | | $ | 3.86 | | | $ | 4.01 | | | $ | 3.89 | | | $ | 3.55 | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Book value | | $ | 25,697,796 | | | $ | 25,240,801 | | | $ | 26,065,290 | | | $ | 25,308,761 | | | $ | 23,091,729 | |
| Less: goodwill and other intangible assets | | | - | | | | 2,427 | | | | 10,530 | | | | 22,487 | | | | 37,317 | |
| Tangible book value | | $ | 25,697,796 | | | $ | 25,238,374 | | | $ | 26,054,760 | | | $ | 25,286,274 | | | $ | 23,054,412 | |
| | | | | | | | | | | | | | | | | | | | | |
| Effect of intangible assets per common share | | $ | - | | | $ | .01 | | | $ | - | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Tangible book value per common share | | $ | 3.88 | | | $ | 3.85 | | | $ | 4.01 | | | $ | 3.89 | | | $ | 3.55 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net income / (loss) | | $ | 1,638,282 | | | $ | 1,680,809 | | | $ | 1,402,063 | | | $ | 1,030,052 | | | $ | (4,707,521 | ) |
| Average equity | | | 40,567,000 | | | | 40,764,000 | | | | 37,115,000 | | | | 29,740,000 | | | | 29,820,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| Return on average equity | | | 4.04 | % | | | 4.12 | % | | | 3.78 | % | | | 3.46 | % | | | (15.79 | )% |
| | | | | | | | | | | | | | | | | | | | | |
| Average equity | | $ | 40,567,000 | | | $ | 40,764,000 | | | $ | 37,115,000 | | | $ | 29,740,000 | | | $ | 29,820,000 | |
| Less: goodwill and other intangible assets | | | - | | | | 2,427 | | | | 10,530 | | | | 22,487 | | | | 37,317 | |
| Average tangible equity | | $ | 40,567,000 | | | $ | 40,761,573 | | | $ | 37,104,470 | | | $ | 29,717,513 | | | $ | 29,782,683 | |
| | | | | | | | | | | | | | | | | | | | | |
| Effect of intangible assets | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | (0.01 | )% | | | (0.02 | )% |
| | | | | | | | | | | | | | | | | | | | | |
| Return on average tangible equity | | | 4.04 | % | | | 4.12 | % | | | 3.78 | % | | | 3.47 | % | | | (15.81 | )% |
| ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Forward-Looking Statements
Cornerstone Bancshares, Inc. (“Cornerstone”) may from time to time make written or oral statements, including statements contained in this report (including, without limitation, certain statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (MD&A) in Item 7), that constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). The words “expect,” “anticipate,” “intend,” “consider,” “plan,” “believe,” “seek,” “should,” “estimate,” and similar expressions are intended to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Cornerstone’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors. Such factors include, without limitation, those specifically described in Item 1A of Part I of this Annual Report on Form 10-K, as well as the following: (i) the possibility that our asset quality would decline or that we experience greater loan losses than anticipated, (ii) high levels of other real estate, primarily as a result of foreclosures, (iii) the impact of liquidity needs on our results of operations and financial condition, (iv) competition from financial institutions and other financial service providers, (v) economic conditions in the local markets where we operate, (vi) the impact of obtaining regulatory approval prior to the payment of dividends, (vii) the impact of our Series A Preferred Stock on net income available to holders of our Common Stock and earnings per common share, (viii) the impact of negative developments in the financial industry and U.S. and global capital and credit markets, (ix) the impact of recently enacted legislation on our business, (x) the relatively greater credit risk of residential construction and land development loans in our loan portfolio, (xi) adverse impact on operations and financial condition due to changes in interest rates, (xii) our ability to obtain additional capital and, if obtained, the possible significant dilution to current shareholders, (xiii) the impact of federal and state regulations on our operations and financial performance, (xiv) whether a significant deferred tax asset we have can be fully realized, (xv) our ability to retain the services of key personnel, (xvi) the impact of Tennessee’s anti-takeover statutes and certain charter provisions on potential acquisitions of the holding company, (xvii) our ability to adapt to technological changes, and (xviii) the impact of business combinations. Many of such factors are beyond Cornerstone’s ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Cornerstone does not intend to update or reissue any forward-looking statements contained in this report as a result of new information or other circumstances that may become known to Cornerstone.
Introduction and Recent Developments
On December 8, 2014, Cornerstone announced the signing of a definitive agreement to merge with SmartFinancial, Inc., which would create a combined company that will operate under the name
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SmartFinancial, Inc. Under the terms of the agreement, each outstanding share of common stock of SmartFinancial will be converted into 4.20 shares of Cornerstone common stock, subject to adjustment based on an anticipated reverse stock split of Cornerstone’s common stock, which is expected to adjust the ratio to 1.05 shares of Cornerstone common stock for each share of SmartFinancial common stock. Additionally, each outstanding share of SmartFinancial preferred stock will be converted into a share of Cornerstone preferred stock with similar rights and preferences. Current holders of Cornerstone’s preferred stock will be asked to vote on an amendment to Cornerstone’s charter to allow Cornerstone to redeem its outstanding preferred stock prior to the completion of the merger. Completion of the merger is subject to a number of conditions, including approval by bank regulatory authorities and both SmartFinancial’s and Cornerstone’s shareholders.Cornerstone(the "
Company") is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, SmartBank (the "Bank"). The Company provides a variety of financial services to individuals and corporate customers through its offices in Tennessee, Alabama, Florida, and Georgia. The Company's primary deposit products are interest-bearing demand deposits and certificates of deposit. Its primary lending products are commercial, residential, and consumer loans. Mergers and Acquisitions
Merger with Capstone Bancshares
On May 22, 2017, the shareholders of the Company approved a merger with Capstone Bancshares, Inc. ("Capstone"), the one bank holding company of Capstone Bank, which became effective November 1, 2017. Capstone shareholders received either stock, cash, or a combination of stock and cash. After the merger, original shareholders of SmartFinancial owned approximately 74 percent of the outstanding common stock of the combined entity on a fully diluted basis while the previous Capstone shareholders owned approximately 26 percent. The assets and liabilities of Capstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of SmartFinancial. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill, which was approximately $38 million. As a result of the merger Company assets increased approximately $536 million and liabilities increased approximately $466 million. The merger had a significant impact on all aspects of the Company's financial statements, and as a result, financial results after the merger may not be comparable to financial results prior to the merger.
Purchase of Cleveland, Tennessee branch
On December 8, 2016, the Bank entered into a purchase and assumption agreement with Atlantic Capital Bank, N.A. on a branch in Cleveland, Tennessee. The purchase was completed on May 19, 2017 for a total of $1.2 million in cash. The assets and liabilities as of the effective date of the transaction were recorded at their respective estimated fair values. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill, which was $660 thousand. In the periods following the acquisition, the financial statements include the results attributable to the Cleveland branch purchase beginning on the date of purchase. As a result of the transaction the Company acquired approximately $27 million in assets and assumed $27 million in liabilities.
Merger of Legacy SmartFinancial and Cornerstone Bancshares
On August 31, 2015, Legacy SmartFinancial merged with Cornerstone Bancshares, Inc. (“Cornerstone”) ticker symbol “CSBQ,” the one bank holding company of Cornerstone Community Bank. While Cornerstone was the acquiring entity for legal purposes, the merger was accounted for as a reverse merger using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, Legacy SmartFinancial is considered the acquirer in the merger, and as a result the historical financial statements of the combined entity are the historical financial statements of Legacy SmartFinancial. As a result of the merger Company assets increased approximately $450 million and liabilities increased approximately $421 million. The merger had a significant impact on all aspects of the Company's financial statements, and as a result, financial results after the merger may not be comparable to financial results prior to the merger.
Acquisition of Assets and Liabilities of the former Gulf South Private Bank
On October 19, 2012, SmartBank assumed all of the deposits and certain other liabilities and acquired certain assets of GulfSouth Private Bank (“GulfSouth”), headquartered in Destin, Florida from the FDIC pursuant to the terms of a Purchase and Assumption Agreement. As a result of the transaction the Company acquired approximately $141 million in assets and assumed $136 million in liabilities.
Business Overview
The Company’s business model consists of leveraging capital into assets funded by liabilities. As a general rule capital can be leveraged approximately ten times. The primary source of revenue is interest income from earning assets, namely loans and securities. These liabilities used to fund the assets are primarily deposits. The Company seeks to maximize net interest income, the difference between interest received on earning assets and the parent companyamount of the Bank, a Tennessee banking corporation which operates primarily in and around Chattanooga, Tennessee. The Bank has five full-service banking offices located in Hamilton County, Tennessee, and one loan production office located in Dalton, Georgia. The Bank’s business consists primarily of attracting deposits from the general public and, with these and other funds, originating real estate loans, consumer loans, business loans, and residential and commercial construction loans. The principal sources of income for the Bank are interest and fees collected on loans, fees collected on deposit accounts, and interest and dividends collected on other investments. The principal expenses of the Bank are interest paid on deposits, employee compensationliabilities. Net interest income to
average assets is a key ratio that measures the profitability of the earning assets of the company. Noninterest income is the second source of revenue and
benefits, office expenses,primarily consists of customer service fees, gains on the sales of securities and loans, and other
overhead expenses.noninterest income. Noninterest income to average assets is a ratio that reflects our effectiveness in generating these other forms of revenue. The Company incurs noninterest expenses as result of the operations of its business. Primary expenses are those of employees, occupancy and equipment, professional services, and data processing. The Company seeks to minimize the amount of noninterest expense relative to the amount of total assets; noninterest expense to assets is a key ratio that measures the efficiency of the costs incurred to operate the business.
Executive Summary
The following is a discussion of Cornerstone’s financial condition at December 31, 2014 and December 31, 2013, and Cornerstone’s results of operations for eachsummary of the three-years ended December 31, 2014, 2013Company’s financial highlights and 2012. The purposesignificant events during 2017:
Completed two acquisitions during the year which increased assets by approximately $563 million : a branch in Cleveland, Tennessee in the second quarter and Capstone Bancshares along with Capstone Community Bank in the fourth quarter.
Earnings available to common shareholders held steady at $4.8 million, in spite of this discussion isa $2.4 million after-tax charge to focus on information about Cornerstone’s financial conditionwrite down the Company's deferred tax assets as a result of the Tax Cuts and resultsJobs Act of operations2017.
Ended 2017 with record high total assets of $1.7 billion, net loans of $1.3 billion, and deposits of $1.4 billion.
Net interest margin, taxable equivalent, increased over 20 basis points in 2017 to 4.30 percent compared to 4.06 percent in 2016.
Efficiency ratio, which is not otherwise apparentequal to noninterest expense divided by the sum of net interest income and noninterest income, decreased to 76.0 percent in 2017, compared to 76.4 percent in 2016, in spite of $2.4 million in merger expenses during 2017.
Analysis of Results of Operations
2017 compared to 2016
Net income was $5.0 million in 2017, compared to $5.8 million in 2016. Net income available to common shareholders was $4.8 million, or $0.55 per diluted common share, in 2017, compared to $4.8 million, or $0.78 per diluted common share, in 2016. Net interest income to average assets of 3.90 percent in 2017 was up from 3.77 percent in 2016, with the increase as a result of a higher percentage of average earning assets to average interest bearing liabilities as well as higher earning asset yields. Noninterest income to average assets of 0.42 percent was up from 0.41 percent in 2016 as a result of increases in customer service fees, higher gains on the sale of loans and other assets, and higher other noninterest income. Noninterest expense to average assets increased from 3.20 percent in 2016 to 3.29 percent in 2017 primarily due to $2.4 million in merger expenses during 2017. The resulting pretax income to average assets was 1.00 percent in 2017 compared to 0.95 percent in 2016. Finally, in 2017 the effective tax rate was 56.2 percent, which was up substantially from 36.7 percent in 2016 due to a $2.4 million after-tax charge to write down the Company's deferred tax assets as a result of the Tax Cuts and Jobs Act of 2017.
.
2016 compared to 2015
Net income was $5.8 million in 2016, which was up substantially from $1.5 million in 2015. Net income available to common shareholders was $4.8 million, or $0.78 per diluted common share, in 2016, an increase from $1.4 million, or $0.32 per diluted common share, in 2015. Net interest income to average assets of 3.77 percent in 2016 was up from 3.66 percent in 2015, with the increase as a result of a higher percentage of average earning assets to average total assets. Noninterest income to average assets of 0.41 percent was up from 0.33 percent in 2015 as a result of increases in customer service fees, higher gains on the sale of securities, gains on the sale of loans and other assets compared to losses in 2015, and higher other noninterest income. Noninterest expense to average assets decreased from 3.39 percent in 2015 to 3.20 percent in 2016 due to realized efficiencies of scale and the absences of merger and conversion related costs. The resulting pretax income to average assets was 0.95 percent in 2016 compared to 0.46 percent in 2015. Finally, in 2016 the effective tax rate was 36.70 percent, which was down substantially from 2015 when taxes were elevated due to merger and acquisition expenses which were nondeductible.
Net Interest Income and Yield Analysis
2017 compared to 2016
Net interest income, taxable equivalent, improved to $46.4 million in 2017 from $38.3 million in 2016. The increase in net interest income, taxable equivalent, was the result of a significant increase in earning assets primarily from the consolidatedCapstone merger but also from organic business activity. Average earning assets increased from $944.6 million in 2016 to $1,083.7 million in 2017. Over
this period, average loan balances increased by $150.9 million and average securities and interest bearing balances at other financial statements. institutions decreased by $24.0 million. In addition, total average interest-bearing deposits increased by $113.8 million. Net interest income to average assets of 3.90 percent in 2017 was up from 3.77 percent in 2016. Net interest margin, taxable equivalent, was 4.30 percent in 2017, compared to 4.06 percent in 2016. Net interest margin, taxable equivalent, was slightly negatively impacted by an increase in the cost of interest bearing liabilities from 0.56 percent in 2016 to 0.66 percent in 2017. In 2018 we expect net interest income to average assets and net interest margin, taxable equivalent, to experience pressure as there is the potential for pressure to increase deposit rates as short term rates have continued to increase but do anticipate the effect of rate increases will be mitigated on the income side by increases in yields of our floating rate earning assets.
2016 compared to 2015
Net interest income, taxable equivalent, improved to $38.3 million in 2016 from $25.0 million in 2015. The increase in net interest income, taxable equivalent, was the result of a significant increase in earning assets primarily from the merger but also from organic business activity. Average earning assets increased from $615.3 million in 2015 to $944.6 million in 2016. Over this period, average loan balances increased by $282.5 million and average securities and interest bearing balances at other financial institutions increased by $54.1 million. In addition, total average interest-bearing deposits increased by $219.0 million. Net interest income to average assets of 3.77 percent in 2016 was up from 3.66 percent in 2015. Net interest margin, taxable equivalent, was 4.06 percent in 2016, compared to 4.07 percent in 2015. Net interest margin, taxable equivalent, was negatively affected by an increase in the cost of interest bearing liabilities from 0.52 percent in 2015 to 0.56 percent in 2016.
The following
discussion and analysis should be read along with Cornerstone’s consolidated financial statementstable summarizes the major components of net interest income and the related
notes included elsewhere herein.
Review of Financial Performance
As of December 31, 2014, Cornerstone had total consolidated assets of approximately $416 million, total loans of approximately $295 million, total deposits of approximately $309 millionyields and stockholders’ equity of approximately $41 million. Cornerstone earned net income of approximately $1.6 millioncosts for 2014 compared to net income of approximately $1.7 million for 2013the periods presented.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2017 | | 2016 | | 2015 |
| (Dollars in thousands) | | Average | | | | Yield/ | | Average | | | | Yield/ | | Average | | | | Yield/ |
| | | Balance | | Interest * | | Cost* | | Balance | | Interest * | | Cost* | | Balance | | Interest * | | Cost* |
| Assets | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
| Loans (1) | | $ | 919,603 |
| | $ | 48,834 |
| | 5.31 | % | | $ | 768,720 |
| | $ | 39,779 |
| | 5.17 | % | | $ | 486,183 |
| | $ | 25,739 |
| | 5.29 | % |
| Investment securities (2) | | 143,329 |
| | 2,953 |
| | 2.07 | % | | 167,352 |
| | 2,609 |
| | 1.56 | % | | 113,281 |
| | 1,877 |
| | 1.66 | % |
| Federal funds and other | | 20,807 |
| | 353 |
| | 1.70 | % | | 8,568 |
| | 247 |
| | 2.88 | % | | 15,853 |
| | 161 |
| | 1.02 | % |
| Total interest-earning assets | | 1,083,739 |
| | $ | 52,140 |
| | 4.82 | % | | 944,640 |
| | $ | 42,635 |
| | 4.51 | % | | 615,317 |
| | $ | 27,777 |
| | 4.51 | % |
| Noninterest-earning assets | | 104,850 |
| | |
| | |
| | 67,592 |
| | |
| | |
| | 68,202 |
| | |
| | |
|
| Total assets | | $ | 1,188,589 |
| | |
| | |
| | $ | 1,012,232 |
| | |
| | |
| | $ | 683,519 |
| | |
| | |
|
| | | | | | | | | | | | | | | | | | | |
| Liabilities and Shareholders’ Equity | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
| Interest-bearing demand deposits | | $ | 166,382 |
| | $ | 539 |
| | 0.32 | % | | $ | 150,649 |
| | $ | 286 |
| | 0.19 | % | | $ | 117,036 |
| | $ | 173 |
| | 0.15 | % |
| Money market and savings deposits | | 342,637 |
| | 1,759 |
| | 0.51 | % | | 258,092 |
| | 1,172 |
| | 0.45 | % | | 161,405 |
| | 656 |
| | 0.41 | % |
| Time deposits | | 329,524 |
| | 3,221 |
| | 0.98 | % | | 316,046 |
| | 2,647 |
| | 0.84 | % | | 227,317 |
| | 1,797 |
| | 0.79 | % |
| Total interest-bearing deposits | | 838,543 |
| | 5,519 |
| | 0.66 | % | | 724,787 |
| | 4,105 |
| | 0.57 | % | | 505,758 |
| | 2,626 |
| | 0.52 | % |
| Securities sold under agreement to repurchase | | 19,856 |
| | 61 |
| | 0.31 | % | | 21,329 |
| | 65 |
| | 0.30 | % | | 11,335 |
| | 30 |
| | 0.26 | % |
| Federal Home Loan Bank advances and other borrowings | | 4,887 |
| | 113 |
| | 2.32 | % | | 17,451 |
| | 129 |
| | 0.74 | % | | 13,490 |
| | 101 |
| | 0.75 | % |
| Total interest-bearing liabilities | | 863,286 |
| | 5,693 |
| | 0.66 | % | | 763,567 |
| | 4,299 |
| | 0.56 | % | | 530,583 |
| | 2,757 |
| | 0.52 | % |
| Net interest income, taxable equivalent | | | | $ | 46,447 |
| | |
| | |
| | $ | 38,336 |
| | |
| | |
| | $ | 25,020 |
| | |
|
| Noninterest-bearing deposits | | 172,842 |
| | |
| | |
| | 139,652 |
| | |
| | |
| | 80,794 |
| | |
| | |
|
| Other liabilities | | 6,657 |
| | |
| | |
| | 5,535 |
| | |
| | |
| | 1,812 |
| | |
| | |
|
| Total liabilities | | 1,042,785 |
| | |
| | |
| | 908,754 |
| | |
| | |
| | 613,189 |
| | |
| | |
|
| Shareholders’ equity | | 145,804 |
| | |
| | |
| | 103,478 |
| | |
| | |
| | 70,330 |
| | |
| | |
|
| Total liabilities and shareholders’ equity | | $ | 1,188,589 |
| | | | | | $ | 1,012,232 |
| | |
| | |
| | $ | 683,519 |
| | |
| | |
|
| | | |
| | | | |
| | | | | | | | | | | | |
| Interest rate spread (3) | | |
| | |
| | 4.16 | % | | |
| | |
| | 3.95 | % | | |
| | |
| | 3.99 | % |
| Tax equivalent net interest margin (4) | | |
| | |
| | 4.30 | % | | |
| | |
| | 4.06 | % | | |
| | |
| | 4.07 | % |
| | | | | | | | | | | | | | | | | | | |
| Percentage of average interest-earning assets to average interest-bearing liabilities | | |
| | |
| | 125.5 | % | | |
| | |
| | 123.7 | % | | |
| | |
| | 116.0 | % |
| Percentage of of average equity to average assets | | |
| | |
| | 12.3 | % | | |
| | |
| | 10.2 | % | | |
| | |
| | 10.3 | % |
| * Taxable equivalent basis | | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
|
| |
| (1) | Loans include nonaccrual loans. Yields related to loans exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $28 thousand for 2017, $16 thousand for 2016 and $8 thousand for 2015. Loan fees included in loan income was $2.5 million, $2.6 million, and $1.3 million for 2017, 2016 and 2015, respectively. |
| |
| (2) | Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was $90 thousand, $55 thousand and $16 thousand for 2017, 2016 and 2015, respectively. |
| |
| (3) | Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
| |
| (4) | Net interest margin represents net interest income divided by average interest-earning assets. |
Rate and
approximately $1.4 million for 2012.Results of Operations
Net Interest Income-Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest-bearing liabilities. Volume Analysis
Net interest income,
is alsotaxable equivalent, increased by $8.1 million between the
most significant component of Cornerstone’s earnings. For the year ended December 31, 2014, Cornerstone recorded net interest income of approximately $15,348,000, which resulted in a net interest margin of 3.90%.For the year ended December 31, 2013, Cornerstone recorded net interest income of approximately $14,930,000, which resulted in a net interest margin of 3.80%. For the year ended December 31, 2012, Cornerstone recorded net interest income of approximately $14,568,000, which resulted in a net interest margin of 3.85%.Table 5 presents information with respect to interest income from average interest-earning assets, expressed both in dollars and yields, and interest expense on average interest-bearing liabilities, expressed both in dollars and rates, for the periods indicated. The table includes loan yields, which reflect the amortization of deferred loan origination and commitment fees. Interest income from investment securities includes the accretion of discounts and amortization of premiums.
TABLE 5
Yields Earned on Average Earning Assets and
Rates Paid on Average Interest-Bearing Liabilities |
| Years Ended December 31, |
| (In thousands) | | 2014 | | | 2013 | | | 2012 | |
ASSETS | | Average
Balance | | | Interest
Income/
Expense(1) | | | Yield/
Rate | | | Average
Balance | | | Interest
Income/
Expense(1) | | | Yield/
Rate | | | Average
Balance | | | Interest
Income/
Expense(1) | | | Yield/
Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans(1)(2) | | $ | 293,708 | | | $ | 16,690 | | | | 5.68 | % | | $ | 278,975 | | | $ | 16,705 | | | | 5.99 | % | | $ | 268,828 | | | $ | 17,289 | | | | 6.43 | % |
| Investment securities(3) | | | 89,114 | | | | 1,416 | | | | 1.72 | % | | | 98,108 | | | | 1,694 | | | | 1.94 | % | | | 89,587 | | | | 2,004 | | | | 2.53 | % |
| Other earning assets | | | 13,615 | | | | 31 | | | | 0.23 | % | | | 20,749 | | | | 54 | | | | 0.26 | % | | | 27,010 | | | | 60 | | | | 0.22 | % |
| Total interest-earning assets | | | 396,437 | | | | 18,137 | | | | 4.60 | % | | | 397,832 | | | | 18,453 | | | | 4.69 | % | | | 385,425 | | | | 19,353 | | | | 5.09 | % |
| Allowance for loan losses | | | (3,284 | ) | | | | | | | | | | | (4,547 | ) | | | | | | | | | | | (6,140 | ) | | | | | | | | |
| Cash and other assets | | | 27,350 | | | | | | | | | | | | 35,409 | | | | | | | | | | | | 35,756 | | | | | | | | | |
| Total assets | | $ | 420,503 | | | | | | | | | | | $ | 428,694 | | | | | | | | | | | $ | 415,041 | | | | | | | | | |
| TOTAL LIABILITIES AND EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | $ | 26,921 | | | $ | 40 | | | | 0.15 | % | | $ | 26,196 | | | $ | 55 | | | | 0.21 | % | | $ | 26,483 | | | $ | 87 | | | | 0.33 | % |
| Money market / savings | | | 82,903 | | | | 273 | | | | 0.33 | % | | | 88,912 | | | | 419 | | | | 0.47 | % | | | 62,958 | | | | 460 | | | | 0.73 | % |
| Time deposits | | | 157,112 | | | | 1,428 | | | | 0.91 | % | | | 165,748 | | | | 1,766 | | | | 1.07 | % | | | 187,733 | | | | 2,471 | | | | 1.32 | % |
| Total interest-bearing deposits | | | 266,936 | | | | 1,741 | | | | 0.65 | % | | | 280,856 | | | | 2,240 | | | | 0.80 | % | | | 277,174 | | | | 3,018 | | | | 1.09 | % |
| Securities sold under agreement to repurchase | | | 22,026 | | | | 85 | | | | 0.39 | % | | | 22,041 | | | | 74 | | | | 0.34 | % | | | 21,312 | | | | 94 | | | | 0.44 | % |
| Other borrowings | | | 30,845 | | | | 964 | | | | 3.13 | % | | | 31,634 | | | | 1,209 | | | | 3.82 | % | | | 39,282 | | | | 1,673 | | | | 4.26 | % |
| Total interest-bearing liabilities | | | 319,807 | | | | 2,790 | | | | 0.87 | % | | | 334,531 | | | | 3,523 | | | | 1.05 | % | | | 337,768 | | | | 4,785 | | | | 1.42 | % |
| Net interest spread | | | | | | | | | | | 3.73 | % | | | | | | | | | | | 3.64 | % | | | | | | | | | | | 3.67 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Other liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 59,219 | | | | | | | | | | | | 51,614 | | | | | | | | | | | | 39,936 | | | | | | | | | |
| Accrued interest payable and other liabilities | | | 910 | | | | | | | | | | | | 1,785 | | | | | | | | | | | | 222 | | | | | | | | | |
| Stockholders' equity | | | 40,567 | | | | | | | | | | | | 40,764 | | | | | | | | | | | | 37,115 | | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 420,503 | | | | | | | | | | | $ | 428,694 | | | | | | | | | | | $ | 415,041 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest margin | | | | | | $ | 15,347 | | | | 3.90 | % | | | | | | $ | 14,930 | | | | 3.80 | % | | | | | | $ | 14,568 | | | | 3.85 | % |
(1) Interest income on loans includes amortization of deferred loan fees and other discounts of $85 thousand, $176 thousand, and $168 thousand for the fiscal years ended December 31, 2014, 2013,2017 and 2012, respectively.
(2) Nonperforming loans are included in2016 and by $6.3 million between the computationyears ended December 31, 2016 and 2015. The following is an analysis of average loan balances, and interest income on such loans is recognized on a cash basis.
(3) Yields on securities are calculated on a fully tax equivalent basis.
Other matters related to the changes in net interest income net interest yields andcomparing the changes attributable to rates and net interest margin are presented below:
those attributable to volumes (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2017 Compared to 2016 Increase (decrease) due to | | 2016 Compared to 2015 Increase (decrease) due to |
| | | Rate | | Days | | Volume | | Net | | Rate | | Days | | Volume | | Net |
| Interest-earning assets: | | |
| | | | |
| | |
| | |
| | | | |
| | |
|
| Loans (1) | | $ | 1,342 |
| | (109 | ) | | $ | 7,822 |
| | $ | 9,055 |
| | $ | (976 | ) | | 70 |
| | $ | 14,946 |
| | $ | 14,040 |
|
| Investment securities (2) | | 727 |
| | (7 | ) | | (376 | ) | | 344 |
| | (171 | ) | | 5 |
| | 898 |
| | 732 |
|
| Federal funds and other | | (246 | ) | | (1 | ) | | 353 |
| | 106 |
| | 160 |
| | — |
| | (74 | ) | | 86 |
|
| Total interest-earning assets | | 1,823 |
| | (117 | ) | | 7,799 |
| | 9,505 |
| | (987 | ) | | 75 |
| | 15,770 |
| | 14,858 |
|
| | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
| Interest-bearing demand deposits | | 224 |
| | (1 | ) | | 30 |
| | 253 |
| | 63 |
| | — |
| | 50 |
| | 113 |
|
| Money market and savings deposits | | 209 |
| | (3 | ) | | 381 |
| | 587 |
| | 118 |
| | 2 |
| | 396 |
| | 516 |
|
| Time deposits | | 467 |
| | (7 | ) | | 114 |
| | 574 |
| | 144 |
| | 5 |
| | 701 |
| | 850 |
|
| Total interest-bearing deposits | | 900 |
| | (11 | ) | | 525 |
| | 1,414 |
| | 325 |
| | 7 |
| | 1,147 |
| | 1,479 |
|
| Securities sold under agreement to repurchase | | — |
| | — |
| | (4 | ) | | (4 | ) | | 9 |
| | — |
| | 26 |
| | 35 |
|
Federal Home Loan Bank advances and other borrowings | | 77 |
| | — |
| | (93 | ) | | (16 | ) | | (2 | ) | | — |
| | 30 |
| | 28 |
|
| Total interest-bearing liabilities | | 977 |
| | (11 | ) | | 428 |
| | 1,394 |
| | 332 |
| | 7 |
| | 1,203 |
| | 1,542 |
|
| Net interest income | | $ | 846 |
| | (106 | ) | | $ | 7,371 |
| | $ | 8,111 |
| | $ | (1,319 | ) | | 68 |
| | $ | 14,567 |
| | $ | 13,316 |
|
|  |
| (1) | Loans include nonaccrual loans. Yields related to loans exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The net interest margin increased 10 basis points from 3.80% as of December 31, 2013 to 3.90% as of December 31, 2014. The improvement in the net interest margintaxable-equivalent adjustment was primarily derived from the decrease in total interest-bearing liability expense. Over the last two years, Cornerstone has been able to reduce its expense in local deposits as well as the expense incurred from Federal Home Loan Bank (FHLB) advances$28 thousand for 2017, $16 thousand for 2016 and other borrowings. The Bank will have an opportunity to further decrease interest costs in FHLB advances during 2015, as $10 million of long-term advances mature. Management anticipates a reduction in interest cost of approximately 300 basis points or $300$8 thousand annually. The new advances will be short-term in nature, 12 months or less, but will allow the Bank to improve its net interest margin and will still allow management to position the balance sheet for interest rate risk if interest rates rise in the near future. |
| | As of December 31, 2014, the Bank’s loan portfolio yield decreased from 5.99% as of December 31, 2013 to 5.68% as of December 31, 2014. The decline in loan portfolio yield is primarily attributable to the competition in Cornerstone’s lending market. Despite the decline in loan yield, the Bank was able to generate approximately the same in interest income as in 2013. In 2013, the Bank earned approximately $16,705,000 in interest income and in 2014 the Bank earned approximately $16,690,000 in interest income. Management anticipates that 2015 could be very similar. Management believes the loan portfolio will continue to increase in 2015. However, a lower loan yield could result as well. |
| | As of December 31, 2014, the Bank’s investment portfolio resulted in a yield of 1.72% compared to 1.94% as of December 31, 2013 and 2.53% as of December 31, 2012. The decline in investment yield is primarily attributable to the reduction in the Bank’s municipal securities. During this three-year period, the Bank elected to realize a significant portion of its unrealized gain in the municipal portfolio. The total gain realized during the three-year period is approximately $1.4 million. The additional revenue from these transactions was used, primarily, to address elevated foreclosed asset expenses. Management believes the size of the investment portfolio is appropriate given the Bank’s anticipated increase in loans during 2015. However, management does not see significant opportunities to improve the investment portfolio yield until interest rates increase. At that point, approximately 74% of the investment portfolio, which is comprised of floating rate mortgage backed securities, will increase in yield. Finally, the Bank will continue to use the investment portfolio for liquidity and pledging purposes with the State of Tennessee Collateral Pool, correspondent bank lines and to secure repurchase agreements. As of December 31, 2014, the Bank’s securities portfolio was invested 89.22% in United States Government agency or sponsored agency securities, 8.19% in municipal general obligation securities and the remaining 2.59% in FHLB stock. |
| |
| (2) | During 2014, the BankYields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 34.0 percent. The taxable-equivalent adjustment was able to reduce its total deposit cost from 0.80% as of December 31, 2013 to 0.65% as of December 31, 2014. This decrease was in part due the Bank consistently monitoring local market conditions$90 thousand, $55 thousand and adjusting interest rates on deposits when appropriate. The Bank did experience a decline in average total interest-bearing deposits to approximately $267 million as of December 31, 2014 from approximately $281 million as of December 31, 2013. The most significant decline occurred in the Bank’s time deposit accounts. Average time deposits decreased by approximately $9 million from the December 31, 2013 total of approximately $166 million to approximately $157 million as of December 31, 2014. Management is currently reviewing liquidity$16 thousand for 2017, 2016 and deposit gathering opportunities to not only address the need to increase total deposits but also provide the best solutions to address future interest rate risk.2015, respectively. |
Tables 6 and 7 present the
Changes in net interest income are attributed to either changes in
interest income and interest expense that are attributable to three factors: | (i) | A change in volume or amount of an asset or liability. |
| (ii) | A change in interest rates. |
| (iii) | A change caused by the combination of changes in asset or deposit mix. |
The tables describe the extent to whichaverage balances (volume change), changes in interestaverage rates and changes in volume of interest-earning(rate change) for earning assets and interest-bearing liabilities have affected Cornerstone’ssources of funds on which interest income and expense duringis received or paid, or changes within the number of days in the two periods indicated. For each category of interest-earning assets and interest-bearing liabilities, informationcompared. Volume change is providedcalculated as to changes attributable to change in volume (change in volume multiplied by current rate) andtimes the previous rate while rate change is change in rate times the previous volume. The change attributed to rates and volumes (change in rate multiplied by currenttimes change in volume). is considered above as a change in volume.
Non Interest Income
The
remaining difference has been allocated to mix.TABLE 6
INTEREST INCOME AND EXPENSE ANALYSIS
| | | Year Ended December 31, | |
| | | 2014 Compared to 2013 | |
| (In Thousands) | | Volume | | | Rate | | | Mix | | | Net
Change | |
| Interest income: | | | | | | | | | | | | | | | | |
| Loans (1)(2) | | $ | 837 | | | $ | (911 | ) | | $ | 59 | | | $ | (15 | ) |
| Investment securities | | | (155 | ) | | | (196 | ) | | | 73 | | | | (278 | ) |
| Other earning assets | | | (16 | ) | | | (4 | ) | | | (3 | ) | | | (23 | ) |
| Total interest income | | | 666 | | | | (1,111 | ) | | | 129 | | | | (316 | ) |
| | | | | | | | | | | | | | | | | |
| Interest expense: | | | | | | | | | | | | | | | | |
| NOW accounts | | | 1 | | | | (16 | ) | | | - | | | | (15 | ) |
| Money market and savings accounts | | | (20 | ) | | | (116 | ) | | | (10 | ) | | | (146 | ) |
| Time deposits | | | (79 | ) | | | (251 | ) | | | (8 | ) | | | (338 | ) |
| Other borrowings | | | (25 | ) | | | (213 | ) | | | (7 | ) | | | (245 | ) |
| Securities sold under agreement to repurchase | | | - | | | | 11 | | | | - | | | | 11 | |
| Total interest expense | | | (123 | ) | | | (585 | ) | | | (25 | ) | | | (733 | ) |
| Change in net interest income (expense) | | | | | | | | | | | | | | $ | 417 | |
| (1) | Loan amounts include interest income recognized on a cash basis on nonaccrual loans. |
| (2) | Interest income includes the portion of loan fees recognized in the respective periods. |
TABLE 7
INTEREST INCOME AND EXPENSE ANALYSIS
| | | Year Ended December 31, | |
| | | 2013 Compared to 2012 | |
| (In Thousands) | | Volume | | | Rate | | | Mix | | | Net
Change | |
| Interest income: | | | | | | | | | | | | | | | | |
| Loans (1)(2) | | $ | 608 | | | $ | (1,227 | ) | | $ | 35 | | | $ | (584 | ) |
| Investment securities | | | 165 | | | | (579 | ) | | | 104 | | | | (310 | ) |
| Other earning assets | | | (16 | ) | | | 8 | | | | 2 | | | | (6 | ) |
| Total interest income | | | 757 | | | | (1,798 | ) | | | 141 | | | | (900 | ) |
| | | | | | | | | | | | | | | | | |
| Interest expense: | | | | | | | | | | | | | | | | |
| NOW accounts | | | (1 | ) | | | (31 | ) | | | - | | | | (32 | ) |
| Money market and savings accounts | | | 122 | | | | (231 | ) | | | 68 | | | | (41 | ) |
| Time deposits | | | (235 | ) | | | (414 | ) | | | (56 | ) | | | (705 | ) |
| Other borrowings | | | (292 | ) | | | (139 | ) | | | (33 | ) | | | (464 | ) |
| Securities sold under agreement to repurchase | | | 2 | | | | (22 | ) | | | - | | | | (20 | ) |
| Total interest expense | | | (404 | ) | | | (837 | ) | | | (21 | ) | | | (1,262 | ) |
| Change in net interest income (expense) | | | | | | | | | | | | | | $ | 362 | |
| (1) | Loan amounts include interest income recognized on a cash basis on nonaccrual loans. |
| (2) | Interest income includes the portion of loan fees recognized in the respective periods. |
Provision for Loan Losses-The provision for loan losses representsfollowing table provides a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, should be adequate to provide coverage for the inherent losses on outstanding loans. The provision for loan losses amounted to $515 thousand for the year ended December 31, 2014 compared to $300 thousand for the year ended December 31, 2013. Cornerstone maintains policies and procedures used to estimate the allowance for loan losses which are periodically reviewed by regulators. Refer to additional documentation on the allowance for loan losses immediately prior to Table 17. There are factors beyond Cornerstone’s control, such as conditions in the local and national economy, which may negatively impact Cornerstone’s asset quality. The measurements are approximations which may require additional provisions to loan losses based upon changing circumstances or when additional information becomes available or known. Other matters relating to the changes in provision for loan losses are presented below:
| | In 2014, Cornerstone increased its allowance for loan losses account to provide an adequate allowance for the increase in outstanding loans. First, Cornerstone recognized $515 thousand of provision expense. Second, for the twelve months ended December 31, 2014, Cornerstone received approximately $1.4 million in recoveries of loans previously charged off. The provision expense and recoveries were offset with existing loan charge offs totaling approximately $1.6 million. Cornerstone’s net charge-offs were approximately $200 thousand. This relatively low net charge-off amount allowed Cornerstone to increase its allowance for loan losses with only $515 thousand in provision expense. Management believes that its allowance methodology and the inputs used in the estimation process are appropriate and consistent with generally accepted accounting principles and interagency policy statements published by the Bank’s regulatory agencies. |
| | To address the problem credits in the Bank’s loan portfolio, a Special Asset Committee was created in 2008. The Committee continues to meet at least monthly to review problem loans. The Committee coordinates various activities across multiple departments in the Bank, such as reviewing loan grades assigned by the Bank’s loan review department and overseeing the development and review of action plans that identify possible strategies to minimize the Bank’s losses. The early detection and proactive resolution process serves to assist customers in the current economic environment while potentially minimizing the Bank’s losses. |
Noninterest Income-Items reported as noninterest income include service charges on checking accounts, insufficient funds charges, automated clearing house (ACH) processing fees and the Bank’s secondary mortgage department earnings. Increases in income derived from service charges and ACH fees are primarily a function of the Bank’s growth while fees from the origination of mortgage loans will often reflect market conditions and fluctuate from period to period.
Table 8 presents the componentssummary of noninterest income for the years ended December 31, 2014, 2013periods presented.
|
| | | | | | | | | | | | |
| | | Year ended December 31, |
| (Dollars in thousands) | | 2017 | | 2016 | | 2015 |
| Service charges and fees on deposit accounts | | $ | 1,374 |
| | $ | 1,128 |
| | $ | 913 |
|
| Gain on sale of securities | | 144 |
| | 199 |
| | 52 |
|
| Gain (loss) on sale of loans and other assets | | 1,276 |
| | 948 |
| | (112 | ) |
| (Loss) gain on sale of foreclosed assets | | (48 | ) | | 191 |
| | 266 |
|
| Other noninterest income | | 2,234 |
| | 1,717 |
| | 1,124 |
|
| Total noninterest income | | $ | 4,979 |
| | $ | 4,183 |
| | $ | 2,243 |
|
2017 compared to 2016
Noninterest income totaled $5.0 million in 2017, which was an increase from $4.2 million in 2016. Noninterest income to average assets of 0.42 percent was up from 0.41 percent in 2016. Primary drivers of the increase were gains on the sale of loans and
2012 (in thousands).TABLE 8
| | | 2014 | | | 2013 | | | 2012 | |
| Customer service fees | | $ | 850 | | | $ | 821 | | | $ | 803 | |
| Other noninterest income | | | 57 | | | | 63 | | | | 64 | |
| Net gain from sale of securities | | | 700 | | | | 652 | | | | - | |
| Net gain from sale of loans & other assets | | | 212 | | | | 404 | | | | 152 | |
| Total noninterest income | | $ | 1,819 | | | $ | 1,940 | | | $ | 1,019 | |
Significant matters relatingother assets and higher other noninterest income. In 2017, there were gains of $1.3 million on the sale of mortgage loans, SBA loans and other assets compared to $0.9 million in 2016. In 2017 there were losses of $48 thousand on the changessale of foreclosed assets, compared to a gain of $191 thousand in 2016. Other noninterest income are presented below:
| | The Bank was ableof $2.2 million in 2017 was up from $1.7 million in 2016 primarily due to higher income from company owned life insurance and higher interchange income. In 2018, we expect noninterest income to average assets to slightly increase its customer service fees during 2014. Management performed research during 2014 to ensure its service charges were appropriate when compared to other financial institutions in our market. Management anticipates a slight increase in customer service fees in 2015, when compared to 2014, as the new fee schedule is in effect for the entire year. |
| | In 2014 and 2013, the Bank elected to liquidate a portion of its municipal securities portfolio to take advantage of market conditions and offset losses associated with the disposal of foreclosed assets. These realized gains have assisted the Bank in reducing its foreclosed assets from approximately $20 million as of December 31, 2012 to approximately $8 million as of December 31, 2014. |
The Bank actively seeks opportunities to lend through the Small Business Administration (SBA) lending programs. As a result of this effortincreased loan sales from the Bank is ablemortgage unit, higher service charges on deposit accounts, and higher other noninterest income.
2016 compared to generate fees2015
Noninterest income totaled $4.2 million in 2016, which was an increase from $2.2 million in 2015. Noninterest income to average assets of 0.41 percent was up from 0.33 percent in 2015. Primary drivers of the increase were higher gains on the sale of securities, gains on the sale of loans and
improve itsother assets compared to losses in 2015, and higher other noninterest income. In
2013,2016, there were gains of $948 thousand on the
Bank was able to close severalsale of mortgage loans, SBA loans and
generate approximately $404other assets compared to a loss of $112 thousand in
fees.2015 due to the loss on the sale of a bank owned property. In
2014,2016 there were gains of $191 thousand on the
Bank did not have as many loan opportunities. Therefore, the amountsale of
fees generated were closer to historic levels as seenforeclosed assets, down from a gain of $266 thousand in
2012. The Bank continues to look for these opportunities to increase it2015. Other noninterest income
and provide lendingof $1.7 million in 2016 was up from $1.1 million in 2015 primarily due to
customers and our community.increased revenue as a result of the merger.
Noninterest Expense-Items reported as
The following table provides a summary of noninterest expense include salariesfor the periods presented.
|
| | | | | | | | | | | | |
| | | Year ended December 31, |
| (Dollars in thousands) | | 2017 | | 2016 | | 2015 |
| Salaries and employee benefits | | $ | 20,743 |
| | $ | 17,715 |
| | $ | 11,831 |
|
| Net occupancy and equipment expense | | 4,271 |
| | 3,996 |
| | 2,682 |
|
| Depository insurance | | 466 |
| | 606 |
| | 488 |
|
| Foreclosed assets | | 84 |
| | 236 |
| | 290 |
|
| Advertising | | 638 |
| | 616 |
| | 453 |
|
| Data processing | | 1,875 |
| | 1,893 |
| | 1,197 |
|
| Professional services | | 2,085 |
| | 2,123 |
| | 2,454 |
|
| Amortization of other intangible assets | | 346 |
| | 305 |
| | 233 |
|
| Service contracts | | 1,398 |
| | 1,154 |
| | 751 |
|
| Merger expenses | | 2,417 |
| | — |
| | 1,155 |
|
| Other operating expenses | | 4,758 |
| | 3,856 |
| | 1,632 |
|
| Total noninterest expense | | $ | 39,082 |
| | $ | 32,500 |
| | $ | 23,166 |
|
2017 compared to 2016
Noninterest expense totaled $39.1 million in 2017 compared to $32.5 million in 2016. Noninterest expense to average assets increased from 3.20 percent in 2016 to 3.29 percent in 2017. Salaries and employee benefits, occupancy and equipment,
expense, depository insurance, net foreclosed assets expense and other
operating expenses.Table 9 presents the components of noninterest expense categories in 2017 were all higher as a result of two full months of post-merger expenses. In 2017 noninterest expense was also elevated by $2.4 million of merger expenses, compared to none in 2016. In 2018, we expect noninterest expense to average assets to decrease as a result of assets growing faster than core operating expenses and a reduction in merger expenses.
2016 compared to 2015
Noninterest expense totaled $32.5 million in 2016 compared to $23.2 million in 2015. Noninterest expense to average assets decreased from 3.39 percent in 2015 to 3.20 percent in 2016. Salaries and employee benefits, occupancy and equipment, data processing, and other noninterest expense categories in 2016 were all higher as a result of twelve full months of post-merger expense compared to four months in 2015. In 2016, the reduction of professional services was due the absence of merger expenses.
Taxes
2017 compared to 2016
In 2017, income tax expense totaled $6.4 million compared to $3.4 million in 2016. Income taxes to average assets were 0.54 percent compared to 0.33 percent in the prior year. Taxes in the current year were elevated due to a $2.4 million after-tax charge to reduce the value of the Company's deferred tax assets as a result of the tax law signed in December which resulted in an effective tax rate of 56.2 percent in 2017 compared to 36.7 percent in 2016. In 2018, we expect our effective tax rate to be in the range of 26 percent.
2016 compared to 2015
In 2016, income tax expense totaled $3.4 million compared to $1.6 million in 2015. Income taxes to average assets were 0.33 percent compared to 0.24 percent in the prior year. The effective tax rate of about 37 percent in 2016 was down from about 52 percent in 2015 which had approximately $0.3 million of nondeductible merger and acquisition expenses.
Loan Portfolio Composition
The Company had total net loans outstanding, including organic and purchased loans, of approximately $1,317.4 million at December 31, 2017 and $808.3 million at December 31, 2016. Loans secured by real estate, consisting of commercial or residential property, are the principal component of our loan portfolio. We do not generally originate traditional long-term residential mortgages for our portfolio but we do originate and hold traditional second mortgage residential real estate loans, adjustable rate mortgages and home equity lines of credit. Even if the principal purpose of the loan is not to finance real estate, when reasonable, we attempt to obtain a security interest in the real estate in addition to any other available collateral to increase the likelihood of ultimate repayment or collection of the loan.
Organic Loans
Our net organic loans increased $181.9 million, or 29.7 percent to $793.8 million at December 31, 2017, from December 31, 2016, as we continue to originate well-underwritten loans. Our goal of streamlining the credit process has improved our efficiency and is a competitive advantage in many of our markets. In addition, continued training and recruiting of experienced loan officers has provided us with the opportunity to close larger and more complex deals than we historically have. Finally, the overall business environment continues to rebound from recessionary conditions. Organic loans include loans which were originally purchased non-credit impaired loans but have been renewed.
Purchased Loans
Purchased non-credit impaired loans of $490.9 million at December 31, 2017 were up $321.7 million from December 31, 2016 as a result of the Capstone acquisition. Also during 2017, our purchased credit impaired (“PCI”) loans increased by $5.6 million to $32.8 million at December 31, 2017. The activity within the purchased credit impaired loans will be impacted by how quickly these loans are resolved and/or our future acquisition activity. Prior to the GulfSouth transaction in 2012 the Company had no purchased loans.
The following tables summarize the composition of our loan portfolio for the years ended December 31, 2014, 2013periods presented (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | |
| | | 2017 |
| | | Organic Loans | | Purchased Non-Credit Impaired Loans | | Purchased Credit Impaired Loans | | Total Amount | | % of Gross Total |
| Commercial real estate-mortgage | | $ | 387,313 |
| | $ | 237,772 |
| | $ | 17,903 |
| | $ | 642,988 |
| | 48.6 | % |
| Consumer real estate-mortgage | | 173,988 |
| | 112,019 |
| | 7,450 |
| | 293,457 |
| | 22.2 | % |
| Construction and land development | | 97,116 |
| | 33,173 |
| | 5,120 |
| | 135,409 |
| | 10.2 | % |
| Commercial and industrial | | 135,271 |
| | 101,958 |
| | 858 |
| | 238,087 |
| | 18.0 | % |
| Consumer and other | | 5,925 |
| | 5,929 |
| | 1,463 |
| | 13,317 |
| | 1.0 | % |
| Total gross loans receivable, net of deferred fees | | 799,612 |
| | 490,852 |
| | 32,794 |
| | 1,323,258 |
| | 100.0 | % |
| Allowance for loan and lease losses | | (5,844 | ) | | — |
| | (16 | ) | | (5,860 | ) | | |
|
| Total loans, net | | $ | 793,768 |
| | $ | 490,852 |
| | $ | 32,778 |
| | $ | 1,317,398 |
| | |
|
|
| | | | | | | | | | | | | | | | | | | |
| | | 2016 |
| | | Organic Loans | | Purchased Non-Credit Impaired Loans | | Purchased Credit Impaired Loans | | Total Amount | | % of Gross Total |
| Commercial real estate-mortgage | | $ | 297,689 |
| | $ | 102,576 |
| | $ | 14,943 |
| | $ | 415,208 |
| | 51.0 | % |
| Consumer real estate-mortgage | | 135,923 |
| | 42,875 |
| | 9,004 |
| | 187,802 |
| | 23.1 | % |
| Construction and land development | | 108,390 |
| | 7,801 |
| | 1,678 |
| | 117,869 |
| | 14.5 | % |
| Commercial and industrial | | 68,235 |
| | 15,219 |
| | 1,568 |
| | 85,022 |
| | 10.5 | % |
| Consumer and other | | 6,786 |
| | 689 |
| | — |
| | 7,475 |
| | 0.9 | % |
| Total gross loans receivable, net of deferred fees | | 617,023 |
| | 169,160 |
| | 27,193 |
| | 813,376 |
| | 100.0 | % |
| Allowance for loan and lease losses | | (5,105 | ) | | — |
| | — |
| | (5,105 | ) | | |
|
| Total loans, net | | $ | 611,918 |
| | $ | 169,160 |
| | $ | 27,193 |
| | $ | 808,271 |
| | |
|
|
| | | | | | | | | | | | | | | | | | | |
| | | 2015 |
| | | Organic Loans | | Purchased Non-Credit Impaired Loans | | Purchased Credit Impaired Loans | | Total Amount | | % of Gross Total |
| Commercial real estate-mortgage | | $ | 229,203 |
| | $ | 120,524 |
| | $ | 20,050 |
| | $ | 369,777 |
| | 50.8 | % |
| Consumer real estate-mortgage | | 95,233 |
| | 53,697 |
| | 12,764 |
| | 161,694 |
| | 22.2 | % |
| Construction and land development | | 73,028 |
| | 29,755 |
| | 2,695 |
| | 105,478 |
| | 14.5 | % |
| Commercial and industrial | | 53,761 |
| | 28,422 |
| | 2,768 |
| | 84,951 |
| | 11.7 | % |
| Consumer and other | | 4,692 |
| | 1,123 |
| | — |
| | 5,815 |
| | 0.8 | % |
| Total gross loans receivable, net of deferred fees | | 455,917 |
| | 233,521 |
| | 38,277 |
| | 727,715 |
| | 100.0 | % |
| Allowance for loan and lease losses | | (4,354 | ) | | — |
| | — |
| | (4,354 | ) | | |
|
| Total loans, net | | $ | 451,563 |
| | $ | 233,521 |
| | $ | 38,277 |
| | $ | 723,361 |
| | |
|
|
| | | | | | | | | | | | | | | | | | | |
| | | 2014 |
| | | Organic Loans | | Purchased Non-Credit Impaired Loans | | Purchased Credit Impaired Loans | | Total Amount | | % of Gross Total |
| Commercial real estate-mortgage | | $ | 186,444 |
| | $ | 3,905 |
| | $ | 3,102 |
| | $ | 193,451 |
| | 53.2 | % |
| Consumer real estate-mortgage | | 75,066 |
| | 1,968 |
| | 4,380 |
| | 81,414 |
| | 22.4 | % |
| Construction and land development | | 52,421 |
| | 48 |
| | 36 |
| | 52,505 |
| | 14.5 | % |
| Commercial and industrial | | 33,716 |
| | — |
| | 3 |
| | 33,719 |
| | 9.3 | % |
| Consumer and other | | 2,314 |
| | — |
| | — |
| | 2,314 |
| | 0.6 | % |
| Total gross loans receivable, net of deferred fees | | 349,961 |
| | 5,921 |
| | 7,521 |
| | 363,403 |
| | 100.0 | % |
| Allowance for loan and lease losses | | (3,880 | ) | | — |
| | — |
| | (3,880 | ) | | |
|
| Total loans, net | | $ | 346,081 |
| | $ | 5,921 |
| | $ | 7,521 |
| | $ | 359,523 |
| | |
|
|
| | | | | | | | | | | | | | | | | | | |
| | | 2013 |
| | | Organic Loans | | Purchased Non-Credit Impaired Loans | | Purchased Credit Impaired Loans | | Total Amount | | % of Gross Total |
| Commercial real estate-mortgage | | $ | 150,849 |
| | $ | 4,448 |
| | $ | 3,969 |
| | $ | 159,266 |
| | 50.6 | % |
| Consumer real estate-mortgage | | 69,588 |
| | 6,966 |
| | 5,276 |
| | 81,830 |
| | 26.0 | % |
| Construction and land development | | 35,111 |
| | 1,087 |
| | 489 |
| | 36,687 |
| | 11.6 | % |
| Commercial and industrial | | 33,763 |
| | 28 |
| | 15 |
| | 33,806 |
| | 10.7 | % |
| Consumer and other | | 2,916 |
| | 347 |
| | 227 |
| | 3,490 |
| | 1.1 | % |
| Total gross loans receivable, net of deferred fees | | 292,227 |
| | 12,876 |
| | 9,976 |
| | 315,079 |
| | 100.0 | % |
| Allowance for loan and lease losses | | (3,755 | ) | | — |
| | (381 | ) | | (4,136 | ) | | |
|
| Total loans, net | | $ | 288,472 |
| | $ | 12,876 |
| | $ | 9,595 |
| | $ | 310,943 |
| | |
|
Loan Portfolio Maturities
The following table sets forth the maturity distribution of our loans, including the interest rate sensitivity for loans maturing after one year.
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Rate Structure for Loans |
| | | | | | | | | Maturing Over One Year |
| | | One Year or Less | | One through Five Years | | Over Five Years | | Total | | Fixed Rate | | Floating Rate |
| Commercial real estate-mortgage | | $ | 173,603 |
| | $ | 259,406 |
| | $ | 209,979 |
| | $ | 642,988 |
| | $ | 332,438 |
| | $ | 136,947 |
|
| Consumer real estate-mortgage | | 118,400 |
| | 92,019 |
| | 83,038 |
| | 293,457 |
| | 106,902 |
| | 68,155 |
|
| Construction and land development | | 63,082 |
| | 34,891 |
| | 37,436 |
| | 135,409 |
| | 42,898 |
| | 29,429 |
|
| Commercial and industrial | | 105,431 |
| | 88,665 |
| | 43,991 |
| | 238,087 |
| | 122,698 |
| | 9,958 |
|
| Consumer and other | | 6,481 |
| | 6,170 |
| | 666 |
| | 13,317 |
| | 5,416 |
| | 1,420 |
|
| Total Loans | | $ | 466,997 |
| | $ | 481,151 |
| | $ | 375,111 |
| | $ | 1,323,258 |
| | $ | 610,352 |
| | $ | 245,909 |
|
Nonaccrual, Past Due, and
2012 (in thousands).TABLE 9
| | | 2014 | | | 2013 | | | 2012 | |
| Salaries and employee benefits | | $ | 7,054 | | | $ | 6,555 | | | $ | 6,327 | |
| Net occupancy and equipment expense | | | 1,231 | | | | 1,335 | | | | 1,447 | |
| Depository insurance | | | 640 | | | | 645 | | | | 804 | |
| Foreclosed assets, net | | | 1,842 | | | | 2,002 | | | | 1,101 | |
| Other operating expenses | | | 3,233 | | | | 3,309 | | | | 3,499 | |
| Total noninterest expense | | $ | 14,000 | | | $ | 13,846 | | | $ | 13,178 | |
Significant matters relatingRestructured Loans
Loans are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. Loans are generally classified as nonaccrual if they are past due for a period of 90 days or more, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower in accordance with the contractual terms.
PCI loans with common risk characteristics are grouped in pools at acquisition. These loans are evaluated for accrual status at the pool level rather than the individual loan level and performance is based on our ability to reasonably estimate the amount and timing of future cash flows rather than a borrower's ability to repay contractual loan amounts. Since we are able to reasonably estimate the amount and timing of future cash flows on the Company's PCI loan pools, none of these loans have been identified as nonaccrual. However, PCI loans included in pools are identified as nonperforming if they are past due 90 days or more at acquisition or become 90 days or more past due after acquisition. The past due status is determined based on the contractual terms of the individual loans.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the changesprincipal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Assets acquired as a result of foreclosure are recorded at estimated fair value in foreclosed assets. Any excess of cost over estimated fair value at the time of foreclosure is charged to the allowance for loan losses. Valuations are periodically performed on these properties, and any subsequent write-downs are charged to earnings. Routine maintenance and other holding costs are included in noninterest expenseexpense.
Loans, excluding pooled PCI loans, are presented below: | | Salaries and employee benefits have increased since 2012 as the Bank continues to address employee cost of living adjustments. Prior to 2013, the Bank had not increased salary expense for cost of living adjustments for three years. Furthermore, Cornerstone elected not to contribute to the 401(k) plan. Cornerstone hopes to address this issue in the near future. |
| | Management continues to evaluate occupancy and equipment expense components to determine if cost savings can be realized. The Bank has been able to reduce this costclassified as troubled debt restructurings (“TDR”) by approximately $216 thousand when comparing 2014 to 2012. Management believes the 2014 amounts will remain constant or slightly decrease as the Bank purchases its Miller Plaza branch facilities and experiences lower operating expense as compared to rent expense amounts. |
| | The Bank’s depository insurance has decreased from approximately $804 thousand in 2012 to approximately $640 thousand in 2014. Cornerstone has been able to reduce this expense as improvements have been made in the Bank’s asset quality and regulatory performance ratings. Management anticipates that the 2015 depository insurance amount will be similar to the amount recorded in 2014. The Bank anticipates a reduction in this expense as asset quality and ratings continue to improve. |
| | In 2014, as with prior years, the Bank experienced elevated amounts of foreclosed asset expense. Management sees this expense item as its greatest opportunity to improve earnings in the near future. The Bank has been able to reduce its foreclosed assets from approximately $20 million as of December 31, 2012 to approximately $8 million as of December 31, 2014. Management anticipates that the Bank’s foreclosed asset expense will remain elevated during 2015 as management attempts to reduce this balance further. |
Income Tax Expense
| | The difference between Cornerstone’s expected income tax expense, computed by multiplying income before income taxes by statutory income tax rates, and actual income tax expense is primarily attributable to new market tax credits for federal and state purposes, tax exempt loans and tax exempt securities. |
Financial Condition
Overview-Cornerstone’s consolidated balance sheet reflects significant changes over the last two years. During 2014, total assets decreased approximately $16 millionCompany when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. The Company grants concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or 3.81%(2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. The Company does not generally grant concessions through forgiveness of principal or accrued interest. The Company’s policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until there is demonstrated performance under new terms. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on non-accrual status. The Company closely monitors these loans and ceases accruing interest on them if we believe that the borrowers may not continue performing based on the restructured note terms.
PCI loans that were classified as TDRs prior to acquisition are not classified as TDRs by the Company after the acquisition date. Subsequent modification of a PCI loan accounted for in a pool that would otherwise meet the definition of a TDR is not reported, or accounted for, as a TDR since pooled PCI loans are excluded from approximately $432 millionthe scope of TDR accounting. A PCI loan not accounted for in a pool would be reported, and accounted for, as a TDR if modified in a manner that meets the definition of a TDR after the acquisition date.
Nonperforming loans as a percentage of gross loans, net of deferred fees, was 0.25 percent as of December 31,
20132017, compared to
approximately $416 million0.26 percent as of December 31,
2014. The decrease was derived primarily from2016. Total nonperforming assets as a
decrease in cash and cash equivalents from approximately $24.9 million as of December 31, 2013 to approximately $15.5 million as of December 31, 2014 and a decrease in foreclosed assets from approximately $12.9 million as of December 31, 2013 to approximately $8.0 million as of December 31, 2014. The total decrease in cash and cash equivalents is primarily related to a decrease in deposits that is described in detail in Tables 23 and 24. Foreclosed assets decreased due to a strategic initiative to move non-earning assets off the balance sheet. Total loans increased approximately $6 million or 2.05% from approximately $289 million as of December 31, 2013 to approximately $295 million as of December 31, 2014. Finally, stockholders’ equity increased approximately $1 million or 1.32% from approximately $40 million as of December 31, 2013 to approximately $41 million as of December 31, 2014.Investments-The Bank’s investment portfolio totaled approximately $90 million or 21.54%percentage of total assets as of December 31, 2014,2017 totaled 0.38 percent compared to a total0.42 percent as of approximately $95 millionDecember 31, 2016. Acquired PCI loans that are included in loan pools are reclassified at acquisition to accrual status and thus are not included as nonperforming assets unless they are 90 days or 21.88% of totalgreater past due. In 2017, there was $64 thousand in interest income recognized on nonaccrual and restructured loans compared to the $151 thousand in gross interest income that would have been recognized if the loans had been current in accordance with their original terms.
The following table summarizes the Company's nonperforming assets as of December 31
2013. The reduction in the investment portfolio resulted from the Bank liquidating a portion of its municipal inventory to offset foreclosed asset expense.The portfolio is accounted for in two classifications: “Held to Maturity” and “Available for Sale”. The Bank also has an investment in Federal Home Loan Bank stock. The objective of the Bank’s investment policy is to invest funds not otherwise needed to meet the loan demand of the Bank’s market area and to meet the following five objectives: Gap Management, Liquidity, Pledging, Return, and Local Community Support. In doing so, the Bank uses the portfolio to provide structure and liquidity that the loan portfolio cannot. The management investment committee balances the market and credit risks against the potential investment return, ensures investments are compatible with the pledge requirements of the Bank’s deposit of public funds, maintains compliance with regulatory investment requirements, and assists various public entities with their financing needs. The management investment committee is authorized to execute security transactions for the investment portfolio based on the decisions of the Directors Asset Liability Committee (ALCO). All investment transactions occurring since the previous ALCO meeting are reviewed by the ALCO at its next quarterly meeting, in addition to the entire portfolio. The investment policy allows portfolio holdings to include short-term securities purchased to provide the Bank’s needed liquidity and longer-term securities purchased to generate stable income for the Bank during periods of interest rate fluctuations.
Table 10 presents the carrying value of the Bank's investments at the dates indicated. Available for sale securities are carried at fair market value and securities held to maturity are held at their book value (amounts in thousands).
TABLE 10
| Investment Portfolio |
| Years Ended December 31, |
| Securities available for sale: | | 2014 | | | 2013 | | | 2012 | |
| U.S. Government agency obligations | | $ | 563 | | | $ | 3,481 | | | $ | 4,018 | |
| Mortgage-backed securities | | | 79,299 | | | | 73,479 | | | | 48,445 | |
| State and political subdivisions | | | 7,331 | | | | 15,249 | | | | 23,634 | |
| Totals | | | 87,193 | | | | 92,209 | | | | 76,097 | |
| | | | | | | | | | | | | |
| Securities held to maturity: | | | | | | | | | | | | |
| Mortgage-backed securities | | | 25 | | | | 34 | | | | 45 | |
| Totals | | | 25 | | | | 34 | | | | 45 | |
| | | | | | | | | | | | | |
| Federal Home Loan Bank stock, at cost | | | 2,323 | | | | 2,323 | | | | 2,323 | |
| | | | | | | | | | | | | |
| Total Investments | | $ | 89,541 | | | $ | 94,566 | | | $ | 78,465 | |
|
| | | | | | | | | | | | | | | | | | | | |
| (Dollars in thousands) | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| Nonaccrual loans | | $ | 1,764 |
| | $ | 1,415 |
| | $ | 2,252 |
| | $ | 5,067 |
| | $ | 1,492 |
|
| Accruing loans past due 90 days or more (1) | | 1,509 |
| | 699 |
| | 502 |
| | — |
| | — |
|
| Total nonperforming loans | | 3,273 |
| | 2,114 |
| | 2,754 |
| | 5,067 |
| | 1,492 |
|
| Foreclosed assets | | 3,254 |
| | 2,386 |
| | 5,358 |
| | 4,983 |
| | 5,221 |
|
| Total nonperforming assets | | $ | 6,527 |
| | $ | 4,500 |
| | $ | 8,112 |
| | $ | 10,050 |
| | $ | 6,713 |
|
| Restructured loans not included above | | $ | 41 |
| | $ | 166 |
| | $ | 3,693 |
| | $ | 1,937 |
| | $ | 2,699 |
|
| | Management anticipates the Bank’s investment portfolio to remain at year end 2014 levels to provide an appropriate investment to total asset percentage. |
| | A second objective of the security portfolio is to provide adequate collateral to satisfy pledging requirements with the State of Tennessee collateral pool, the Federal Home Loan Bank, repurchase agreements and correspondent banks. As of December, 31, 2014, the Bank had pledged securities with a market value of approximately $69 million and unpledged securities with a market value of approximately $18 million. |
For December 31, 2014, tables 11 and 12 present the book value of the Bank's investments, the weighted average yields on the Bank's investments and the periods to maturity of the Bank's investments for the “Securities Available for Sale” and the “Securities Held to Maturity,” respectively. Tables 13 and 14 present this information for December 31, 2013.
TABLE 11 (amounts in thousands)
| Weighted Average Yields on the Available For Sale Investments |
| Periods of Maturity from December 31, 2014 |
| | | Less than 1 year | | | 1 to 5 years | | | 5 to 10 years | | | Over 10 years | |
| Securities available for sale: | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | |
| U.S. Government agencies | | $ | - | | | | - | | | $ | - | | | | - | | | $ | 560 | | | | 1.18 | % | | $ | - | | | | - | |
| Mortgage-backed securities (2) | | | - | | | | - | | | | 7 | | | | 5.20 | % | | | 5,022 | | | | 1.84 | % | | | 74,103 | | | | 1.27 | % |
| Tax-exempt municipal bonds | | | - | | | | - | | | | 899 | | | | 6.21 | % | | | 2,271 | | | | 5.03 | % | | | 3,858 | | | | 4.37 | % |
| Totals | | $ | - | | | | - | | | $ | 906 | | | | 6.20 | % | | $ | 7,853 | | | | 2.72 | % | | $ | 77,961 | | | | 1.42 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Securities Available for Sale | | $ | 86,720 | | | | 1.58 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | The weighted average yieldsBalances include PCI loans past due 90 days or more that are grouped in pools which accrue interest based on tax-exempt securities have been computed on a tax-equivalent basis.pool yields. |
| (2) | Mortgages are allocated by maturity and not amortized. |
TABLE 12(amounts in thousands)
| Weighted Average Yields on the Held to Maturity Investments |
| Periods of Maturity from December 31, 2014 |
| | | Less than 1 year | | | 1 to 5 years | | | 5 to 10 years | | | Over 10 years | |
| Securities held to maturity | | Amount | | | Weighted
Avg.
Yield(1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | |
| Mortgage-backed securities (2) | | $ | - | | | | - | | | $ | 6 | | | | 2.09 | % | | $ | 14 | | | | 1.53 | % | | $ | 5 | | | | 2.88 | % |
| Totals | | $ | - | | | | - | | | $ | 6 | | | | 2.09 | % | | $ | 14 | | | | 1.53 | % | | $ | 5 | | | | 2.88 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Securities Held to Maturity | | $ | 25 | | | | 1.92 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal Home Loan Bank stock, at cost | | $ | 2,323 | | | | 4.98 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Investments | | $ | 89,068 | | | | 1.67 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | The weighted average yields on tax-exempt securities have been computed on a tax-equivalent basis. |
| (2) | Mortgages are allocated by maturity and not amortized. |
TABLE 13 (amounts in thousands)
| Weighted Average Yields on the Available For Sale Investments |
| Periods of Maturity from December 31, 2013 |
| | | Less than 1 year | | | 1 to 5 years | | | 5 to 10 years | | | Over 10 years | |
| Securities available for sale: | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | |
| U.S. Government agencies | | $ | - | | | | - | | | $ | - | | | | - | | | $ | - | | | | - | | | $ | 3,433 | | | | 1.02 | % |
| Mortgage-backed securities (2) | | | - | | | | - | | | | - | | | | - | | | | 13 | | | | 5.47 | % | | | 73,443 | | | | 1.16 | % |
| Tax-exempt municipal bonds | | | - | | | | - | | | | 1,266 | | | | 6.09 | % | | | 4,237 | | | | 4.46 | % | | | 9,406 | | | | 5.21 | % |
| Totals | | $ | - | | | | - | | | $ | 1,266 | | | | 6.09 | % | | $ | 4,250 | | | | 4.46 | % | | $ | 86,282 | | | | 1.60 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Securities Available for Sale | | $ | 91,798 | | | | 1.79 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | The weighted average yields on tax-exempt securities have been computed on a tax-equivalent basis. |
| (2) | Mortgages are allocated by maturity and not amortized. |
TABLE 14(amounts in thousands)
| Weighted Average Yields on the Held to Maturity Investments |
| Periods of Maturity from December 31, 2013 |
| | | Less than 1 year | | | 1 to 5 years | | | 5 to 10 years | | | Over 10 years | |
| Securities held to maturity | | Amount | | | Weighted
Avg.
Yield(1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | | | Amount | | | Weighted
Avg.
Yield (1) | |
| Mortgage-backed securities (2) | | $ | - | | | | - | | | $ | 7 | | | | 1.92 | % | | $ | 16 | | | | 1.80 | % | | $ | 11 | | | | 1.54 | % |
| Totals | | $ | - | | | | - | | | $ | 7 | | | | 1.92 | % | | $ | 16 | | | | 1.80 | % | | $ | 11 | | | | 1.54 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Securities Held to Maturity | | $ | 34 | | | | 1.74 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal Home Loan Bank stock, at cost | | $ | 2,323 | | | | 4.18 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Investments | | $ | 94,155 | | | | 1.85 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | The weighted average yields on tax-exempt securities have been computed on a tax-equivalent basis. |
| (2) | Mortgages are allocated by maturity and not amortized. |
Lending-All lending activities of the Bank are under the direct supervision and control of the Directors Loan Committee (DLC). The DLC is comprised of three members of management and five independent directors that serve only in a director capacity and are not employees of the Bank. Also present at meetings of the committee are the loan review officer and other lending officers, as required. This oversight committee enforces loan authorizations for each officer, makes lending decisions on loans exceeding such limits, reviews and oversees problem credits, and determines the allocation of funds for each lending category.At December 31, 20142017 problem loans amounted to approximately $821.9 thousand or 0.06 percent of total loans outstanding. Potential problem loans, which are not included in nonperforming loans, represent those loans with a well-defined weakness and 2013, Cornerstone’s net loan portfolio constituted approximately 70.2% and 66.2%where information about possible credit problems of Cornerstone’s total assets, respectively.
Table 15 presentsborrowers has caused management to have doubts about the compositionborrower's ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Bank's primary regulators, for loans classified as substandard or worse, but not considered nonperforming loans.
Allocation of Cornerstone’s loan portfoliothe Allowance for Loan Losses
We maintain the allowance at
a level that we deem appropriate to adequately cover the
indicated dates.TABLE 15
| Loan Portfolio Composition |
| Years Ended December 31, |
| (In thousands) | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | |
| Commercial, financial and agricultural | | $ | 37,863 | | | | 12.82 | % | | $ | 38,999 | | | | 13.47 | % | | $ | 40,140 | | | | 14.49 | % | | $ | 37,458 | | | | 13.99 | % | | $ | 51,160 | | | | 17.94 | % |
| Real estate – construction | | | 34,449 | | | | 11.66 | % | | | 41,597 | | | | 14.37 | % | | | 38,557 | | | | 13.92 | % | | | 31,031 | | | | 11.59 | % | | | 29,848 | | | | 10.46 | % |
| Real estate – mortgage | | | 76,907 | | | | 26.04 | % | | | 76,315 | | | | 26.37 | % | | | 71,195 | | | | 25.70 | % | | | 70,543 | | | | 26.34 | % | | | 71,878 | | | | 25.20 | % |
| Real estate – commercial | | | 143,168 | | | | 48.47 | % | | | 129,799 | | | | 44.84 | % | | | 125,172 | | | | 45.19 | % | | | 126,057 | | | | 47.08 | % | | | 129,031 | | | | 45.23 | % |
| Consumer loans | | | 2,977 | | | | 1.01 | % | | | 2,730 | | | | 0.95 | % | | | 1,927 | | | | 0.70 | % | | | 2,676 | | | | 1.00 | % | | | 3,330 | | | | 1.17 | % |
| Total Loans | | $ | 295,364 | | | | 100.00 | % | | $ | 289,440 | | | | 100.00 | % | | $ | 276,991 | | | | 100.00 | % | | $ | 267,765 | | | | 100.00 | % | | $ | 285,247 | | | | 100.00 | % |
Significant matters relating to the changesprobable losses inherent in the loan portfolio composition are presented below:
| | During 2014, the Bank experienced a decrease in real estate construction loans and an increase in real estate commercial loans as the loans were converted from construction to permanent financing. Management anticipates that this trend will continue into 2015 as the Chattanooga, TN market continues to remodel existing properties or build new projects. These types of projects allow the Bank to assist in building the community and creates an opportunity for a long term relationship. |
Table 16 presents the scheduled maturities of the loans in Cornerstone’s loan portfolio asportfolio. As of December 31, 2014 based on their contractual terms2017 and December 31, 2016, our allowance for loan losses was $5.9 million and $5.1 million, respectively, which we deemed to maturity. Overdrafts are reported as due in less than one year. Loans unpaidbe adequate at maturity are renegotiated based on current market rates and terms.
TABLE 16
Loans Maturing
Year-end Balance as of December 31, 2014 |
| (In thousands) | | Less than
One Year | | | 1 to 5
Years | | | Over 5
Years | | | Total | |
| Commercial, financial and agricultural | | $ | 24,559 | | | $ | 11,439 | | | $ | 1,865 | | | $ | 37,863 | |
| Real estate – construction | | | 23,151 | | | | 11,038 | | | | 260 | | | | 34,449 | |
| Real estate – mortgage | | | 9,052 | | | | 40,500 | | | | 27,355 | | | | 76,907 | |
| Real estate – commercial | | | 19,889 | | | | 91,594 | | | | 31,685 | | | | 143,168 | |
| Consumer | | | 1,389 | | | | 1,588 | | | | - | | | | 2,977 | |
| Total Loans | | $ | 78,040 | | | $ | 156,159 | | | $ | 61,165 | | | $ | 295,364 | |
Typeseach of Loans
Commercial, Financial and Agricultural Loans-the respective dates. The Bank’s commercial loan portfolio is comprised of commercial, industrial, and non-farm non-residential loans, hereinafter referred to as commercial loans (excluding commercial construction loans). These installment loans and lines of credit are extended to individuals, partnerships and corporations for a variety of business purposes, such as accounts receivable and inventory financing, equipment financing, business expansion and working capital. The following is a list of terms imbeddedincrease in the Bank’s commercialallowance for loan portfolio:
| § | The terms of the Bank's commercial loans generally range from ninety days to a fifteen year amortization with a five year balloon. |
| § | Commercial loans are generally tied to the prime index and adjust with changes in the prime rate. The Bank also extends fixed interest rate loans when appropriate to match the borrower’s needs. |
| § | Loans secured by marketable equipment are required to be amortized over a period not to exceed 60 months. |
| § | Generally, loans secured by current assets suchlosses in 2017 as inventory or accounts receivable are structured as revolving lines of credit with annual maturities. |
| § | Loans secured by chattel, mortgages and accounts receivable may not exceed 85% of their market value. |
| § | Loans secured by listed stocks, municipal bonds and mutual funds may not exceed 70% of their market value. |
| § | Unsecured short-term loans and lines of credit must meet criteria set by the Bank’s Loan Committee. Current financial statements support all commercial loans, and such financial statements are updated annually. |
| § | Substantially all of the Bank's commercial loans are secured and are guaranteed by the principals of the borrower. |
Real Estate: Construction Loans-The Bank makes residential construction loans to owner-occupants and to persons building residential properties for resale. The Bank has two main areas of construction loans: one is to residential real estate developers for speculative or custom single-family residential properties, and the other is to custom commercial construction projects with guaranteed takeout provisions. Construction loans are usually variable rate loans made for terms of one year or less, but extensions are permitted if construction has continued satisfactorily, the loan is current and other circumstances warrant the extension. Construction loans are limited to 80% of the appraised value of the lot and the completed value of the proposed structure.
Construction financing generally is considered to involve a higher degree of credit risk than permanent mortgage financing of residential properties, and this additional risk usually is reflected in higher interest rates. The higher risk of loss on construction loans is attributable in large part to the fact that loan funds are estimated and advanced upon the security of the project under construction, which is of uncertain value prior to the completion of construction. Moreover, because of the uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages and other unpredictable contingencies, it is relatively difficult to accurately evaluate the total loan funds required to complete a project and to accurately evaluate the related loan-to-value ratios. If the estimates of construction costs and the saleability of the property upon completion of the project prove to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment.
The Bank's underwriting criteria are designed to evaluate and minimize the risk of each construction loan. Among other items, the Bank considers evidence of the availability of permanent financing or a take-out commitment to the borrower, the financial strength and reputation of the borrower, an independent appraisal and review of cost estimates, market conditions, and, if applicable, the amount of the borrower's equity in the project, pre-construction sale or leasing information and cash flow projections of the borrower.
Real Estate: Mortgage Loans-Real estate mortgage loans include all one to four family residential loans secured by real estate for purposes other than construction or acquisition and development. All real estate loans are held in the Bank’s loan portfolio except for loans that are designated as loans held for sale. The loans held for sale are qualified by the Federal National Mortgage Association and have been pre-approved by an underwriting specialist prior to closing. The remainder of the Bank’s mortgage loans are home equity loans and are made at fixed interest rates for terms of one to three years with balloon payment provisions and amortized over a 10 to 15 year period. The Bank's experience indicates that real estate loans normally remain outstanding for much shorter periods than their stated maturity because the borrowers repay the loans in full either upon the sale of the secured property or upon the refinancing of the original loan.
In the case of owner occupied single-family residences, real estate loans are made for up to 95% of the value of the property securing the loan, based upon an appraisal if the loan amount is over $100,000. When the loan is secured by real estate containing a non-owner occupied dwelling of one to four family units, loans generally are made for up to 80% of the value, based upon an appraisal if the loan amount is over $100,000. The Bank also requires title insurance to insure the priority of the property lien on its real estate loans over $50,000 and requires fire and casualty insurance on all of its loans.
The real estate loans originated by the Bank contain a "due-on-sale" clause, which provides that the Bank may declare the unpaid balance of the loan immediately due and payable upon the sale of the mortgaged property. Such clauses are an important means of reducing the average loan life and increasing the yield on existing fixed-rate real estate loans, and it is the Bank's policy to enforce due-on-sale clauses.
Real Estate: Commercial Loans-Commercial real estate mortgage loans include commercial loans secured by real estate for purposes other than construction or acquisition and development. All real estate loans are held in the Bank’s loan portfolio except for loans that have been participated to correspondent banks. The Bank will sell these participations if a loan exceeds the Bank’s legal lending limit or as is deemed appropriate by the Director’s Loan Committee. Commercial real estate mortgage loans are a combination of properties that are leased out or used for a primary place of a business the Bank has a relationship with. Most of the commercial real estate loans have fixed interest rates for terms of one to three years with balloon payment provisions and are amortized over a 10 to 15 year period, but whenever possible the Bank will seek a variable rate loan which would be tied to the New York prime rate and adjusted monthly. The Bank's experience indicates that real estate loans normally remain outstanding for much shorter periods than their stated maturity because the borrowers repay the loans in full either upon the sale of the secured property or upon the refinancing of the original loan. Commercial real estate loans are made for up to 85% of the value of the property securing the loan, based upon an appraisal if the loan amount is over $100,000. The Bank also requires title insurance to insure the priority of the property lien on its real estate loans over $50,000 and requires fire and casualty insurance on all of its loans.
Consumer Loans-These loans consist of consumer installment loans and consumer credit card balances. The Bank makes both secured and unsecured consumer loans for a variety of personal and household purposes. Most of the Bank's consumer loans are automobile loans, boat loans, property improvement loans and loans to depositors on the security of their certificates of deposit. These loans are generally made for terms of up to five years at fixed interest rates. The Bank considers consumer loans to involve a relatively high credit risk compared to real estate loans. Consumer2016 is primarily the result of increases in organic loan growth offset slightly by improving overall credit metrics within our portfolio. Our allowance for loan loss as a percentage of total loans therefore, generally yield a relatively high return to the Bank and provide a relatively short maturity. The Bank believes that the generally higher yields and the shorter terms available on various types of consumer loans tend to offset the relatively higher risk associated with such loans, and contribute to a profitable spread between the Bank's average yield on earning assets and the Bank's cost of funds.
Lending Commitments-Commitments under standby letters of credit and undisbursed loan commitments totaled approximately $47 million as ofhas decreased from 0.63 percent at December 31, 2014 compared2016 to approximately $34 million as of0.44 percent at December 31, 2013. This number includes all lines of credit that have not been fully drawn and loan commitments in the same status.
Origination, Purchase and Sale of Loans
The Bank originates the majority of its loans in Hamilton County, Tennessee. However, the Bank also originates loans in Marion, Sequatchie and Bradley Counties in Tennessee, and Dade, Walker, Whitfield and Catoosa Counties in Georgia, each of which is within 150 miles of Chattanooga, Tennessee. Loans are originated by 13 relationship managers who operate from the Bank's offices in Chattanooga, Tennessee and from the loan production office in Dalton, Georgia. These relationship managers actively solicit loan applications from existing customers, local manufacturers and retailers, builders, real estate developers, real estate agents and others. The Bank also receives numerous loan applications2017, as a result of customer referrals and walk-ins to its offices.
Upon receipt of athe decrease in organic loan application and all required supporting information from a prospective borrower, the Bank obtains a credit report and verifies specific information relating to the loan applicant's employment, income and creditworthiness. For significant extensions of credit in which real estate will secure the proposed loan, a certified appraisal of the real estate is undertaken by an independent appraiser approved by the Bank. The Bank's relationship managers then analyze the credit worthiness of the borrower and the value of any collateral involved.
The Bank’s loan approval process is intended to be conservative but also responsive to customer needs. Loans are approved in accordance with the Bank's written loan policy, which provides for several tiers of approval authority, based on a borrower's aggregate debt with the Bank. The Bank’s legal lending limit is 25% of the Bank’s qualifying equity for secured loans and 15% for unsecured loans.
The Bank has in the past purchased and sold commercial loan participations with correspondent banks and will continue the practice when management feels the action would be in the best interest of the Bank. The purchase of loan participations allows the Bank to expand its loan portfolio and increase profitability while still maintaining the high credit standards, which are applied to all extensions of credit made by the Bank. The sale of loan participations allows the Bank to make larger loans and retain a servicing fee for its labor, which it otherwise would be unable to make due to capital or other funding considerations.
Loan Fee Income
In addition to interest earned on loans, the Bank receives origination fees for making loans, commitment fees for making certain loans, and other fees for miscellaneous loan-related services. Such fee income varies with the volume of loans made, prepaid or sold, and the rates of fees vary from time to time depending on the supply of funds and competitive conditions.
Commitment fees are charged by the Bank to the borrower for certain loans and are calculatedbalances as a percentage of the principal amounttotal portfolio as acquired loans made up a larger percentage. As a percentage of organic loans the loan. These fees normally are deductedallowance for loan losses decreased from 0.83 percent at December 31, 2016 to 0.73 percent at December 31, 2017. In 2018, we expect the proceedsallowance to organic loans to remain in the range of the loan and generally range from 0.5%0.70 to 2.0% of the principal amount, depending0.85 percent.
Our purchased loans were recorded at fair value upon acquisition. The fair value adjustments on the
type and volume ofperforming purchased loans
made and market conditions such as the demand for loans, the availability of money and general economic conditions. The Bank complies with Accounting Standard Codification Topic 310, “Receivables,” and amortizes all significant loan feeswill be accreted into income over the life of the
loan.loans. At December 31, 2017, the remaining accretable yield was $9.3 million. Also at the end of 2017, the balance on PCI loans was $43.6 million and the carrying value was $32.8 million, for a net difference of $10.8 million in discounts. These loans are subject to the same allowance methodology as our legacy portfolio. The
Bank also receives miscellaneous fee income from late payment charges, overdraft fees, property inspection fees,calculated allowance is compared to the remaining fair value discount to determine if additional provisioning should be recognized. At December 31, 2017, there was an allowance of $16 thousand on PCI loans. The judgments and
miscellaneous services relatedestimates associated with our allowance determination are described in Note 1 in the “Notes to
its existing loans.Problem Loans and Allowance for Loan Losses
Problem Loans-In originating loans, Cornerstone recognizes that it will experience credit losses and thatConsolidated Financial Statements.”
The following table sets forth, based on our best estimate, the
risk of loss will vary with, among other things, the type of loan being made, the creditworthinessallocation of the
borrower overallowance to types of loans as well as the
termunallocated portion as of
the loan and, in the case of a secured loan, the quality of the securityDecember 31 for
the loan. Cornerstone has instituted measures at the Bank and Eagle which are designed to reduce the risk of, and monitor exposure to, credit losses.The Bank’s loan portfolio is systematically reviewed by the Bank's management, internal auditors and State and Federal regulators to ensure that the Bank’s larger loan relationships are being maintained within the loan policy guidelines, and remain properly underwritten. Input from all the above sources is used by the Bank to take corrective actions as necessary. As discussed below, each of the Bank'spast five years and the percentage of loans is assigned a rating in accordance with the Bank's internal loan rating system. All past dueeach category to total loans are reviewed by the Bank's senior lending officers and all past due loans over $25,000 are reviewed monthly by the Director’s Loan Committee. All loans classifiedas substandard or doubtful, as well as any "special mention" loans (defined(in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, |
| | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
| Commercial real estate-mortgage | | $ | 2,465 |
| | 42.1 | % | | $ | 2,369 |
| | 46.4 | % | | $ | 1,906 |
| | 43.8 | % | | $ | 1,734 |
| | 44.7 | % | | $ | 1,608 |
| | 38.8 | % |
| Consumer real estate-mortgage | | 1,596 |
| | 27.2 | % | | 1,382 |
| | 27.1 | % | | 1,015 |
| | 23.3 | % | | 906 |
| | 23.3 | % | | 1,041 |
| | 25.2 | % |
| Construction and land development | | 521 |
| | 8.9 | % | | 717 |
| | 14.0 | % | | 627 |
| | 14.4 | % | | 690 |
| | 17.8 | % | | 727 |
| | 17.6 | % |
| Commercial and industrial | | 1,062 |
| | 18.1 | % | | 520 |
| | 10.2 | % | | 777 |
| | 17.8 | % | | 524 |
| | 13.5 | % | | 497 |
| | 12.0 | % |
| Consumer and other | | 216 |
| | 3.7 | % | | 117 |
| | 2.3 | % | | 29 |
| | 0.7 | % | | 26 |
| | 0.7 | % | | 263 |
| | 6.4 | % |
| Total allowance for loan losses | | $ | 5,860 |
| | 100.0 | % | | $ | 5,105 |
| | 100.0 | % | | $ | 4,354 |
| | 100.0 | % | | $ | 3,880 |
| | 100.0 | % | | $ | 4,136 |
| | 100.0 | % |
The increase in the
following paragraph), are placed on the Bank’s watch list and reviewed at least monthly by the Director’s Loan Committee. In addition, all loans to a particular borrower are reviewed, regardless of classification, each time such borrower requests a renewal or extension of any loan or requests an additional loan. All lines of credit are reviewed annually prior to renewal. Such reviews include, but are not limited to, the ability of the borrower to repay the loan, a re-assessment of the borrower’s financial condition, the value of any collateral and the estimated potential loss to the Bank, if any.The Bank's internal problem loan rating system establishes three classifications for problem assets: substandard, doubtful and loss. Additionally, in connection with regulatory examinations of the Bank, Federal and State examiners have authority to identify problem assets and, if appropriate, require the Bank to classify them. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the Bank is not warranted. Consequently, such assets are charged-off in the month they are classified as loss. Federal regulations also designate a “special mention” category, described as assets which do not currently expose the Bank to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention.
Assets classified as substandard or doubtful require the Bank to establish general or specific allowances for loan losses. If an asset or portion thereof is classified as loss, the Bank must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified as loss or charge-off such amount. General loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included, up to certain limits, in determining the Bank's regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital.
The Bank's collection procedures provide that when a loan becomes between 15 days and 30 days delinquent, the borrower is contacted by mail and payment is requested. If the delinquency continues, subsequent efforts are made to contact and request payment from the delinquent borrower. Most loan delinquencies are cured within 60 days and no legal action is required. In certain circumstances, the Bank, for a fee, may modify the loan, grant a limited moratorium on loan payments or revise the payment schedule to enable the borrower to restructure his or her financial affairs.Generally, the Bank stops accruing interest and any accrued non collected interest will be reversed in accordance with US GAAP on delinquent loans when payment is in arrears for 90 days or when collection otherwise becomes doubtful. If the delinquency exceeds 120 days and is not cured through the Bank's normal collection procedures or through a restructuring, the Bank will institute measures to enforce its remedies resulting from the default, including commencing a foreclosure, repossession or collection action. In certain cases, the Bank will consider accepting a voluntary conveyance of collateral in lieu of foreclosure or repossession. Real property acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed assets until it is sold and is carried at the lower of cost or fair value less estimated costs to dispose. Accounting standards define fair value as the amount that is expected to be received in a current sale between a willing buyer and seller other than in a forced or liquidation sale. Fair values at foreclosure are based on appraisals. Losses arising from the acquisition of foreclosed properties are charged against the allowance for loan losses. Subsequent write-downs are provided by a charge to income through losses on other real estate in the period in which the need arises.
Allowance for Loan Losses-The allowance or reserve for possible loan losses is a means of absorbing future losses, which could be incurred from the current loan portfolio. The Bank maintains an allowance for possible loan losses, and management adjusts the general allowance quarterly by charges to income in response to changes to outstanding loan balances.
Theoverall allowance for loan losses is evaluateddue to the increased balance of organic loans offset by improvements of our loan portfolio and the reduction of nonperforming loans and net charge-offs, which is largely influenced by the overall improvement in the economies in our market areas. The allocation by category is determined based on the assigned risk rating, if applicable, and environmental factors applicable to each category of loans. For impaired loans, those loans are reviewed for a regular basis by managementspecific allowance allocation. Specific valuation allowances related to impaired loans were approximately $445 thousand at December 31, 2017, compared to $4 thousand at December 31, 2016. Additional information on the allocation of the allowance between performing and impaired loans is provided in Note 4 to the “Notes to Consolidated Financial Statements.”
Analysis of the Allowance for Loan Losses
The following is a summary of changes in the allowance for loan losses for each of the years in the five-year period ended December 31, 2017 and the ratio of the allowance for loan losses to total loans as of the end of each period (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| Balance at beginning of period | | $ | 5,105 |
| | $ | 4,354 |
| | $ | 3,880 |
| | $ | 4,136 |
| | $ | 3,691 |
|
| Provision for loan losses | | 783 |
| | 788 |
| | 923 |
| | 432 |
| | 582 |
|
| Charged-off loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate-mortgage | | — |
| | — |
| | (95 | ) | | — |
| | (123 | ) |
| Consumer real estate-mortgage | | (111 | ) | | (102 | ) | | (247 | ) | | (623 | ) | | — |
|
| Construction and land development | | — |
| | (14 | ) | | (50 | ) | | (7 | ) | | (17 | ) |
| Commercial and industrial | | (24 | ) | | (35 | ) | | — |
| | (118 | ) | | — |
|
| Consumer and other | | (141 | ) | | (155 | ) | | (114 | ) | | (65 | ) | | (30 | ) |
| Total charged-off loans | | (276 | ) | | (306 | ) | | (506 | ) | | (813 | ) | | (170 | ) |
| Recoveries of previously charged-off loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate-mortgage | | 8 |
| | 45 |
| | — |
| | 2 |
| | — |
|
| Consumer real estate-mortgage | | 99 |
| | 76 |
| | — |
| | — |
| | — |
|
| Construction and land development | | 13 |
| | 22 |
| | 26 |
| | — |
| | 10 |
|
| Commercial and industrial | | 67 |
| | 58 |
| | 19 |
| | — |
| | — |
|
| Consumer and other | | 61 |
| | 68 |
| | 12 |
| | 123 |
| | 23 |
|
| Total recoveries of previously charged-off loans | | 248 |
| | 269 |
| | 57 |
| | 125 |
| | 33 |
|
| Net charge-offs | | (28 | ) | | (37 | ) | | (449 | ) | | (688 | ) | | (137 | ) |
| Balance at end of period | | $ | 5,860 |
| | $ | 5,105 |
| | $ | 4,354 |
| | $ | 3,880 |
| | 4,136 |
|
| Ratio of allowance for loan losses to total loans outstanding at end of period | | 0.44 | % | | 0.63 | % | | 0.60 | % | | 1.07 | % | | 1.31 | % |
| Ratio of net charge-offs to average loans outstanding for the period | | — | % | | — | % | | (0.09 | )% | | (0.20 | )% | | (0.04 | )% |
We assess the adequacy of the allowance at the end of each calendar quarter. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management’s periodic review of the collectability of loans in light of historical experience, the nature and volumeour evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, the views of the Bank's regulators, adverse situations that may affect the borrower’sborrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and prevailing economic conditions.peer bank loan quality indications and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that aremay be susceptible to significant revision as more information becomes available. A loan or portion thereofchange.
Investment Portfolio
Our investment portfolio which is charged-off againstcarried at fair market value, consisting primarily of Federal agency bonds, mortgage-backed securities, state and municipal securities and other debt securities amounted to $151.9 million and $129.4 million at December 31, 2017 and 2016, respectively. This increase was a result of purchasing additional investments from liquidity received through the allowance when management has determined that losses on such loans are probable. Recoveries on any loans charged-off in prior fiscal periods are credited to the allowance. It is the opinionsale of the Bank's management thatCapstone investment portfolio after the merger on November 1, 2017. In 2015, the investment portfolio amounted to $166.4 million and it decreased in 2016 to $129.4 million as a result of selling portions of the investment portfolio to fund loan growth. Our investment to asset ratio has decreased from 16.3 percent at December 31, 2015, to 12.2 percent at December 31, 2016, and then to 8.8 percent at December 31, 2017. Over the last several years we have reduced the ratio of investments to total assets and the absolute level of investment securities on our balance sheet as we have allocated more funding to loans. Our investment portfolio serves many purposes including serving as a potential liquidity source, collateral for public funds, and as a stable source of income.
The following table shows the book value of the Company’s investment securities. In 2017, 2016, and 2015, all investment securities were classified as available for sale.
Book Value of Investment Securities
(in thousands)
|
| | | | | | | | | | | | |
| | | 2017 | | 2016 | | 2015 |
| U.S. Government agencies | | $ | 26,207 |
| | $ | 18,279 |
| | $ | 22,745 |
|
| State and political subdivisions | | 9,122 |
| | 8,182 |
| | 7,614 |
|
| Other debt securities | | 974 |
| | — |
| | — |
|
| Mortgage-backed securities | | 117,263 |
| | 104,585 |
| | 136,625 |
|
| Total securities | | $ | 153,566 |
| | $ | 131,046 |
| | $ | 166,984 |
|
The following table presents the allowancecontractual maturity of investment securities by contractual maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis). The composition and maturity / repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.
Expected Maturity of Investment Securities
As of December 31, 2017
(in thousands)
|
| | | | | | | | | | | | | | | | | | | | |
| | | Maturity By Years |
| | | 1 or Less | | 1 to 5 | | 5 to 10 | | Over 10 | | Total |
| U.S. Government agencies | | $ | 1,997 |
| | $ | 21,000 |
| | $ | 3,210 |
| | $ | — |
| | $ | 26,207 |
|
| State and political subdivisions | | 177 |
| | 607 |
| | 3,852 |
| | 4,486 |
| | 9,122 |
|
| Mortgage-backed securities | | — |
| | 9,089 |
| | 23,747 |
| | 84,427 |
| | 117,263 |
|
| Total securities available for sale | | $ | 2,174 |
| | $ | 30,696 |
| | $ | 31,783 |
| | $ | 88,913 |
| | $ | 153,566 |
|
Weighted average yield (1) | | 1.55 | % | | 1.97 | % | | 1.96 | % | | 2.40 | % | | 2.21 | % |
(1) Based on amortized cost, taxable equivalent basis
Deposits
Deposits are the primary source of funds for the Company's lending and investing activities. The Company provides a range of deposit services to businesses and individuals, including noninterest bearing checking accounts, interest bearing checking accounts, savings accounts, money market accounts, Individual Retirement Accounts ("IRAs") and certificates of deposit ("CDs"). These accounts generally earn interest at rates the Company establishes based on market factors and the anticipated amount and timing of funding needs. The establishment or continuity of a core deposit relationship can be a factor in loan lossespricing decisions. While the Company's primary focus is on establishing customer relationships to attract core deposits, at times, the Company uses brokered deposits and other wholesale deposits to supplement its funding sources. As of December 31, 2017, brokered deposits represented approximately 14.1 percent of total deposits.
The composition of the deposit portfolio, by category, as of December 31,
2014 is adequate to absorb possible losses from loans currently2017 was as follows: 30.8 percent in
time deposits, 37.8 percent in money market and savings, 16.1 percent in interest-bearing demand deposit, and 15.3 percent in noninterest bearing demand deposits. The composition of the
portfolio.Table 17 presents the Bank’s internal watchlist for loans classified as doubtfuldeposit portfolio, by category, as of December 31, 20142016 was as follows: 34.9 percent in time deposits, 30.3 percent in money market and 2013. Table 18 presentssavings, 17.9 percent in interest-bearing demand deposit, and 16.9 percent in noninterest bearing demand deposits.
The following table summarizes the Bank’s internal watchlistaverage balances outstanding and average interest rates for loans classified as substandardeach major category of deposits for 2017 and 2016.
|
| | | | | | | | | | | | | | | | | | | | |
| | | 2017 | | 2016 |
| | | Average | | | | | | Average | | | | |
| (Dollars in thousands) | | Balance | | % of Total | | Average Rate | | Balance | | % of Total | | Average Rate |
| Noninterest demand | | $ | 172,842 |
| | 17.1 | % | | — |
| | $ | 139,652 |
| | 16.2 | % | | — |
|
| Interest-bearing demand | | 166,382 |
| | 16.5 | % | | 0.32 | % | | 150,649 |
| | 17.4 | % | | 0.19 | % |
| Money market and savings | | 342,637 |
| | 33.9 | % | | 0.51 | % | | 258,092 |
| | 29.9 | % | | 0.45 | % |
| Time deposits | | 329,524 |
| | 32.5 | % | | 0.98 | % | | 316,046 |
| | 36.5 | % | | 0.84 | % |
| Total average deposits | | $ | 1,011,385 |
| | 100.0 | % | | 0.54 | % | | $ | 864,439 |
| | 100.0 | % | | 0.47 | % |
During 2017 the overall mix of average deposits has shifted to a higher percentage of noninterest bearing demand and money market and savings deposits, with reductions in the percentage of deposits held in interest-bearing demand accounts and time deposits. The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of deposits was 0.54 percent in 2017 compared to 0.47 percent in 2016 due to changes in deposit mix and higher deposit interest rates.
Total deposits as of December 31,
20142017 were $1,438.6 million, which was an increase of $531.5 million from December 31, 2016. As of December 31, 2017, the Company had outstanding time deposits under $100,000 of $201.8 million, time deposits over $100,000 of $239.9 million, and
2013.TABLE 17
Internal Watchlist Composition-Doubtful |
| | December 31, 2014 | | | December 31, 2013 | |
(In thousands) | | Amount | | | Impairment | | | Amount | | | Impairment | |
Commercial and industrial | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Construction and development | | | - | | | | - | | | | - | | | | - | |
Single family real estate | | | - | | | | - | | | | - | | | | - | |
Multi-family real estate | | | - | | | | - | | | | - | | | | - | |
Owner occupied commercial real estate | | | - | | | | - | | | | - | | | | - | |
Non-owner occupied commercial real estate | | | - | | | | - | | | | - | | | | - | |
Consumer | | | - | | | | - | | | | - | | | | - | |
Totals | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
TABLE 18
| Internal Watchlist Composition-Substandard |
| | | December 31, 2014 | | | December 31, 2013 | |
| (In thousands) | | Amount | | | Impairment | | | Amount | | | Impairment | |
| Commercial and industrial | | $ | 1,992 | | | $ | 273 | | | $ | 2,137 | | | $ | 55 | |
| Construction and development | | | 1,231 | | | | - | | | | 674 | | | | - | |
| Single family real estate | | | 2,702 | | | | 15 | | | | 5,210 | | | | 11 | |
| Multi-family real estate | | | - | | | | - | | | | 125 | | | | - | |
| Owner occupied commercial real estate | | | 1,334 | | | | 228 | | | | 4,646 | | | | 86 | |
| Non-owner occupied commercial real estate | | | 3,152 | | | | 150 | | | | 2,217 | | | | 412 | |
| Consumer | | | - | | | | - | | | | - | | | | - | |
| Totals | | $ | 10,411 | | | $ | 666 | | | $ | 15,009 | | | $ | 564 | |
| | The information listed in tables 17 and 18 reflect the amount of the Bank’s loans net of any partial charge-off amount that has been previously recorded. |
| | During 2014, the Bank saw a decrease in the number and dollar volume of substandard loans. The Bank has been able to convert substandard loans to foreclosed assets or upgrade to performing loans. At December 31, 2014, management had determined that approximately $666 thousand was needed in specific loan impairment for substandard loans and $30 thousand for non-substandard loans. The majority of this amount, approximately $651 thousand, was concentrated in three loans. Management believes two of these loans, which have been assigned an impairment amount of $423 thousand, could be refinanced or the underlying businesses sold in 2015. In either instance, the Bank is anticipating that it will be able to collect the full amount of its outstanding book balance. The remaining, with an assigned impairment amount of approximately $228 thousand, will most likely continue to have an impairment during 2015 and could take additional time for management to work with the borrower. |
Table 19 presents Cornerstone's allocationa time deposit fair value adjustment of $1,092 thousand. The following table summarizes the allowance for loan lossesmaturities of time deposits $100,000 or more as of December 31, 2014, 2013, 2012, 2011,2017.
|
| | | |
| | December 31, |
| (Dollars in thousands) | 2017 |
| | |
| Remaining maturity: | |
|
| Three months or less | $ | 53,996 |
|
| Three to six months | 47,735 |
|
| Six to twelve months | 83,529 |
|
| More than twelve months | 54,624 |
|
| Total | $ | 239,884 |
|
Borrowings
The Company uses short-term borrowings and
2010.TABLE 19
| Allowance for Loan Losses |
| Years Ended December 31, |
| | | 2014 | | | 2013 | | | 2012 | |
(In thousands)
Balance at end of period applicable to | | Amount | | | Percent
of loans
by
category
to total
loans | | | Amount | | | Percent
of loans
by
category
to total
loans | | | Amount | | | Percent
of loans
by
category
to total
loans | |
| Commercial, financial and agricultural | | $ | 638 | | | | 12.82 | % | | $ | 352 | | | | 13.47 | % | | $ | 809 | | | | 14.49 | % |
| Real estate – construction | | | 130 | | | | 11.66 | % | | | 319 | | | | 14.37 | % | | | 1,241 | | | | 13.92 | % |
| Real estate – mortgage | | | 1,097 | | | | 26.04 | % | | | 938 | | | | 26.37 | % | | | 1,528 | | | | 25.70 | % |
| Real estate – commercial | | | 1,595 | | | | 48.47 | % | | | 1,549 | | | | 44.84 | % | | | 2,549 | | | | 45.19 | % |
| Consumer | | | 35 | | | | 1.01 | % | | | 45 | | | | .95 | % | | | 14 | | | | 0.70 | % |
| Totals | | $ | 3,495 | | | | 100.00 | % | | $ | 3,203 | | | | 100.00 | % | | $ | 6,141 | | | | 100.00 | % |
| | | 2011 | | | 2010 | |
(In thousands)
Balance at end of period applicable to | | Amount | | | Percent
of loans
by
category
to total
loans | | | Amount | | | Percent
of loans
by
category
to total
loans | |
| Commercial, financial and agricultural | | $ | 482 | | | | 13.99 | % | | $ | 925 | | | | 17.94 | % |
| Real estate – construction | | | 827 | | | | 11.59 | % | | | 3,238 | | | | 10.46 | % |
| Real estate – mortgage | | | 2,518 | | | | 26.34 | % | | | 3,111 | | | | 25.20 | % |
| Real estate – commercial | | | 3,557 | | | | 47.08 | % | | | 1,793 | | | | 45.23 | % |
| Consumer | | | 16 | | | | 1.00 | % | | | 65 | | | | 1.17 | % |
| Totals | | $ | 7,400 | | | | 100.00 | % | | $ | 9,132 | | | | 100.00 | % |
| | In 2014, Cornerstone calculated its allowance for loan and leases losses (“ALLL”) by including measurements such as environmental factors for growth, environmental factors for real estate values, historical metrics and specific loan products with increased levels of risk, such as asset based lending. Further, Cornerstone calculated its ALLL using a ten-quarter look-back time frame. Management believes its allowance methodology is consistent with generally accepted accounting principles and interagency policy statements published by the Bank’s regulatory agencies. |
Table 20 representslong-term debt to provide both funding and, to a lesser extent, regulatory capital for debt at the scheduled maturitiesCompany level which can be downstreamed as Tier 1 capital to the Bank. Short-term borrowings totaled $33.6 million at December 31, 2017, and consisted entirely of floatingfederal funds purchased. Short-term borrowings totaled $18.5 million at December 31, 2016, and consisted of $5.0 million in FHLB advances maturing within twelve months and $13.5 million federal funds purchased. Short-term borrowings totaled $22 million at December 31, 2015, and consisted of $18 million in FHLB advances maturing within twelve months and $4 million federal funds purchased. Long-term debt totaled $10 million at December 31, 2017 and consisted of one line of credit that matures in 2022. There was no long term debt outstanding at December 31, 2016. Long-term debt totaled $12.0 million at December 31, 2015, consisting of outstanding long-term FHLB advances of $10.0 million and $2.0 million outstanding on a line of credit.
Capital Resources
The Company uses leverage analysis to examine the potential of the institution to increase assets and liabilities using the current capital base. The key measurements included in this analysis are the Banks' Common Equity Tier 1 capital, Tier 1 capital, leverage and total capital ratios. At December 31, 2017 and 2016, our capital ratios, including our Banks’ capital ratios, exceeded regulatory minimum capital requirements. From time to time we may be required to support the capital needs of our bank subsidiary. We believe we have various capital raising techniques available to us to provide for the capital needs of our Bank, if necessary. Additional information on capital is provided in Note 13 to the “Notes to Consolidated Financial Statements.”
Off-Balance Sheet Arrangements
At December 31, 2017, we had $292.8 million of pre-approved but unused lines of credit and $5.5 million of standby letters of credit. These commitments generally have fixed expiration dates and many will expire without being drawn upon. The total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank has the ability to liquidate Federal funds sold or securities available-for-sale, or on a short-term basis to borrow and purchase Federal funds from other financial institutions. Additional information about our off-balance sheet risk exposure is presented in Note 12 of the "Notes to the Consolidated Financial Statements."
Market Risk and Liquidity Risk Management
The Bank’s Asset Liability Management Committee (“ALCO”) is responsible for making decisions regarding liquidity and funding solutions based upon approved liquidity, loan, capital and investment policies. The ALCO must consider interest rate sensitivity and liquidity risk management when rendering a decision on funding solutions and loan pricing. To assist in this process the Bank has contracted with an independent third party to prepare quarterly reports that summarize several key asset-liability measurements. In addition, the third party will also provide recommendations to the Bank’s ALCO regarding future balance sheet structure, earnings and liquidity strategies. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.
Interest Rate Sensitivity
Interest rate sensitivity refers to the responsiveness of interest-earning assets and interest-bearing liabilities to changes in market interest rates. In the normal course of business, we are exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates the interest rate risk so that we can meet customer demands for various types of loans and deposits. ALCO determines the most appropriate amounts of on-balance sheet and off-balance sheet items. The primary measurements we use to help us manage interest rate sensitivity are an earnings simulation model and an economic value of equity model. These measurements are used in Cornerstone’s loan portfolioconjunction with competitive pricing analysis and are further described below.
Earnings Simulation Model We believe interest rate risk is effectively measured by our earnings simulation modeling. Earning assets, interest-bearing liabilities and off-balance sheet financial instruments are combined with simulated forecasts of interest rates for the next 12 months and 24 months. To limit interest rate risk, we have guidelines for our earnings at risk which seek to limit the variance of net interest income in instantaneous changes to interest rates. We also periodically monitor simulations based on various rate scenarios such as non-parallel shifts in market interest rates over time. For changes up or down in rates from our flat interest rate forecast over the next 12 and 24 months, limits in the decline in net interest income are as follows:
|
| | | | | | |
| | | Maximum Percentage Decline in Net Interest Income from the Budgeted or Base Case Projection of Net Interest Income |
| | | Next 12 Months | | Next 24 Months |
An instantaneous, parallel rate increase or decrease of the following at the beginning of the first quarter: | | |
| | |
|
| ± 100 basis points | | 9 | % | | 9 | % |
| ± 200 basis points | | 14 | % | | 14 | % |
| ± 300 basis points | | 20 | % | | 20 | % |
| ± 400 basis points | | 25 | % | | 25 | % |
We were in compliance with our earnings simulation model policies as of December 31, 2014, based on their contractual terms2017, indicating what we believe to maturity. Overdraftsbe a slightly asset sensitive profile.
Economic Value of Equity Our economic value of equity model measures the extent that estimated economic values of our assets, liabilities and off-balance sheet items will change as a result of interest rate changes. Economic values are reported as loans duedetermined by discounting expected cash flows from assets, liabilities and off-balance sheet items, which establishes a base case economic value of equity.
To help monitor our related risk, we’ve established the following policy limits regarding simulated changes in
less than one year.TABLE 20
| | | Less than | | | 1 to 5 | | | Over | | | | |
| | | 1 Year | | | Years | | | 5 Years | | | Total | |
| Floating Interest Rate Loans: | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | $ | 14,822 | | | $ | 1,725 | | | $ | 1,627 | | | $ | 18,174 | |
| Real estate-construction | | | 13,553 | | | | 3,518 | | | | 240 | | | | 17,311 | |
| Real estate-commercial | | | 1,869 | | | | 17,425 | | | | 20,189 | | | | 39,483 | |
| Real estate-mortgage | | | 2,905 | | | | 3,308 | | | | 18,570 | | | | 24,783 | |
| Consumer | | | 323 | | | | 166 | | | | - | | | | 489 | |
| Total floating interest rate loans | | $ | 33,472 | | | $ | 26,142 | | | $ | 40,626 | | | $ | 100,240 | |
| | | | | | | | | | | | | | | | | |
| Fixed Interest Rate Loans: | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | $ | 9,737 | | | $ | 9,714 | | | $ | 238 | | | $ | 19,689 | |
| Real estate-construction | | | 9,598 | | | | 7,520 | | | | 20 | | | | 17,138 | |
| Real estate-commercial | | | 18,020 | | | | 74,169 | | | | 11,496 | | | | 103,685 | |
| Real estate-mortgage | | | 6,147 | | | | 37,192 | | | | 8,785 | | | | 52,124 | |
| Consumer | | | 1,066 | | | | 1,422 | | | | - | | | | 2,488 | |
| Total fixed interest rate loans | | | 44,568 | | | | 130,017 | | | | 20,539 | | | | 195,124 | |
| Total loans | | $ | 78,040 | | | $ | 156,159 | | | $ | 61,165 | | | $ | 295,364 | |
Table 21 presents Cornerstone's delinquent, nonaccrual and troubled debt restructuring loans asour economic value of equity:
|
| | |
Instantaneous, Parallel Change in Prevailing Interest Rates Equal to | Maximum Percentage Decline in Economic Value of Equity from the Economic Value of Equity at Currently Prevailing Interest Rates |
| ±100 basis points | 20 | % |
| ±200 basis points | 25 | % |
| ±300 basis points | 30 | % |
| ±400 basis points | 35 | % |
At December 31,
for the five years indicated.TABLE 21
| Delinquent, Nonaccrual and Troubled Debt Restructured Loans |
| | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| Ratio of non-performing assets to total loans | | | 3.68 | % | | | 5.70 | % | | | 9.51 | % | | | 9.86 | % | | | 9.27 | % |
| Ratio of delinquent (30-days or more) but accruing loans to: | | | | | | | | | | | | | | | | | | | | |
| Total loans | | | 0.56 | % | | | 0.78 | % | | | 2.38 | % | | | 3.05 | % | | | 0.81 | % |
| Total assets | | | 0.40 | % | | | 0.52 | % | | | 1.49 | % | | | 1.93 | % | | | 0.52 | % |
| Actual for Years Ended December 31, |
| (In thousands) | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| Accruing loans that are contractually past due 90-days or more: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Real estate-construction | | | - | | | | - | | | | - | | | | - | | | | - | |
| Real estate-commercial | | | - | | | | - | | | | - | | | | - | | | | - | |
| Real estate-mortgage | | | - | | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | - | | | | - | | | | - | | | | - | | | | - | |
| Total loans | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Nonaccruing loans 90-days or more: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | $ | 1,195 | | | $ | 1,631 | | | $ | 2,467 | | | $ | 42 | | | $ | 75 | |
| Real estate-construction | | | 40 | | | | 47 | | | | 53 | | | | 1,622 | | | | - | |
| Real estate-commercial | | | 496 | | | | 882 | | | | 2,869 | | | | 2,563 | | | | 8,426 | |
| Real estate-mortgage | | | 1,134 | | | | 1,006 | | | | 616 | | | | 3,641 | | | | 5.114 | |
| Consumer | | | - | | | | - | | | | - | | | | 14 | | | | 18 | |
| Total loans | | $ | 2,865 | | | $ | 3,566 | | | $ | 6,005 | | | $ | 7,882 | | | $ | 13,633 | |
| | | | | | | | | | | | | | | | | | | | | |
| Troubled debt restructurings not included above | | | 3,767 | | | | 3,328 | | | | 5,316 | | | | 2,671 | | | | 948 | |
| Total loans | | $ | 295,364 | | | $ | 289,440 | | | $ | 276,991 | | | $ | 267,765 | | | $ | 285,247 | |
| | The Bank has seen an improvement in recent years in its ratio of non-performing assets to total loans. This trend has been the result of the Bank working with existing customers to restructure problem loans and the reduction of other real estate owned in the event a workout solution could not be found and the Bank had to foreclose on the property. To facilitate the disposal of other real estate the Bank elected to realize investment portfolio gains. This additional revenue allowed management to be more aggressive in the disposal of other real estate during this period. To provide further emphasis on this point, the Bank had approximately $20.3 million in foreclosed assets as recent as December 31, 2012. As of December 31, 2014, the amount of foreclosed assets had been reduced to approximately $8.0 million. While the December 31, 2014 amount in foreclosed assets remains at elevated levels compared to amounts pre-2008, management has seen a significant improvement in the Bank’s non-performing asset ratios and anticipates reductions in other real estate operating expense in future years. |
| | The Bank has also seen an improvement in its loans that are past due 30 days or more. Management believes this ratio is an important indicator for possible future problems in its loan portfolio. The level of past due loans 30 days or more of 0.56% as of December 31, 2014 and the decline in the Bank’s nonaccrual loans to approximately $2.9 million for the same time period are both positive indicators regarding the trend in the Bank’s asset quality. Management believes the Bank’s nonaccrual loan total will decrease during 2015 if further improvements occur in several large loans as expected. |
In addition to the Bank's loan rating system for problem assets described above (see “Problem Loans,” above), the Bank has established a loan rating system for all categories of loans which assists management and the Board of Directors in determining the adequacy2017, our model results indicated that we were within these policy limits.
Each of the
Bank's allowance for loan losses. Each loanabove analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in
the Bank's portfolio is assigned a rating which is reviewedinterest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by
management periodically to ensure its continued suitability. An exception is madechanges in
the case of (i) monthly installment loans which are grouped together by delinquency status such as over 10, 30, 60, or 90 days past due and (ii) problem assets which are rated as substandard, doubtful, or loss as discussed above. All other loans are assigned a rating of excellent, good, or average. | | The Bank has developed an internal loan watchlist that identifies classified loans and assists management in monitoring their potential risk to Bank earnings. The Bank also had loans graded substandard of approximately $10.4 million as of December 31, 2014 compared to approximately $15.0 million as of December 31, 2013. The Bank also had loans graded special mention of approximately $7.8 million as of December 31, 2014 compared to approximately $10.6 million as of December 31, 2013. Management continues to see positive results in the majority of metrics used to measure loan quality. During 2015, management expects the amount of substandard loans to decrease. Increases in special mention, especially, early in the year could occur as loans are upgraded from substandard to special mention for a period of evaluation before loans are ultimately assigned a pass grade. |
Table 22 presents Cornerstone’s loan loss experience for the periods indicated.
TABLE 22
| Loan Loss Reserve Analysis |
| Years Ending December 31, |
| (in thousands) | | 2014 | | | 2013 | | | 2012 | | | 2011 | | | 2010 | |
| Average loans | | $ | 293,708 | | | $ | 278,925 | | | $ | 268,828 | | | $ | 273,523 | | | $ | 311,407 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for possible loan | | | | | | | | | | | | | | | | | | | | |
| losses, beginning of the period | | $ | 3,203 | | | $ | 6,141 | | | $ | 7,400 | | | $ | 9,132 | | | $ | 5,905 | |
| | | | | | | | | | | | | | | | | | | | | |
| Charge-offs for the period: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | | 108 | | | | 699 | | | | 74 | | | | 36 | | | | 433 | |
| Real estate – construction | | | 58 | | | | 1,193 | | | | 782 | | | | 232 | | | | 1,260 | |
| Real estate – mortgage | | | 896 | | | | 842 | | | | 1,022 | | | | 1,613 | | | | 562 | |
| Real estate – commercial | | | 470 | | | | 1,879 | | | | 958 | | | | 1,238 | | | | 2,309 | |
| Consumer | | | 50 | | | | 96 | | | | 33 | | | | 29 | | | | 114 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total charge-offs | | | 1,582 | | | | 4,709 | | | | 2,869 | | | | 3,148 | | | | 4,688 | |
| | | | | | | | | | | | | | | | | | | | | |
| Recoveries for the period: | | | | | | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural | | | 58 | | | | 99 | | | | 144 | | | | 94 | | | | 282 | |
| Real estate – construction | | | 771 | | | | 1,058 | | | | 145 | | | | 532 | | | | 19 | |
| Real estate – mortgage | | | 324 | | | | 241 | | | | 36 | | | | 65 | | | | 54 | |
| Real estate – commercial | | | 156 | | | | 68 | | | | 838 | | | | 259 | | | | 213 | |
| Consumer | | | 50 | | | | 5 | | | | 17 | | | | 21 | | | | 56 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total recoveries | | | 1,359 | | | | 1,471 | | | | 1,180 | | | | 971 | | | | 624 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net charge-offs for the period | | | 223 | | | | 3,238 | | | | 1,689 | | | | 2,177 | | | | 4,064 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 515 | | | | 300 | | | | 430 | | | | 445 | | | | 7,291 | |
| | | | | | | | | | | | | | | | | | | | | |
| Allowance for possible loan losses, end of period | | $ | 3,495 | | | $ | 3,203 | | | $ | 6,141 | | | $ | 7,400 | | | $ | 9,132 | |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of allowance for loan losses to total average loans outstanding | | | 1.19 | % | | | 1.15 | % | | | 2.28 | % | | | 2.71 | % | | | 2.93 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Ratio of net charge-offs during the period to average loans outstanding during the period | | | 0.08 | % | | | 1.16 | % | | | 0.63 | % | | | 0.80 | % | | | 1.31 | % |
Sources of Funds
Overview-Time, money market, savings and demand deposits are the major source of the Bank’s funds for lending and other investment purposes. All deposits are held by the Bank.interest rates. In addition, the Bank obtainsmagnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates.
In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as interest rate caps and floors) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. Our ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies.
Liquidity Risk Management
The purpose of liquidity risk management is to ensure that there are sufficient cash flows to satisfy loan demand, deposit withdrawals, and our other needs. Traditional sources of liquidity for a bank include asset maturities and growth in core deposits. A bank may achieve its desired liquidity objectives from the management of its assets and liabilities and by internally generated funding through its operations. Funds invested in marketable instruments that can be readily sold and the continuous maturing of other earning assets are sources of liquidity from an asset perspective. The liability base provides sources of liquidity through attraction of increased deposits and borrowing funds from various other institutions.
Changes in interest rates also affect our liquidity position. We currently price deposits in response to market rates and intend to continue this policy. If deposits are not priced in response to market rates, a loss of deposits could occur which would negatively affect our liquidity position.
Scheduled loan principal repayments and proceeds from sales of loan participations and investment securities. Loan repaymentspayments are a relatively stable source of funds, whilebut loan payoffs and deposit inflowsflows fluctuate significantly, being influenced by interest rates, general economic conditions and outflowscompetition. Additionally, debt security investments are subject to prepayment and salescall provisions that could accelerate their payoff prior to stated maturity. We attempt to price our deposit products to meet our asset/liability objectives consistent with local market conditions. Our ALCO is responsible for monitoring our ongoing liquidity needs. Our regulators also monitor our liquidity and capital resources on a periodic basis.
Impact of loan participationsInflation and investment securitiesChanging Prices
As a financial institution, we have an asset and liability make-up that is distinctly different from that of an entity with substantial investments in plant and inventory, because the major portions of a commercial bank’s assets are monetary in nature. As a result, our performance may be significantly influenced by prevailingchanges in interest rates. Although we, and the banking industry, are more affected by changes in interest rates economic conditionsthan by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the Bank’s assetcost of supplies and liability management strategies. Borrowingsoutside services tend to increase more during periods of high inflation.
Critical Accounting Policies
The Company has identified accounting policies that are used on eitherthe most critical to fully understand and evaluate its reported financial results and require management's most difficult, subjective or complex judgments. Management has reviewed the following critical accounting policies and related disclosures with the Audit Committee of the Board of Directors. These policies along with a short-term basis to compensate for reductionsbrief discussion of the material implications of the uncertainties of each policy are below. For a full description of these critical accounting policies, see Note 1 in the availability“Notes to Consolidated Financial Statements.”
Allowance for loan losses – In establishing the allowance we take into account reserves required for impaired loans, historical charge-offs for loan types, and a variety of other sources of funds or on a longer-term basis to reduce interest rate risk.Table 23 presents the Bank’s core vs. non-core funding as of December 31, 2014qualitative factors including economic outlook, portfolio concentrations, and 2013.
TABLE 23
| Core and Non-Core Funding |
| (In thousands) | | | | | | |
| | | December 31, 2014 | | | December 31, 2013 | |
| Core funding: | | Amount | | | Percent | | | Amount | | | Percent | |
| Noninterest-bearing demand deposits | | $ | 57,035 | | | | 15.2 | % | | $ | 75,206 | | | | 19.3 | % |
| Interest-bearing demand deposits | | | 26,464 | | | | 7.1 | % | | | 24,564 | | | | 6.3 | % |
| Savings and money market accounts | | | 80,861 | | | | 21.6 | % | | | 86,330 | | | | 22.2 | % |
| Time deposits under $100,000 | | | 57,128 | | | | 15.3 | % | | | 74,080 | | | | 19.0 | % |
| Total core funding | | | 221,488 | | | | 59.2 | % | | | 260,180 | | | | 66.8 | % |
| | | | | | | | | | | | | | | | | |
| Non-core funding: | | | | | | | | | | | | | | | | |
| Time deposits greater than $100,000 | | | 87,166 | | | | 23.3 | % | | | 81,234 | | | | 20.9 | % |
| Federal funds purchased | | | 10,000 | | | | 2.7 | % | | | - | | | | -% | |
| Securities sold under agreements to repurchase | | | 19,410 | | | | 5.2 | % | | | 22,974 | | | | 5.9 | % |
| Federal Home Loan Bank advances | | | 36,000 | | | | 9.6 | % | | | 25,000 | | | | 6.4 | % |
| Total non-core funding | | | 152,576 | | | | 40.8 | % | | | 129,208 | | | | 33.2 | % |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 374,064 | | | | 100.0 | % | | $ | 389,388 | | | | 100.0 | % |
| | The Bank’s noninterest-bearing demand deposits decreased from approximately $75 million as of December 31, 2013 to approximately $57 million as of December 31, 2014. Decreases were also seen in the Bank’s under $100,000 time deposit accounts. The Bank has been able to improve its net interest margin by repricing the maturing time deposits during this time. However, the loss of noninterest-bearing demand deposits negatively impacted the Bank. Management is in the process of evaluating liquidity plans that not only improve the company’s core funding percentages but also address interest rate risk. The improvement of the Bank’s core funding position will be a high priority for management during 2015. |
| | During 2014, the Bank has attempted to remain interest rate competitive on interest-bearing demand deposits, savings and money market relationships. The majority of the Bank’s depository base is seeking these types of products as opposed to time deposits. Customers have consistently kept their deposits in non-maturity based products in anticipation of interest rate increases in the market. |
| | To offset the decrease in core funding, the Bank elected to increase its borrowings from the Federal Home Loan Bank (FHLB). Recent borrowings from FHLB have been short-term and have, therefore, enabled the Bank to reduce its cost of funds. Approximately $10 million of long-term advances will mature in 2015 and management anticipates the new advances to be short-term in nature to allow the Bank to improve its net interest margin and allow management to position the balance sheet for interest rate risk if interest rates rise in the near future. |
Deposits-The Bank offers several types of deposit accounts, with the principal differences relating to the minimum balances required, the time period the funds must remain on deposit and the interest rate. Deposits are obtained primarily from the Bank's Chattanooga, Tennessee MSA. The Bank does advertise for deposits outside of this area and has had moderate success attracting deposits from credit unions around the United States. The Bank does not rely upon any single person or group of related persons for a material portion of its deposits. A principal source of deposits for the Bank consists of short-term money market and other accounts, which are highly responsive to changes in market interest rates. Accordingly, the Bank, like all financial institutions, is subject to short-term fluctuations in deposits in response to customer actions due to changing short-term market interest rates. The abilityportfolio credit quality. Many of the Bank to attract and maintain deposits and the Bank's cost of funds has been and will continue to be significantly affected by money market conditions.
Table 24 presents the composition of deposits for the Bank, excluding accrued interest payable, by type for the years ended December 31, 2014, 2013 and 2012 (in thousands).
TABLE 24
| Deposit Composition |
| Years Ended December 31, |
| (In thousands) | | 2014 | | | 2013 | | | 2012 | |
| Demand deposits | | $ | 57,035 | | | $ | 75,206 | | | $ | 60,054 | |
| NOW deposits | | | 26,464 | | | | 24,564 | | | | 30,179 | |
| Savings and money market deposits | | | 80,861 | | | | 86,330 | | | | 80,994 | |
| Time deposits $100,000 and over | | | 87,166 | | | | 81,234 | | | | 87,737 | |
| Time deposits under $100,000 | | | 57,128 | | | | 74,080 | | | | 85,917 | |
| Total Deposits | | $ | 308,654 | | | $ | 341,415 | | | $ | 344,881 | |
Table 25 presents a breakdown by category of the average amount of deposits and the average rate paid on deposits for the periods indicated:
TABLE 25
| Average Amount and Average Rate Paid on Deposits |
| Years Ending December 31, |
| (In thousands) | | 2014 | | | 2013 | | | 2012 | |
| | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | |
| Demand deposits | | $ | 59,219 | | | | | | | $ | 51,614 | | | | | | | $ | 39,936 | | | | | |
| NOW deposits | | | 26,921 | | | | 0.15 | % | | | 26,196 | | | | 0.21 | % | | | 26,483 | | | | 0.33 | % |
| Savings and money market deposits | | | 82,903 | | | | 0.33 | % | | | 88,912 | | | | 0.47 | % | | | 62,958 | | | | 0.73 | % |
| Time deposits | | | 157,112 | | | | 0.91 | % | | | 165,748 | | | | 1.07 | % | | | 187,733 | | | | 1.32 | % |
| Total Deposits | | $ | 326,155 | | | | 0.53 | % | | $ | 332,470 | | | | 0.68 | % | | $ | 317,110 | | | | 0.95 | % |
Table 26 presents a breakdown as of December 31, 2014, of the Bank’s scheduled maturity of time deposits (in thousands):
TABLE 26
| | | Balances | |
| Denominations less than $100,000 | | | | |
| Three months or less | | $ | 9,519 | |
| Over three but less than six months | | | 10,196 | |
| Over six but less than twelve months | | | 16,795 | |
| Over twelve months | | | 20,618 | |
| | | $ | 57,128 | |
| | | | | |
Denomination greater than $100,000 | | | | |
| Three months or less | | $ | 20,506 | |
| Over three but less than six months | | | 5,241 | |
| Over six but less than twelve months | | | 32,850 | |
| Over twelve months | | | 28,569 | |
| | | $ | 87,166 | |
| Totals | | $ | 144,294 | |
Borrowings-The Bank joined the Federal Home Loan Bank of Cincinnati in October 2000. The Federal Home Loan Bank (FHLB) allows the Bank to borrow funds on a contractual basis many times at rates lower than the costs of local certificates of deposit. In addition, the FHLB has the ability to provide structured advances that best reduce or leverage the interest rate risk of the Bank. During 2014, the Bank increased its FHLB borrowings by $11 million. The increase allowed the Bank to obtain short-term funding at favorable interest rates. As of December 31, 2014, the interest rates on these loans ranged from 0.23% to 4.25%. The weighted average interest rate for all FHLB advances equals 2.32%. Thisqualitative factors are measurable but there is an area of opportunity for the Bank during 2015 as an additional $10 million in FHLB advances will mature. This will allow the Bank to significantly reduce its interest cost by renewing the $10 million in advances at shorter terms and lower interest rates. As of December 31, 2014, the Bank had approximately $13.4 million in additional availability with the FHLB.
The Bank has five Federal Funds lines of credit available with correspondent banks with a total availability of $30 million as of December 31, 2014. This is an improvement over the availability as of December 31, 2013. At that time the Bank had three Federal Funds lines of credit totaling $15 million.
Cornerstone’s short-term borrowings (borrowings which mature within the next fiscal year) consist primarily of federal funds purchased and securities sold under agreements to repurchase, Federal Home Loan Bank (FHLB) advances, and other borrowings. Information concerning these short-term borrowings as of and for each of the years in the three-year period ended December 31, 2014, is as follows (dollars in thousands):
TABLE 27
| | | At December 31, | |
| | | 2014 | | | 2013 | | | 2012 | |
| Amounts outstanding at year-end: | | | | | | | | | | | | |
| Federal funds purchased and securities | | | | | | | | | | | | |
| sold under agreements to repurchase | | $ | 29,410 | | | $ | 22,974 | | | $ | 19,587 | |
| FHLB advances | | | 26,000 | | | | 5,000 | | | | 10,000 | |
| Other borrowings | | | - | | | | 1,740 | | | | 870 | |
| | | | | | | | | | | | | |
| Weighted average interest rates at year-end: | | | | | | | | | | | | |
| Federal funds purchased and securities | | | | | | | | | | | | |
| sold under agreements to repurchase | | | 0.33 | % | | | 0.33 | % | | | 0.37 | % |
| FHLB advances | | | 1.60 | % | | | 4.43 | % | | | 4.05 | % |
| Other borrowings | | | -% | | | | 2.00 | % | | | 6.50 | % |
| | | | | | | | | | | | | |
| Maximum amount of borrowings at any month-end: | | | | | | | | | | | | |
| Federal funds purchased and securities | | | | | | | | | | | | |
| sold under agreements to repurchase | | $ | 47,143 | | | $ | 32,974 | | | $ | 28,399 | |
| FHLB advances | | | 26,000 | | | | 5,000 | | | | 10,000 | |
| Other borrowings | | | 1,740 | | | | 1,740 | | | | 870 | |
| | | | | | | | | | | | | |
| Average balances for the year: | | | | | | | | | | | | |
| Federal funds purchased and securities | | | | | | | | | | | | |
| sold under agreements to repurchase | | $ | 22,319 | | | $ | 22,041 | | | $ | 21,312 | |
| FHLB advances | | | 18,000 | | | | 5,000 | | | | 8,462 | |
| Other borrowings | | | 858 | | | | 1,595 | | | | 870 | |
| | | | | | | | | | | | | |
| Weighted average interest rates for the year: | | | | | | | | | | | | |
| Federal funds purchased and securities | | | | | | | | | | | | |
| sold under agreements to repurchase | | | 0.32 | % | | | 0.34 | % | | | 0.44 | % |
| FHLB advances | | | 3.00 | % | | | 4.47 | % | | | 4.08 | % |
| Other borrowings | | | 1.00 | % | | | 2.41 | % | | | 6.50 | % |
Capital
Capital Resources-Stockholder’s average equity for 2014 and 2013 totaled $40.6 and $40.8 million, respectively. As of December 31, 2014, Cornerstone’s actual stockholder equity totaled $40.7 million compared to $40.1 million as of December 31, 2013. As of December 31, 2014 and 2013, the number of shares of Series A Preferred Stock outstanding was 600,000. The number of common shares outstanding were 6,627,398 and 6,547,074 as of December 31, 2014 and December 31, 2013, respectively.
Capital Adequacy-Capital adequacy refers to the level of capital required to sustain asset growth and to absorb losses. The objective of Cornerstone’s management is to maintainalso a level of capitalization that is sufficient to take advantage of profitable growth opportunities while meeting regulatory requirements. This is achieved by improving profitability by effectively allocating resources to more profitable business, improving asset quality, strengthening service quality, and streamlining costs. The primary measures used by management to monitor the results of these efforts are the ratios of actual equity to average assets and actual equity to risk-adjusted assets.
The FDIC has adopted capital guidelines governing the activities of banks. These guidelines require the maintenance of an amount of capital based on risk-adjusted assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments. The capital guidelines classify capital into two tiers, referred to as Tier I and Tier II. Under risk-based capital requirements, total capital consists of Tier I capital, which is generally common shareholder’s equity less goodwill, and Tier II, which is primarily Tier I capital plus a portion of the loan loss allowance. In determining risk-based capital requirements, assets are assigned risk-weights of 0% to 100%, depending primarily on the regulatory assigned levels of credit risk associated with such assets. Off-balance sheet items are considered in the calculation of risk-adjusted assets through conversion factors established by regulators. The framework for calculating risk-based capital requires banks to meet the regulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990, regulators added a leverage computation to the capital requirements, comparing Tier I capital to total average assets less goodwill.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) established five capital categories for banks. Under the regulation defining these five capital categories, each bank is classified into one of the five categories based on its level of risk-based capital as measured by Tier I capital, total risk-based capital, and Tier I leverage ratios and its supervisory ratings. Table 28 lists the five categories of capital and each of the minimum requirements for the three risk-based ratios.
TABLE 28
Minimum Requirements for Risk-Based Capital Ratios |
| | Total Risk-Based
Capital Ratio
| | Tier I Risk-Based
Capital Ratio
| | Leverage Ratio
|
Well capitalized | | 10% or above | | 6% or above | | 5% or above |
Adequately capitalized | | 8% or above | | 4% or above | | 4% or above |
Under capitalized | | Less than 8% | | Less than 4% | | Less than 4% |
Significantly undercapitalized | | Less than 6% | | Less than 3% | | Less than 3% |
Critically undercapitalized | | | | | | 2% or less |
The Bank was considered well capitalized as of December 31, 2014 and its capital ratios were as follows:
Tier 1 leverage ratio | 9.38% |
Tier 1 risk-based capital ratio | 12.32% |
Total risk-based capital ratio | 13.45% |
Liquidity-Of primary importance to depositors, creditors and regulators is the ability to have readily available funds sufficient to repay fully maturing liabilities. Cornerstone’s liquidity, represented by cash and cash equivalents, is a result of its operating, investing and financing activities. In order to ensure funds are available at all times, Cornerstone devotes resources to projecting on a monthly basis the amount of funds accessible. Liquidity requirements can also be met through short-term borrowing or the disposition of short-term assets, which are generally matched to correspond to the maturity of liabilities.
The Bank’s liquidity target is measured by adding net cash, short-term and marketable securities not pledged and dividing this number by total deposits and short-term liabilities not secured by assets pledged. The Bank’s liquidity ratio at December 31, 2014 was 19.8% The Bank is not subject to any specific liquidity requirements imposed by regulatory orders. The Bank is subject, however, to general FDIC guidelines which are concerned with funding sources and dependence on noncore deposits and does not require a specific minimum level of liquidity. Management believes its liquidity ratios and funding sources meet or exceed these guidelines.
Cornerstone’s liquidity is dependent on dividends from its subsidiary. Currently, the holding company’s expenses are tied to shareholder and related Securities and Exchange Commission required filings expense. The Bank is presently restricted from passing up any dividends to the holding company unless the Bank receives prior approval from the FDIC who reviews the Bank’s profitability and overall safety and soundness before allowing dividends to be paid.
Management does not know of any other trends, demands, commitments, events or uncertainties that will result in or are reasonably likely to result in liquidity increasing or decreasing in any material manner.
Table 29 presents the average loan to deposit ratios, a liquidity measure, for periods indicated:
TABLE 29
| | | December 31, 2014 | | | December 31, 2013 | |
| Average loans to average deposits | | | 90.05 | % | | | 83.91 | % |
Off-Balance Sheet Arrangements
Cornerstone does not have any off-balance sheet arrangements.
Critical Accounting Policies
Cornerstone’s accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Our significant accounting policies are described in Note 1, “Summary of Significant Accounting Policies,” to the consolidated financial statements and are integral to understanding the MD&A. Critical accounting policies include the initial adoption of an accounting policy that has a material impact on our financial presentation as well as accounting estimates reflected in our financial statements that require us to make estimates andsubjective assumptions. If those assumptions about matters that were highly uncertain at the time. Disclosure about critical estimates is required if different estimates that Cornerstone reasonablychange it could have used in the current period would have a material impact on the presentation of our financial condition, changes in financial condition or results of operations. The following is a description of our critical accounting policies.
Allowance for Loan Losses
The allowance for loan losses is established and maintained at levels management deems adequate to absorb credit losses inherent in the portfolio as of the balance sheet date. The allowance is increased through the provision for loan and lease losses and reduced through loan and lease charge-offs, net of recoveries. The level of the allowance is based on knownrequired and inherent risks in the portfolio, past loan loss experience, underlying estimated values of collateral securing loans, current economic conditions and other factors as well as the level of specific impairments associated with impaired loans. This process involves our analysis of complex internal and external variables and it requires that management exercise judgment to estimate an appropriate allowance.
Changes in the financial condition of individual borrowers, economic conditions or changes to our estimated risks could require us to significantly decrease or increase the level of the allowance. Such a change could materially impact Cornerstone’s net income as a result the earnings of the changeCompany. As an example an increase in the provisionamount of the reserve to organic loans of 0.05 percent in 2017 would have resulted in a reduction of approximately 3 percent in pre-tax income.
Fair values for loan losses. Refer toacquired assets and assumed liabilities- Assets and liabilities acquired are recorded at their respective fair values as of the “Problem Loans and Allowance for Loan Losses” section withindate of the MD&A for a discussionacquisition. The excess of Cornerstone’s methodologythe purchase price over the net estimated fair values of establishing the allowance as well as Note 1 in the notes to Cornerstone’s consolidated financial statements.
Estimates of Fair Value
Fair value is used on a recurring basis for certainacquired assets and liabilities in which fair value is the primary basis of accounting. Cornerstone’s available for sale securities are measured at fair value on a recurring basis. Additionally, fair value is usedallocated to measure certain assets and liabilities on a nonrecurring basis. Cornerstone uses fair value on a nonrecurring basis for foreclosed assets and collateral associated with impaired collateral-dependent loans. Fair value is also used in certain impairment valuations, including assessments of goodwill, otheridentifiable intangible assets with the remaining excess allocated to goodwill. Goodwill has an indefinite useful life and long-lived assets.
Fair value is evaluated for impairment annually, or more frequently if events and circumstances indicate that the priceasset might be impaired. An impairment loss is recognized to the extent that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Estimating fair value in accordance with applicable accounting guidance requires that Cornerstone make a number of significant judgments. Accounting guidance provides three levels ofthe carrying amount exceeds the asset’s fair value. Level 1 fair value refers to observable market prices for identical assets or liabilities. Level 2 fair value refers to similar assets or liabilities with observable market data. Level 3 fair value refers to assets and liabilities where market prices are unavailable or impracticable to obtain for similar assets or liabilities. Level 3 valuations require modeling techniques, such as discounted cash flow analyses. These modeling techniques incorporate Cornerstone’s assessments regarding assumptions that market participants would use in pricing the asset or the liability.
Changes in fair value could materially impact our financial results. Refer to Note 12, “Fair Value Disclosures,” in the notes to Cornerstone’s consolidated financial statements for a discussion of the methodology in calculating fair value.
Income Taxes
Cornerstone is subject to various taxing jurisdictions where Cornerstone conducts business. Cornerstone estimates income tax expense based on amounts expected to be owed to these jurisdictions. Cornerstone evaluates the reasonableness of our effective tax rate based on a current estimate of annual net income, tax credits, non-taxable income, non-deductible expenses and the applicable statutory tax rates. The estimated income tax expense or benefit is reported in the consolidated statements of income.
The accrued tax liability or receivable represents the net estimated amount due or to be received from tax jurisdictions either currently or in the future and are reported in other liabilities or other assets, respectively, in Cornerstone’s consolidated balance sheets. Cornerstone assesses the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other pertinent information and maintains tax accruals consistent with management’s evaluation. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations by tax authorities and newly enacted statutory, judicial and regulatory guidance that could impact the relative merits of tax positions. These changes, if or when they occur, could impact accrued taxes and future tax expense and could materially affect our financial results.
Cornerstone periodically evaluates uncertain tax positions and estimates the appropriate level of tax reserves related to each of these positions. Additionally, Cornerstone evaluates its deferred tax assets for possible valuation allowances based on the amounts expected to be realized. The evaluation of uncertain tax positions and deferred tax assets involves a high degree of judgment and subjectivity. Changes in the results of these evaluations could have a material impact on our financial results. Refer to Note 8, “Income Taxes,” in the notes to Cornerstone’s consolidated financial statements for more information. As of December 31, 2014, Cornerstone had2017 there was approximately $42.9 million in goodwill. The Company has not identified any triggering events that would indicate potential impairment of goodwill.
Cash flow estimates on purchased credit-impaired loans- Purchase credit impaired loans do not have traditional loan yields and interest income; instead they have accretable yield and accretion. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income as accretion over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The amount expected to be accreted divided by the accretable discount is the accretable yield. Cash flow estimates are re-evaluated quarterly. If the estimated cash flows increase then the accretable yield over the life of the loan increases. If, however, the estimated cash flows decrease then impairment is generally recognized immediately. As an example a netloan with a fair value of $200,000 with estimated cash flows of $300,000 over five years would have an accretable yield of approximately 8.2 percent and would have accretion of approximately $16,400 a year. If the cash flow estimate changed to $350,000 the accretable yield would increase to approximately 10.1 percent and the yearly accretion recognized into income would be approximately $20,300. If, however, the cash flow estimate changed to $250,000 the Company would generally recognize an impairment of $50,000 immediately, instead of reducing the accretion over the life of the loan.
Valuation of foreclosed assets - Foreclosed assets are initially recorded at fair value less selling costs. If the fair value decreases the assets are written down. As of December 31, 2017, there was approximately $3.3 million in foreclosed assets carried at a 17.8 percent discount to appraisal values.
Valuation of deferred tax asset of $1.8 million and did not establish a valuation allowance against its netassets- Deferred income tax expense results from changes in deferred tax assets as of December 31, 2013 or December 31, 2014 becauseand liabilities between periods. Deferred tax assets are recognized if it is more likely than not that all of these assetsthe tax position will be realized. In evaluatingrealized or sustained upon examination. The determination of whether or not a tax position has met the need formore-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance we estimated future taxable incomeif, based on management prepared forecasts. This process required significant judgment by management about mattersthe weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2017, there were approximately $5.0 million in net deferred tax assets.
Evaluation of investment securities for other than temporary impairment- We evaluate investment securities for other than temporary impairment taking into account if we do not have the intent to sell a debt security prior to recovery and it is more likely than not that we will not have to sell the debt security prior to recovery, the security would not be considered other than temporarily impaired unless a credit loss has occurred in the security. Temporary impairments are by nature uncertain.recognized on the balance sheet in other comprehensive income / loss. If future events differ significantly from our current forecasts, we may need to establish a valuation allowance, which could have a material adverse effectsecurity becomes permanently impaired the impairment expense would be recognized and reduce earnings. As of December 31, 2017, there was approximately $1.8 million in losses on our results of operations and financial condition.investment securities that were classified as temporarily impaired.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The Bank’s Asset Liability Management Committee (“ALCO”)
This Item is
responsible for making decisions regarding liquidity and funding solutions based upon approved liquidity, loan, capital and investment policies. The ALCO must consider interest rate sensitivity and liquidity risk management when rendering a decision on funding solutions and loan pricing. To assist in this process the Bank has contracted with an independent third partynot applicable to
prepare quarterly reports that summarize several key asset-liability measurements. In addition, the third party will also provide recommendations to the Bank’s ALCO regarding future balance sheet structure, earnings and liquidity strategies. The following is a brief discussion of the primary tools used by the ALCO to perform its responsibilities: | | Earnings at Risk Model |
The Bank uses an earnings at risk model to analyze interest rate risk. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of interest rates for the next 12 months and are combined with other factors in order to produce various earnings simulations.
At December 31, 2014, the Bank’s earnings at risk model demonstrated that the Bank was within its policy limits for a 200, 300 and 400 basis point change in interest rates. The policy limits have been established by the Directors ALCO committee and are calculated and reported quarterly.
| | Economic Value of Equity |
The Bank’s economic value of equity model measures the extent that estimated economic values of the Bank’s assets and liabilities will change as a result of interest rate changes. Economic values are determined by discounting expected cash flows from assets and liabilities, which establishes a base case economic value of equity.
As of December 31, 2014, the Bank’s economic value of equity model demonstrated that the Bank was within its policy limits for a 200, 300 and 400 basis point change in interest rates. The policy limits have been established by the Directors ALCO committee and are calculated and reported quarterly.
| | Liquidity Analysis |
The Bank uses a liquidity analysis model to examine the current liquidity position and analyze the potential sources of coverage in the event of a liquidity crisis. The following is a brief description of the key measurements contained in the analysis:
Regular Liquidity Position-This is a measurement used to capture the ability of an institution to cover its current debt obligations.
As of December 31, 2014, the Bank’s regular liquidity measurements indicated that the liquidity position was within policy limits. The policy limits have been established by the Directors ALCO committee and are calculated and reported quarterly.
Basic Surplus-The basic surplus ratio is used to determine the number of times non-obligated assets could be used to meet immediate liquidity needs.
As of December 31, 2014, the Bank’s basic surplus measurement indicated that the Bank was within policy limits. The policy limits have been established by the Directors ALCO committee and are calculated and reported quarterly.
Dependency Ratio-The dependency ratio determines the reliance on short-term liabilities.
As of December 31, 2014, the Bank’s dependency ratio measurement indicated that the current position was within policy limits. The policy limits have been established by the Directors ALCO committee and are calculated and reported quarterly.
| | Leverage Analysis |
The leverage analysis examines the potential of the institution to absorb additional debt. The key measurements included in this analysis are the Bank’s Tier 1 capital, leverage and total capital ratios.
| Balance | Sheet Analytics |
Balance sheet analytics involve an in depth examination of the balance sheet structure, including diversification of structure and most recent pricing practices. This review uses trend analysis to compare previous balance sheet positions. The analysis enables the ALCO to review significant changes in the Bank’s loan and security portfolios as well as the Bank’s deposit composition.
Like any forecasting technique, interest rate simulation modeling is based on a large number of assumptions. In this case, the assumptions relate primarily to loan and deposit growth, asset and liability prepayments, interest rates and balance sheet management strategies. Management believes that both individually and in the aggregate the assumptions are reasonable. Nevertheless, the simulation modeling process produces only a sophisticated estimate, not a precise calculation of exposure.
| | The majority of the Bank’s variable loans are indexed to the Prime Rate as published inThe Wall Street Journal. These variable rate loans contain a provision stating that an interest rate floor ranging from 4.0% to 7.5% exists. Almost all of the Bank’s variable rate loans have repriced to the interest rate floors. The Bank’s interest rate model estimates the most likely rate adjustment scenario. |
Impact of Inflation and Changing Price-The financial statements and related financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of the financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time and due to inflation. Management is primarily concerned with two inflationary factors. The first, and most common, factor is the general impact of inflation on the operations of Cornerstone and is reflected in increased operating costs. The second, and more material to the Bank’s profitability, factor is interest rate adjustments by the Federal Reserve and the general fixed income market in reaction to inflation. In other words, interest rate risk substantially impacts Cornerstone differently than most industrial companies, because virtually all of the assets and liabilities of Cornerstone are monetary in nature. As a result, interest rates may have a more significant impact on Cornerstone’s performance than the effects of general levels of inflation. Interest rate fluctuations do not necessarily move in the same direction or in the same magnitude as the price of goods and services and each issue must be dealt with independently.
smaller reporting companies. | ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
CORNERSTONE BANCSHARES,
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SMARTFINANCIAL, INC. AND SUBSIDIARY
Report on Consolidated Financial Statements
For the years ended December 31, 2017 and FootnotesTable of 2016
SmartFinancial, Inc. and Subsidiary
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of CornerstoneSmartFinancial, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. Internalreporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Accordingly, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth in Internal Control – Integrated Framework (2013 edition) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As permitted by SEC guidance, management excluded from its assessment the operations of the Capstone acquisition made during 2017, which is described in Note 2 of the Consolidated Financial Statements. The total assets of the entity acquired in this acquisition represented approximately 28.1 percent of the Company’s total consolidated assets as of December 31, 2017 and 9.9 percent of consolidated revenue for the year then ended. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2017 is effective based on the specified criteria.
Mauldin & Jenkins, LLC, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017, is included herein.
Report of Independent Registered Public Accounting Firm
To the Stockholders and
Board of Directors
SmartFinancial, Inc.
Knoxville, Tennessee
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of SmartFinancial, Inc. and Subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2017, and the related notes to the consolidated financial statements (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (the “PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 16, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or underfraud. Our audits included performing procedures to assess the supervisionrisks of Cornerstone’s principal executivematerial misstatement of the consolidated financial statements, whether due to error or fraud, and principalperforming procedures that respond to those risks. Such procedures included examining, on test basis, evidence regarding the amounts and disclosures in the consolidated financial officersstatements. Our audits also included evaluating the accounting principles used and effectedsignificant estimates made by Cornerstone’s boardmanagement, as well as, evaluating the overall presentation of directors,the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Mauldin & Jenkins, LLC
We have served as the Company’s auditor since 2013.
Chattanooga, Tennessee
March 16, 2018
Report of Independent Registered Public Accounting Firm
To the Stockholders and
Board of Directors
SmartFinancial, Inc.
Knoxville, Tennessee
Opinion on the Internal Control Over Financial Reporting
We have audited SmartFinancial, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company and subsidiaries as of the December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated March 16, 2018, expressed and unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Report on Internal Control Over Financial Reporting (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other personnel,procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles andprinciples. A company’s internal control over financial reporting includes those policies and procedures
that: | · | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of Cornerstone’s assets; |
| · | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that Cornerstone’s receipts and expenditures are being made only in accordance with authorizations of Cornerstone’s management and directors; and |
| · | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Cornerstone’s assets that could have a material effect on the financial statements. |
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determinedthat (1) pertain to be effective canthe maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide only reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with respect to financial statement preparationgenerally accepted accounting principles, and presentation.
Cornerstone’s management has assessed the effectiveness of internal controls over financial reporting as of December 31, 2014. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizationsthat receipts and expenditures of the Treadway Commissioncompany are being made only in “Internal Control-Integrated Framework.”
Basedaccordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on this assessment management believes that, asthe financial statements.
Because of
December 31, 2014, Cornerstone’sits inherent limitations, internal control over financial reporting
was effective based on those criteria.This annual report doesmay not include an attestation reportprevent or detect misstatements. Also, projections of Cornerstone’s registered public accounting firm regarding internal control over financial reporting. Management’s report was notany evaluation of effectiveness to future periods are subject to attestation by Cornerstone’s registered public accounting firm pursuant to transitional rulesthe risk that controls may become inadequate because of changes in conditions, or that the Securities and Exchange Commission that permit Cornerstone to provide only management’s report in this annual report.
Reportdegree of Independent Registered Public Accounting Firm
Tocompliance with the Stockholders and
Board of Directors
Cornerstone Bancshares, Inc.
policies or procedures may deteriorate.
/s/ Mauldin & Jenkins, LLC
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheets of Cornerstone Bancshares,
March 16, 2018
SmartFinancial, Inc. and Subsidiary (the “Company”) as of
Consolidated Financial Statements
Consolidated Balance Sheets
December 31, 20142017 and 2013, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Cornerstone Bancshares, Inc. and Subsidiary for the year ended December 31, 2012, was audited by other auditors who have ceased operations and whose report dated March 28, 2013, expressed an unqualified opinion on those statements.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cornerstone Bancshares, Inc. and Subsidiary as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years then ended in conformity with United States generally accepted accounting principles.
/s/ MAULDIN & JENKINS, LLC
Chattanooga, Tennessee
March 30, 2015
The report below is a copy of the report issued by the Company's previous independent auditors, Hazlett, Lewis & Bieter, PLLC.
Report of Independent Registered Public Accounting Firm
To the Stockholders and
Board of Directors
Cornerstone Bancshares, Inc.
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheets of Cornerstone Bancshares, Inc. and subsidiary (Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cornerstone Bancshares, Inc. and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with United States generally accepted accounting principles.
/s/Hazlett, Lewis & Bieter, PLLC
Chattanooga, Tennessee
March 28, 2013
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
CONSOLIDATED BALANCE SHEETS |
December 31, 2014 and 2013 |
|
| | | 2014 | | | 2013 | |
| | | | | | | | | |
| ASSETS | | | | | | | | |
| | | | | | | | | |
| Cash and due from banks | | $ | 1,930,751 | | | $ | 2,149,467 | |
| Interest-bearing deposits at other financial institutions | | | 13,596,970 | | | | 22,702,270 | |
| | | | | | | | | |
| Total cash and cash equivalents | | | 15,527,721 | | | | 24,851,737 | |
| | | | | | | | | |
| Securities available for sale | | | 87,192,909 | | | | 92,208,672 | |
| Securities held to maturity (fair value of $25,702 in 2014 and $35,027 in 2013) | | | 25,428 | | | | 34,165 | |
| Federal Home Loan Bank stock, at cost | | | 2,322,900 | | | | 2,322,900 | |
| Loans, net of allowance for loan losses of $3,495,129 in 2014 and $3,203,158 in 2013 | | | 291,869,338 | | | | 286,236,578 | |
| Bank premises and equipment, net | | | 4,828,123 | | | | 4,992,449 | |
| Accrued interest receivable | | | 1,142,899 | | | | 977,925 | |
| Foreclosed assets | | | 8,000,365 | | | | 12,925,748 | |
| Other assets | | | 4,830,113 | | | | 7,673,179 | |
| | | | | | | | | |
| Total assets | | $ | 415,739,796 | | | $ | 432,223,353 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | | |
| Deposits: | | | | | | | | |
| Noninterest-bearing demand deposits | | $ | 57,034,792 | | | $ | 75,206,540 | |
| Interest-bearing demand deposits | | | 26,464,173 | | | | 24,563,987 | |
| Savings deposits and money market accounts | | | 80,861,110 | | | | 86,329,930 | |
| Time deposits | | | 144,294,390 | | | | 155,313,920 | |
| | | | | | | | | |
| Total deposits | | | 308,654,465 | | | | 341,414,377 | |
| | | | | | | | | |
| Accrued interest payable | | | 71,925 | | | | 82,320 | |
| Federal funds purchased and securities sold under agreements to repurchase | | | 29,409,505 | | | | 22,974,117 | |
| Federal Home Loan Bank advances and other borrowings | | | 36,000,000 | | | | 26,740,000 | |
| Other liabilities | | | 941,796 | | | | 878,811 | |
| | | | | | | | | |
| Total liabilities | | | 375,077,691 | | | | 392,089,625 | |
| | | | | | | | | |
| Stockholders' equity: | | | | | | | | |
| Preferred stock - no par value; 2,000,000 shares authorized; 600,000 shares issued and outstanding in 2014 and 2013 | | | 14,964,309 | | | | 14,892,927 | |
| Common stock - $1.00 par value; 20,000,000 shares authorized in 2014 and 2013; | | | | | | | | |
| 6,709,199 shares issued in 2014 and 2013; 6,627,398 and 6,547,074 shares outstanding in 2014 and 2013 | | | 6,627,398 | | | | 6,547,074 | |
| Additional paid-in capital | | | 21,821,060 | | | | 21,549,883 | |
| Accumulated deficit | | | (3,032,551 | ) | | | (3,099,451 | ) |
| Accumulated other comprehensive income | | | 281,889 | | | | 243,295 | |
| | | | | | | | | |
| Total stockholders' equity | | | 40,662,105 | | | | 40,133,728 | |
| | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 415,739,796 | | | $ | 432,223,353 | |
The2016
|
| | | | | | | | |
| | | 2017 | | 2016 |
| ASSETS | | |
| | |
|
| | | | | |
| Cash and due from banks | | $ | 64,097,287 |
| | $ | 34,290,617 |
|
| Interest-bearing deposits at other financial institutions | | 41,965,597 |
| | 34,457,691 |
|
| Federal funds sold | | 6,964,000 |
| | — |
|
| | | | | |
| Total cash and cash equivalents | | 113,026,884 |
| | 68,748,308 |
|
| | | | | |
| Securities available for sale | | 151,944,567 |
| | 129,421,914 |
|
| Restricted investments, at cost | | 6,430,700 |
| | 5,627,950 |
|
| Loans, net of allowance for loan losses of $5,860,291 in 2017 and $5,105,255 in 2016 | | 1,317,397,909 |
| | 808,271,003 |
|
| Bank premises and equipment, net | | 43,000,249 |
| | 30,535,594 |
|
| Foreclosed assets | | 3,254,392 |
| | 2,386,239 |
|
| Goodwill and core deposit intangible, net | | 50,836,840 |
| | 6,635,655 |
|
| Cash surrender value of life insurance | | 21,646,894 |
| | 1,320,723 |
|
| Other assets | | 13,232,247 |
| | 9,508,899 |
|
| | | | | |
| Total assets | | $ | 1,720,770,682 |
| | $ | 1,062,456,285 |
|
| | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | |
| | |
|
| | | | | |
| Deposits: | | |
| | |
|
| Noninterest-bearing demand deposits | | $ | 220,520,287 |
| | $ | 153,482,650 |
|
| Interest-bearing demand deposits | | 231,643,508 |
| | 162,702,457 |
|
| Money market and savings deposits | | 543,644,830 |
| | 274,604,724 |
|
| Time deposits | | 442,774,094 |
| | 316,275,340 |
|
| | | | | |
| Total deposits | | 1,438,582,719 |
| | 907,065,171 |
|
| | | | | |
| Securities sold under agreement to repurchase | | 24,054,730 |
| | 26,621,984 |
|
| Federal Home Loan Bank advances and other borrowings | | 43,600,000 |
| | 18,505,390 |
|
| Accrued expenses and other liabilities | | 8,681,393 |
| | 5,023,600 |
|
| | | | | |
| Total liabilities | | 1,514,918,842 |
| | 957,216,145 |
|
| | | | | |
| Stockholders' equity: | | |
| | |
|
| Preferred stock - $1 par value; 2,000,000 shares authorized; None issued and outstanding as of December 31, 2017; 12,000 issued and outstanding in 2016 | | — |
| | 12,000 |
|
| Common stock - $1 par value; 40,000,000 shares authorized; 11,152,561 and 5,896,033 shares issued and outstanding in 2017 and 2016, respectively | | 11,152,561 |
| | 5,896,033 |
|
| Additional paid-in capital | | 174,008,753 |
| | 83,463,051 |
|
| Retained earnings | | 21,888,575 |
| | 16,871,296 |
|
| Accumulated other comprehensive loss | | (1,198,049 | ) | | (1,002,240 | ) |
| | | | | |
| Total stockholders' equity | | 205,851,840 |
| | 105,240,140 |
|
| | | | | |
| Total liabilities and stockholders' equity | | $ | 1,720,770,682 |
| | $ | 1,062,456,285 |
|
See Notes to Consolidated Financial Statements are an integral part
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of
these statements.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
CONSOLIDATED STATEMENTS OF INCOME |
Years Ended December 31, 2014, 2013, and 2012 |
|
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| INTEREST INCOME | | | | | | | | | | | | |
| Loans, including fees | | $ | 16,690,496 | | | $ | 16,705,237 | | | $ | 17,288,855 | |
| Securities and interest-bearing deposits at other financial institutions | | | 1,416,190 | | | | 1,694,292 | | | | 2,003,620 | |
| Federal funds sold | | | 30,678 | | | | 53,502 | | | | 60,404 | |
| | | | | | | | | | | | | |
| Total interest income | | | 18,137,364 | | | | 18,453,031 | | | | 19,352,879 | |
| | | | | | | | | | | | | |
| INTEREST EXPENSE | | | | | | | | | | | | |
| Time deposits | | | 1,427,758 | | | | 1,766,237 | | | | 2,471,135 | |
| Other deposits | | | 313,105 | | | | 473,921 | | | | 546,812 | |
| Federal funds purchased and securities sold under agreements to repurchase | | | 84,641 | | | | 73,903 | | | | 94,402 | |
| Federal Home Loan Bank advances and other borrowings | | | 964,351 | | | | 1,208,490 | | | | 1,672,478 | |
| | | | | | | | | | | | | |
| Total interest expense | | | 2,789,855 | | | | 3,522,551 | | | | 4,784,827 | |
| | | | | | | | | | | | | |
| Net interest income before provision for loan losses | | | 15,347,509 | | | | 14,930,480 | | | | 14,568,052 | |
| | | | | | | | | | | | | |
| Provision for loan losses | | | 515,000 | | | | 300,000 | | | | 430,000 | |
| | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 14,832,509 | | | | 14,630,480 | | | | 14,138,052 | |
| | | | | | | | | | | | | |
| NONINTEREST INCOME | | | | | | | | | | | | |
| Customer service fees | | | 849,984 | | | | 821,072 | | | | 803,251 | |
| Other noninterest income | | | 57,148 | | | | 62,457 | | | | 64,519 | |
| Net gains from sale of securities | | | 700,390 | | | | 652,421 | | | | - | |
| Net gains from sale of loans and other assets | | | 211,819 | | | | 403,569 | | | | 151,710 | |
| | | | | | | | | | | | | |
| Total noninterest income | | | 1,819,341 | | | | 1,939,519 | | | | 1,019,480 | |
| | | | | | | | | | | | | |
| NONINTEREST EXPENSES | | | | | | | | | | | | |
| Salaries and employee benefits | | | 7,054,474 | | | | 6,555,059 | | | | 6,327,226 | |
| Net occupancy and equipment expense | | | 1,230,099 | | | | 1,335,126 | | | | 1,447,204 | |
| Depository insurance | | | 640,097 | | | | 644,918 | | | | 803,902 | |
| Foreclosed assets, net | | | 1,841,575 | | | | 2,001,755 | | | | 1,100,670 | |
| Other operating expenses | | | 3,233,318 | | | | 3,309,532 | | | | 3,498,867 | |
| | | | | | | | | | | | | |
| Total noninterest expenses | | | 13,999,563 | | | | 13,846,390 | | | | 13,177,869 | |
| | | | | | | | | | | | | |
| Income before income tax expense | | | 2,652,287 | | | | 2,723,609 | | | | 1,979,663 | |
| | | | | | | | | | | | | |
| Income tax expense | | | 1,014,005 | | | | 1,042,800 | | | | 577,600 | |
| | | | | | | | | | | | | |
| Net income | | | 1,638,282 | | | | 1,680,809 | | | | 1,402,063 | |
| | | | | | | | | | | | | |
| Preferred stock dividend requirements | | | 1,500,000 | | | | 1,500,000 | | | | 1,229,780 | |
| Accretion of preferred stock discount | | | 71,382 | | | | 71,381 | | | | 63,924 | |
| | | | | | | | | | | | | |
| Net income available to common stockholders | | $ | 66,900 | | | $ | 109,428 | | | $ | 108,359 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| EARNINGS PER COMMON SHARE | | | | | | | | | | | | |
| Basic | | $ | 0.01 | | | $ | 0.02 | | | $ | 0.02 | |
| Diluted | | | 0.01 | | | | 0.02 | | | | 0.02 | |
TheIncome
For the years ended December 31, 2017 and 2016
|
| | | | | | | | |
| | | 2017 | | 2016 |
| INTEREST INCOME | | |
| | |
|
| Loans, including fees | | $ | 48,805,647 |
| | $ | 39,763,582 |
|
| Securities and interest bearing deposits at other financial institutions | | 2,862,825 |
| | 2,553,652 |
|
| Federal funds sold and other earning assets | | 353,924 |
| | 247,157 |
|
| Total interest income | | 52,022,396 |
| | 42,564,391 |
|
| | | | | |
| INTEREST EXPENSE | | |
| | |
|
| Deposits | | 5,518,350 |
| | 4,105,304 |
|
| Securities sold under agreements to repurchase | | 61,933 |
| | 65,276 |
|
| Federal Home Loan Bank advances and other borrowings | | 113,070 |
| | 129,102 |
|
| Total interest expense | | 5,693,353 |
| | 4,299,682 |
|
| Net interest income before provision for loan losses | | 46,329,043 |
| | 38,264,709 |
|
| Provision for loan losses | | 782,687 |
| | 787,545 |
|
| Net interest income after provision for loan losses | | 45,546,356 |
| | 37,477,164 |
|
| | | | | |
| NONINTEREST INCOME | | |
| | |
|
| Customer service fees | | 1,374,068 |
| | 1,127,814 |
|
| Gain on sale of securities | | 143,508 |
| | 199,587 |
|
| Gain on sale of loans and other assets | | 1,275,925 |
| | 948,080 |
|
| (Loss) gain on sale of foreclosed assets | | (47,795 | ) | | 191,050 |
|
| Other noninterest income | | 2,233,787 |
| | 1,716,794 |
|
| Total noninterest income | | 4,979,493 |
| | 4,183,325 |
|
| | | | | |
| NONINTEREST EXPENSES | | |
| | |
|
| Salaries and employee benefits | | 20,743,153 |
| | 17,715,222 |
|
| Net occupancy and equipment expense | | 4,271,289 |
| | 3,995,631 |
|
| Depository insurance | | 465,844 |
| | 605,917 |
|
| Foreclosed assets | | 83,908 |
| | 236,148 |
|
| Advertising | | 637,600 |
| | 615,751 |
|
| Data processing | | 1,875,462 |
| | 1,893,386 |
|
| Professional services | | 2,084,735 |
| | 2,122,845 |
|
| Amortization of intangible assets | | 346,435 |
| | 305,452 |
|
| Service contracts | | 1,398,018 |
| | 1,154,003 |
|
| Merger expenses | | 2,417,070 |
| | — |
|
| Other operating expenses | | 4,758,480 |
| | 3,855,246 |
|
| Total noninterest expenses | | 39,081,994 |
| | 32,499,601 |
|
| Income before income tax expense | | 11,443,855 |
| | 9,160,888 |
|
| Income tax expense | | 6,428,791 |
| | 3,362,080 |
|
| Net income | | 5,015,064 |
| | 5,798,808 |
|
| Preferred stock dividends | | 195,000 |
| | 1,022,000 |
|
| Net income available to common stockholders | | $ | 4,820,064 |
| | $ | 4,776,808 |
|
| | | | | |
| EARNINGS PER COMMON SHARE | | | | |
| Basic | | $ | 0.56 |
| | $ | 0.82 |
|
| Diluted | | 0.55 |
| | 0.78 |
|
| Weighted average common shares outstanding | | |
| | |
|
| Basic | | 8,639,212 |
| | 5,838,574 |
|
| Diluted | | 8,793,527 |
| | 6,118,943 |
|
| Dividends per common share | | N/A |
| | N/A |
|
See Notes to Consolidated Financial Statements are an integral part
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of
these statements.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME |
Years Ended December 31, 2014, 2013, and 2012 |
|
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| Net income | | $ | 1,638,282 | | | $ | 1,680,809 | | | $ | 1,402,063 | |
| | | | | | | | | | | | | |
| Other comprehensive income, net of tax: | | | | | | | | | | | | |
| Unrealized holding gains (losses) arising during the year, net of tax (expense) benefit of $(289,804), $492,528 and $(203,643) in 2014, 2013 and 2012, respectively | | | 472,836 | | | | (803,598 | ) | | | 332,259 | |
| | | | | | | | | | | | | |
| Reclassification adjustment for gains included in net income, net of tax expense of $266,148 and $247,920 in 2014 and 2013, respectively | | | (434,242 | ) | | | (404,501 | ) | | | - | |
| | | | | | | | | | | | | |
| Total other comprehensive income (loss) | | | 38,594 | | | | (1,208,099 | ) | | | 332,259 | |
| | | | | | | | | | | | | |
| Comprehensive income | | $ | 1,676,876 | | | $ | 472,710 | | | $ | 1,734,322 | |
TheComprehensive Income
For the years ended December 31, 2017 and 2016
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Net income | | $ | 5,015,064 |
| | $ | 5,798,808 |
|
| | | | | |
| Other comprehensive loss, net of tax: | | |
| | |
|
| Unrealized holding gains (losses) arising during the year, net of tax expense (benefit) of $55,405 and $(326,697) in 2017 and 2016, respectively | | 90,381 |
| | (526,954 | ) |
| | | | | |
| Reclassification adjustment for gains included in net income, net of tax expense of $54,533 and $76,422 in 2017 and 2016, respectively | | (88,975 | ) | | (123,165 | ) |
| | | 1,406 |
| | (650,119 | ) |
| | | | | |
| Effect of tax rate change on unrealized gains (losses) on available for sale securities | | $ | (197,215 | ) | | $ | — |
|
| | | | | |
| Total other comprehensive loss | | $ | (195,809 | ) | | $ | (650,119 | ) |
| | | | | |
| Comprehensive income | | $ | 4,819,255 |
| | $ | 5,148,689 |
|
See Notes to Consolidated Financial Statements are an integral part
SmartFinancial, Inc. and Subsidiary
Consolidated Statements of
these statements.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY |
Years Ended December 31, 2014, 2013, and 2012 |
|
| | | | | | | | | | | | | | | Accumulated | | | | |
| | | | | | | | | Additional | | | | | | Other | | | Total | |
| | | Preferred | | | Common | | | Paid-in | | | Accumulated | | | Comprehensive | | | Stockholders' | |
| | | Stock | | | Stock | | | Capital | | | Deficit | | | Income | | | Equity | |
| | | | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2011 | | $ | 9,899,544 | | | $ | 6,500,396 | | | $ | 21,316,438 | | | $ | (3,627,208 | ) | | $ | 1,119,135 | | | $ | 35,208,305 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation expense | | | - | | | | - | | | | 74,048 | | | | - | | | | - | | | | 74,048 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of Series A Convertible Preferred Stock | | | 4,858,078 | | | | - | | | | - | | | | - | | | | - | | | | 4,858,078 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred stock dividends paid | | | - | | | | - | | | | - | | | | (985,917 | ) | | | - | | | | (985,917 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Accretion on preferred stock | | | 63,924 | | | | - | | | | - | | | | (63,924 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | 1,402,063 | | | | - | | | | 1,402,063 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized holding gains on securities available for sale, net of reclassification adjustment and taxes | | | - | | | | - | | | | - | | | | - | | | | 332,259 | | | | 332,259 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2012 | | | 14,821,546 | | | | 6,500,396 | | | | 21,390,486 | | | | (3,274,986 | ) | | | 1,451,394 | | | | 40,888,836 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation expense | | | - | | | | - | | | | 129,056 | | | | - | | | | - | | | | 129,056 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of common stock, 46,678 shares | | | - | | | | 46,678 | | | | 30,341 | | | | - | | | | - | | | | 77,019 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred stock dividends paid | | | - | | | | - | | | | - | | | | (1,433,893 | ) | | | - | | | | (1,433,893 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Accretion on preferred stock | | | 71,381 | | | | - | | | | - | | | | (71,381 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | 1,680,809 | | | | - | | | | 1,680,809 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized holding gains (losses) on securities available for sale, net of reclassification adjustment | | | - | | | | - | | | | - | | | | - | | | | (1,208,099 | ) | | | (1,208,099 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2013 | | | 14,892,927 | | | | 6,547,074 | | | | 21,549,883 | | | | (3,099,451 | ) | | | 243,295 | | | | 40,133,728 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock compensation expense | | | - | | | | - | | | | 160,500 | | | | - | | | | - | | | | 160,500 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Issuance of common stock, 80,324 shares | | | - | | | | 80,324 | | | | 110,677 | | | | - | | | | - | | | | 191,001 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred stock dividends paid | | | - | | | | - | | | | - | | | | (1,500,000 | ) | | | - | | | | (1,500,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Accretion on preferred stock | | | 71,382 | | | | - | | | | - | | | | (71,382 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | - | | | | - | | | | - | | | | 1,638,282 | | | | - | | | | 1,638,282 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized holding gains on securities available for sale, | | | | | | | | | | | | | | | | | | | | | | | | |
| net of reclassification adjustment | | | - | | | | - | | | | - | | | | - | | | | 38,594 | | | | 38,594 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2014 | | $ | 14,964,309 | | | $ | 6,627,398 | | | $ | 21,821,060 | | | $ | (3,032,551 | ) | | $ | 281,889 | | | $ | 40,662,105 | |
TheChanges in Stockholders’ Equity
For the years ended December 31, 2017 and 2016
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Preferred
Shares | | Common
Shares | | Preferred
Stock | | Common
Stock | | Additional
Paid-in
Capital | | Retained
Earnings | | Accumulated Other Comprehensive Loss | | Total
Stockholders'
Equity |
| BALANCE, December 31, 2015 | | 12,000 |
| | 5,806,477 |
| | $ | 12,000 |
| | $ | 5,806,477 |
| | $ | 82,616,015 |
| | $ | 12,094,488 |
| | $ | (352,121 | ) | | $ | 100,176,859 |
|
| | | | | | | | | | | | | | | | | |
| Net income | | — |
| | — |
| | — |
| | — |
| | — |
| | 5,798,808 |
| | — |
| | 5,798,808 |
|
| | | | | | | | | | | | | | | | | |
| Other comprehensive loss | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (650,119 | ) | | (650,119 | ) |
| | | | | | | | | | | | | | | | | |
| Exercise of stock options | | — |
| | 89,556 |
| | — |
| | 89,556 |
| | 714,401 |
| | — |
| | — |
| | 803,957 |
|
| | | | | | | | | | | | | | | | | |
| Dividends on preferred stock | | — |
| | — |
| | — |
| | — |
| | — |
| | (1,022,000 | ) | | — |
| | (1,022,000 | ) |
| | | | | | | | | | | | | | | | | |
| Stock option compensation expense | | — |
| | — |
| | — |
| | — |
| | 132,635 |
| | — |
| | — |
| | 132,635 |
|
| | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2016 | | 12,000 |
| | 5,896,033 |
| | 12,000 |
| | 5,896,033 |
| | 83,463,051 |
| | 16,871,296 |
| | (1,002,240 | ) | | 105,240,140 |
|
| | | | | | | | | | | | | | | | | |
| Net income | | — |
| | — |
| | — |
| | — |
| | — |
| | 5,015,064 |
| | — |
| | 5,015,064 |
|
| | | | | | | | | | | | | | | | | |
| Other comprehensive gain | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 1,406 |
| | 1,406 |
|
| | | | | | | | | | | | | | | | | |
| Reclassification adjustment for tax rate change | | — |
| | — |
| | — |
| | — |
| | — |
| | 197,215 |
| | (197,215 | ) | | — |
|
| | | | | | | | | | | | | | | | | |
| Issuance of common stock | | — |
| | 1,840,000 |
| | — |
| | 1,840,000 |
| | 31,094,676 |
| | — |
| | — |
| | 32,934,676 |
|
| | | | | | | | | | | | | | | | | |
| Issuance of stock grants | | — |
| | 1,511 |
| | — |
| | 1,511 |
| | 30,280 |
| | — |
| | — |
| | 31,791 |
|
| | | | | | | | | | | | | | | | | |
| Redemption of preferred stock | | (12,000 | ) | | — |
| | (12,000 | ) | | — |
| | (11,988,000 | ) | | — |
| | — |
| | (12,000,000 | ) |
| | | | | | | | | | | | | | | | | |
| Conversion shares issued to shareholders of Capstone Bancshares, Inc. | | — |
| | 2,908,094 |
| | — |
| | 2,908,094 |
| | 66,875,727 |
| | — |
| | — |
| | 69,783,821 |
|
| | | | | | | | | | | | | | | | | |
| Exercise of stock options | | — |
| | 506,923 |
| | — |
| | 506,923 |
| | 4,378,723 |
| | — |
| | — |
| | 4,885,646 |
|
| | | | | | | | | | | | | | | | | |
| Dividends on preferred stock | | — |
| | — |
| | — |
| | — |
| | — |
| | (195,000 | ) | | — |
| | (195,000 | ) |
| | | | | | | | | | | | | | | | | |
| Restricted stock compensation expense | | — |
| | — |
| | — |
| | — |
| | 56,330 |
| | — |
| | — |
| | 56,330 |
|
| | | | | | | | | | | | | | | | | |
| Stock option compensation expense | | — |
| | — |
| | — |
| | — |
| | 97,966 |
| | — |
| | — |
| | 97,966 |
|
| | | | | | | | | | | | | | | | | |
| BALANCE, December 31, 2017 | | — |
| | 11,152,561 |
| | $ | — |
| | $ | 11,152,561 |
| | $ | 174,008,753 |
| | $ | 21,888,575 |
| | $ | (1,198,049 | ) | | $ | 205,851,840 |
|
See Notes to Consolidated Financial Statements.
SmartFinancial, Inc. and Subsidiary
Consolidated Statements
are an integral part of
these statements.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
CONSOLIDATED STATEMENTS OF CASH FLOWS |
Years Ended December 31, 2014, 2013, and 2012 |
|
| | | 2014 | | | 2013 | | | 2012 | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | | | | | |
| Net income | | $ | 1,638,282 | | | $ | 1,680,809 | | | $ | 1,402,063 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 413,496 | | | | 506,902 | | | | 529,001 | |
| Provision for loan losses | | | 515,000 | | | | 300,000 | | | | 430,000 | |
| Stock compensation expense | | | 160,500 | | | | 129,056 | | | | 74,048 | |
| Gains from sale of securities | | | (700,390 | ) | | | (652,421 | ) | | | - | |
| Net gains from sale of loans and other assets | | | (211,819 | ) | | | (403,569 | ) | | | (151,710 | ) |
| Loss from sale and write-downs of foreclosed assets | | | 1,412,960 | | | | 1,687,965 | | | | 899,534 | |
| Deferred income taxes | | | 540,748 | | | | 105,340 | | | | (383,150 | ) |
| Changes in other operating assets and liabilities: | | | | | | | | | | | | |
| Accrued interest receivable | | | (164,974 | ) | | | 235,853 | | | | 113,680 | |
| Accrued interest payable | | | (10,395 | ) | | | (38,238 | ) | | | 9,855 | |
| Other assets and liabilities | | | (51,955 | ) | | | 869,860 | | | | 1,720,001 | |
| | | | | | | | | | | | | |
| Net cash provided by operating activities | | | 3,541,453 | | | | 4,421,557 | | | | 4,643,322 | |
| | | | | | | | | | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | | | | | | | | | | | |
| Proceeds from security sales, maturities, and paydowns: | | | | | | | | | | | | |
| Securities available for sale | | | 21,406,610 | | | | 34,902,675 | | | | 43,951,252 | |
| Securities held to maturity | | | 8,715 | | | | 10,892 | | | | 24,032 | |
| Purchase of securities available for sale | | | (15,676,305 | ) | | | (52,397,426 | ) | | | (33,522,131 | ) |
| Distribution from equity investment | | | 2,393,603 | | | | - | | | | - | |
| Loan originations and principal collections, net | | | (6,054,571 | ) | | | (13,018,303 | ) | | | (15,789,776 | ) |
| Purchase of bank premises and equipment | | | (228,252 | ) | | | (14,253 | ) | | | (160,164 | ) |
| Proceeds from sale of bank premises and equipment and foreclosed assets | | | 3,658,254 | | | | 3,422,717 | | | | 2,328,625 | |
| | | | | | | | | | | | | |
| Net cash provided by (used in) investing activities | | | 5,508,054 | | | | (27,093,698 | ) | | | (3,168,162 | ) |
| | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | | | | | | | | | | |
| Net (decrease) increase in deposits | | | (32,759,912 | ) | | | (3,466,216 | ) | | | 30,838,649 | |
| Increase (decrease) in federal funds purchased and securities sold under agreements to repurchase | | | 6,435,388 | | | | 3,386,730 | | | | (9,803,423 | ) |
| Proceeds from Federal Home Loan Bank advances | | | 16,000,000 | | | | - | | | | - | |
| Repayment of Federal Home Loan Bank advances | | | (5,000,000 | ) | | | (10,000,000 | ) | | | (5,000,000 | ) |
| Repayment of other borrowings | | | (1,740,000 | ) | | | (435,000 | ) | | | (870,000 | ) |
| Payment of dividends | | | (1,500,000 | ) | | | (1,433,893 | ) | | | (985,917 | ) |
| Issuance of common stock | | | 191,001 | | | | 77,019 | | | | - | |
| Issuance of preferred stock | | | - | | | | - | | | | 4,858,078 | |
| | | | | | | | | | | | | |
| Net cash (used in) provided by financing activities | | | (18,373,523 | ) | | | (11,871,360 | ) | | | 19,037,387 | |
| | | | | | | | | | | | | |
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | | | (9,324,016 | ) | | | (34,543,501 | ) | | | 20,512,547 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS, beginning of year | | | 24,851,737 | | | | 59,395,238 | | | | 38,882,691 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS, end of year | | $ | 15,527,721 | | | $ | 24,851,737 | | | $ | 59,395,238 | |
| | | | | | | | | | | | | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | | | | | | | | | | | | |
| Cash paid during the period for interest | | $ | 2,800,250 | | | $ | 3,560,789 | | | $ | 4,774,972 | |
| Cash paid during the period for taxes | | | 767,687 | | | | 1,107,997 | | | | 965,888 | |
| | | | | | | | | | | | | |
| NONCASH INVESTING AND FINANCING ACTIVITIES | | | | | | | | | | | | |
| Acquisition of real estate through foreclosure | | $ | 1,681,157 | | | $ | 1,672,659 | | | $ | 8,530,357 | |
| Financed sales of foreclosed assets | | | 1,538,976 | | | $ | 3,939,495 | | | $ | 3,484,160 | |
TheCash Flows
For the years ended December 31, 2017 and 2016
|
| | | | | | | | |
| | | 2017 | | 2016 |
| CASH FLOWS FROM OPERATING ACTIVITIES | | |
| | |
|
| Net income | | $ | 5,015,064 |
| | $ | 5,798,808 |
|
| Adjustments to reconcile net income to net cash provided by operating activities: | | |
| | |
|
| Depreciation and amortization | | 2,464,414 |
| | 2,189,088 |
|
| Provision for loan losses | | 782,687 |
| | 787,545 |
|
| Stock option compensation expense | | 97,966 |
| | 132,635 |
|
| Restricted stock compensation expense | | 56,330 |
| | — |
|
| Net gains from sale of securities | | (143,508 | ) | | (199,587 | ) |
| Net gains from sale of loans and other assets | | (1,275,925 | ) | | (948,080 | ) |
| Net losses (gains) from sale of foreclosed assets | | 47,795 |
| | (191,050 | ) |
| Changes in other assets and liabilities: | | |
| | |
|
| Accrued interest receivable | | (331,347 | ) | | 110,952 |
|
| Accrued interest payable | | 31,488 |
| | (8,373 | ) |
| Other assets and liabilities | | (102,663 | ) | | 3,918,803 |
|
| | | | | |
| Net cash provided by operating activities | | 6,642,301 |
| | 11,590,741 |
|
| | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES, net of acquisitions | | |
| | |
|
| Purchase of securities available for sale | | (53,998,043 | ) | | (22,111,781 | ) |
| Proceeds from security sales, maturities, and paydowns | | 82,636,066 |
| | 57,495,436 |
|
| Purchase (redemption) of restricted investments | | 246,350 |
| | (1,176,900 | ) |
| Purchase of bank owned life insurance | | (10,000,000 | ) | | — |
|
| Loan originations and principal collections, net | | (72,126,299 | ) | | (82,804,921 | ) |
| Purchase of bank premises and equipment | | (2,798,898 | ) | | (6,994,729 | ) |
| Proceeds from sale of foreclosed assets | | 82,864 |
| | 1,279,554 |
|
| Net cash and cash equivalents paid in business combinations | | (178,312 | ) | | — |
|
| | | | | |
| Net cash used in investing activities | | (56,136,272 | ) | | (54,313,341 | ) |
| | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES, net of acquisitions | | |
| | |
|
| Net increase in deposits | | 50,474,866 |
| | 48,582,620 |
|
| Net decrease in securities sold under agreements to repurchase | | (2,567,254 | ) | | (1,446,231 | ) |
| Issuance of common stock | | 37,852,113 |
| | 803,957 |
|
| Payment of dividends on preferred stock | | (195,000 | ) | | (752,000 | ) |
| Redemption of preferred stock | | (12,000,000 | ) | | — |
|
| Repayment of Federal Home Loan Bank advances and other borrowings | | (119,196,383 | ) | | (67,282,071 | ) |
| Proceeds from Federal Home Loan Bank advances and other borrowings | | 139,404,205 |
| | 51,600,000 |
|
| | | | | |
| Net cash provided by financing activities | | 93,772,547 |
| | 31,506,275 |
|
| | | | | |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | 44,278,576 |
| | (11,216,325 | ) |
| | | | | |
| CASH AND CASH EQUIVALENTS, beginning of year | | 68,748,308 |
| | 79,964,633 |
|
| | | | | |
| CASH AND CASH EQUIVALENTS, end of year | | $ | 113,026,884 |
| | $ | 68,748,308 |
|
| | | 2017 | | 2016 |
| | | | | |
| | | | | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | | |
| | |
|
| Cash paid during the period for interest | | $ | 5,399,749 |
| | $ | 4,308,055 |
|
| Cash paid during the period for taxes | | 3,531,984 |
| | 3,754,784 |
|
| Cash received during the period from tax refunds | | — |
| | 1,592,224 |
|
| | | | | |
| NONCASH INVESTING AND FINANCING ACTIVITIES | | |
| | |
|
| Change in unrealized losses on securities available for sale | | $ | (2,276 | ) | | $ | 1,053,238 |
|
| Acquisition of real estate through foreclosure | | 588,775 |
| | 1,431,857 |
|
| Financed sales of foreclosed assets | | — |
| | 3,315,064 |
|
See Notes to Consolidated Financial Statements
are an integral part of these statements.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
| Note 1. | Note 1. Summary of Significant Accounting Policies |
The accounting and reporting policies of Cornerstone Bancshares, Inc. and subsidiary (Cornerstone) conform with United States generally accepted accounting principles (U.S. GAAP) and practices within the banking industry. The FinancialSignificant Accounting Standards Board (FASB) has adopted the FASB Accounting Standards Codification (ASC) as the single source of authoritative nongovernmental U.S. GAAP. Rules and interpretive releases of the Securities and Exchange Commission (SEC) are also sources of authoritative U.S. GAAP for SEC registrants. The policies that materially affect financial position and results of operations are summarized as follows:
Policies
Nature of
operations:CornerstoneBusiness:
SmartFinancial, Inc. (the "Company") is a bank-holdingbank holding company which owns allwhose principal activity is the ownership and management of the outstanding common stock of Cornerstone Community Bankits wholly-owned subsidiary, SmartBank (the Bank)"Bank"). The BankCompany provides a variety of financial services to individuals and corporate customers through five full service branch locationsits offices in Chattanooga, Tennessee, Alabama, Florida, and a loan production office in Dalton, Georgia. The Bank'sCompany's primary deposit products are interest-bearing demand deposits savings accounts, and certificates of deposit. Its primary lending products are commercial, loans, real estate loans,residential, and installmentconsumer loans.Principles On May 22, 2017, the Company along with the Bank entered into an agreement and plan of consolidation:
merger with Capstone Bancshares, Inc., an Alabama corporation and Capstone Bank, an Alabama-chartered commercial bank and wholly owned subsidiary of Capstone Bancshares, Inc. which became effective on November 1, 2017.
Basis of Presentation and Accounting Estimates:
The consolidated financial statements include the accounts of
Cornerstonethe Company and
the Bank.its wholly-owned subsidiary. All
materialsignificant intercompany
accountsbalances and transactions have been eliminated in consolidation.
Use of estimates:
In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of
foreclosed assets and deferred
tax assets, other-than-temporarytaxes, other than temporary impairments of securities,
valuation of foreclosed assets, and the fair value of financial instruments.
The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.
The Company's loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent on local economic conditions.
While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Company to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term.
The Company has evaluated subsequent events for potential recognition and/or disclosure in the consolidated financial statements and accompanying notes included in this Annual Report through the date of the issued consolidated financial statements.
Cash and Cash Equivalents:
For purposes of reporting consolidated cash flows, cash and due from banks includes cash on hand, cash items in process of collection and amounts due from banks. Cash and cash equivalents also includes interest-bearing deposits in banks and federal funds sold. Cash flows from loans, federal funds sold, securities sold under agreements to repurchase and deposits are reported net.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant group concentrationsAccounting Policies, Continued
Cash and Cash Equivalents (continued):
The Bank is required to maintain average balances in cash or on deposit with the Federal Reserve Bank. The reserve requirement was $16,546,000 and $15,208,000 at December 31, 2017 and 2016, respectively.
The Company places its cash and cash equivalents with other financial institutions and limits the amount of credit
risk:Most of Cornerstone’s activities are with customers located in middle and eastern Tennessee. The types of securities that Cornerstone invests in are included in Note 4. The types of lending Cornerstone engages in are included in Note 5. Cornerstone does not have any significant concentrationsexposure to any one industry or customer.
Commercial real estate, including commercial construction loans, represented 55 percentfinancial institution. From time to time, the balances at these financial institutions exceed the amount insured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses on these accounts and 54 percent of the loan portfolio at December 31, 2014 and 2013, respectively.
At December 31, 2014, there were no concentrations of deposits. At December 31, 2013, Cornerstone hadmanagement considers this to be a concentration in deposits of one customer totaling approximately $20,204,000. This balance accounted for approximately 6 percent of total deposits at December 31, 2013.
normal business risk.
Securities:
Debt securities are
Management has classified
as held to maturity when the Bank has the intent and ability to hold theall securities
to maturity. Securities held to maturity are carried at amortized cost. The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Securities: (continued)
Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carriedrecorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Realized gains and losses on securities available for sale are included in other income and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Gains and losses on sales of securities are determined using the specific-identification method.loss. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The
Bank conducts a regular assessment of itsCompany evaluates investment securities
portfolio to determine whether any are other-than-temporarily impaired. In estimating other-than-temporaryquarterly for other than temporary impairment
losses, management considers, among other factors,using relevant accounting guidance specifying that (a) if the
length of time and extent to which the fair value has been less than cost, the financial condition and near term prospects of the issuer, andCompany does not have the intent
and ability of the Bank to
retain its investment for a period of time sufficient to allow for any anticipated recovery. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value forsell a debt security
prior to recovery and (b) it is
determinedmore likely than not that it will not have to
be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected fromsell the debt security
(theprior to recovery, the security would not be considered other than temporarily impaired unless a credit
loss)loss has occurred in the security. If management does not intend to sell the security and
(b)it is more likely than not that they will not have to sell the
amountsecurity before recovery of the
total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related tocost basis, management will recognize the credit
loss is recognizedcomponent of an other-than- temporary impairment of a debt security in
earnings. The amount ofearnings and the
total other-than-temporary impairment related to all other factors is recognizedremaining portion in other comprehensive
income.Federal Home Loan Bank stock:
Cornerstone,loss.
Securities borrowed or purchased under agreements to resell and securities loaned or sold under agreements to repurchase are treated as collateralized financial transactions. These agreements are recorded at the amount at which the securities were acquired or sold plus accrued interest. It is the Company's policy to take possession of securities purchased under resale agreements. The market value of these securities is monitored, and additional securities are obtained when deemed appropriate to ensure such transactions are adequately collateralized. The Company also monitors its exposure with respect to securities sold under repurchase agreements, and a memberrequest for the return of excess securities held by the Federal Home Loan Bank (FHLB) system,counterparty is made when deemed appropriate.
Restricted - Investments:
The Company is required to maintain an investment in capital stock of
the FHLB.various entities. Based on redemption provisions of
the FHLB,these entities, the stock has no quoted market value and is carried at cost. At
itstheir discretion,
the FHLBthese entities may declare dividends on the stock. Management reviews for impairment based on the ultimate recoverability of the cost basis in
the FHLB stock.Loans:
Cornerstone grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by real estate loans secured by properties located in Chattanooga, Tennessee and surrounding areas. The ability of Cornerstone’s debtors to honor their contracts is dependent on the real estate and economic conditions in these areas.
stocks.
Loans:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity
or pay-off are
statedreported at
unpaidtheir outstanding principal balances less
deferred fees and costs on originated loans and the allowance for loan
losses and net deferred loan fees and costs. When applicable, mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate.losses. Interest income is accrued based on the unpaidoutstanding principal balance. Loan origination and commitment fees, as well asnet of certain direct origination costs of consumer and installment loans are deferred and amortized as a yield adjustment overrecognized at the lives oftime the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
the books. Loan origination fees for all other loans are deferred and recognized as an adjustment of the yield over the life of the loan using the straight-line method without anticipating prepayments.
The accrual of interest on
mortgage and commercial loans is discontinued
when, in management's opinion, the borrower may be unable to meet payments as they become due, or at the time the loan is 90 days past due, unless the
creditloan is well-secured and in
the process of collection.
Credit card loans and other consumerUnsecured loans are typically charged off no later than 120 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or
charged offcharged-off at an earlier date if collection of principal
orand interest is considered doubtful.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Loans: (continued)
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Theincome or charged to the allowance, unless management believes that the accrual of interest is recoverable through the liquidation of collateral. Interest income on thesenonaccrual loans is accounted forrecognized on the cash-basis or cost-recovery method,cash basis, until qualifying for returnthe loans are returned to accrual.accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
A troubled-debt restructuring (TDR) is athe loan that the Bank has granted a concessionbeen performing according to the borrower,contractual terms for a period of not less than six months.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Acquired Loans:
Acquired loans are those acquired in business combinations by the Company or Bank. The fair values of acquired loans with evidence of credit deterioration, purchased credit impaired loans (“PCI loans”), are recorded net of a nonaccretable discount and accretable discount. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable discount, which would not otherwise be considered dueis included in the carrying amount of acquired loans. Subsequent decreases to the borrower experiencing financial difficulty. Ifexpected cash flows will generally result in a provision for loan islosses. Subsequent increases in nonaccrual status before it is determinedcash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretable discount. Acquired loans are initially recorded at fair value at acquisition date. Accretable discounts related to certain fair value adjustments are accreted into income over the estimated lives of the loans.
The Company accounts for performing loans acquired in the acquisition using the expected cash flows method of recognizing discount accretion based on the acquired loans' expected cash flows. Management recasts the estimate of cash flows expected to be
collected on each acquired impaired loan pool periodically. If the present value of expected cash flows for a
TDR, thenpool is less than its carrying value, an impairment is recognized by an increase in the allowance for loan losses and a charge to the provision for loan losses. If the present value of expected cash flows for a pool is greater than its carrying value, any previously established allowance for loan losses is reversed and any remaining difference increases the accretable yield which will be taken into interest income over the remaining life of the loan
remains in nonaccrual status. TDRpool. Acquired impaired loans
in nonaccrual status may be returnedare generally not subject to
accrual statusindividual evaluation for impairment and are not reported with impaired loans, even if
there has beenthey would otherwise qualify for such treatment. Purchased performing loans are recorded at
leastfair value, including a
six month sustained period of repayment performance by the borrower. When the Bank modifies the terms of an existing loan that is not considered a TDR, the Bank accounts for the loan modification as a new loan if the termscredit discount. Credit losses on acquired performing loans are estimated based on analysis of the
newperforming portfolio. Such estimated credit losses are recorded as nonaccretable discounts in a manner similar to purchased impaired loans. The fair value discount other than for credit loss is accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan
resulting from the refinancing or restructuring are at least as favorablelosses is recorded for any deterioration in these loans subsequent to the
Bank as the terms for comparable loans to other customers with similar risk characteristics who are not undergoing a refinancing or restructuring and the modifications are more than minor.acquisition.
Allowance for
loan losses:Loan Losses:
The allowance for loan losses is
maintained atestablished as losses are estimated to have occurred through a
level that management believesprovision for loan losses charged to
be adequate to absorb probable losses in the loan portfolio.expense. Loan losses are charged against the allowance when management believes
that the
full collectabilityuncollectibility of
the loan is unlikely. As such, a loan
may be partially charged-off after a "confirming event" has occurred, which serves to validate that full repayment pursuant to the terms of the loanbalance is
unlikely.confirmed. Confirmed losses are charged off immediately. Subsequent recoveries,
if any, are credited to the allowance.
Management’s determination
The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the
adequacyloan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the
allowance is based on an evaluationuncollectibility of
loans in light of historical experience, the
portfolio, current economic conditions,nature and volume
growth, composition of the loan portfolio,
homogeneous pools of loans, risk ratingsoverall portfolio quality, review of specific
problem loans,
historical loan loss factors, loss experiencecurrent economic conditions that may affect the borrower's ability to pay, estimated value of
various loan segments, identified impaired loans,any underlying collateral and
other factors related to the portfolio.prevailing economic conditions. This evaluation
is performed at least quarterly and is inherently subjective as it requires
material estimates that are susceptible to significant
change includingrevision as more information becomes available. This evaluation does not include the
amounts and timingeffects of
expected losses on specific loans or groups of loans that are related to future
cash flowsevents or expected
changes in economic conditions. While management uses the best information available to
be received on any impaired loans.As part of management’s quarterly assessment ofmake its evaluation, future adjustments to the allowance management divides the loan portfolio into five segments: commercial real estate-mortgage (includes owner-occupied and all other), consumer real estate-mortgage, construction and land development, commercial and industrial, and consumer and other. Each segment is then analyzed such that a specific and general allocation of the allowance is estimated for each loan segment.
The general component involves the use of a historic loss model to estimate losses inherent in the loan portfolio. The model includes each of the five loan portfolio segments and utilizes the incurred losses over the last ten quarters to estimate inherent losses. The historic loss percentages derived from this modelmay be necessary if there are then applied to the outstanding non-impaired loan balance for each loan category. The amounts for each loan category are then summed to determine the amount of loan loss allowance required.
The estimated general loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several environmental factors. The allocation for environmental factors is particularly subjective. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and is based upon quarterly trend assessments in delinquent and nonaccrual loans, unanticipated charge-offs, credit concentration changes, prevailing economic conditions,significant changes in lending personnel experience, changes in lending policies or procedures, and other influencing factors. These environmental factors are considered for each of the loan segments and the general allowance allocation, as determined by the processes noted above for each component, is increased or decreased based on the incremental assessment of these various environmental factors.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Allowance for loan losses: (continued)
The Bank’s allowance for loan losses includes a specific allocation for loans classified as impaired. In assessing the adequacy of the allowance, Cornerstone considers the results of our ongoing independent loan review process. Cornerstone undertakes this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in the overall evaluation of the risk characteristics of the entire loan portfolio. Cornerstone’s loan review process includes the judgment of management, independent loan reviewers, and reviews that may have been conducted by third-party reviewers. Cornerstone incorporates relevant loan review results in the loan impairment determination. For each impaired loan, management determines the impaired amount and assigns a specific reserve.economic conditions. In addition, regulatory agencies, as an integral part of their examination process, will periodically review Cornerstone’sthe Company's allowance for loan losses, and may require the companyCompany to record adjustmentsmake additions to the allowance based on their judgment about information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired. For impaired loans, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the Company's historical loss experience adjusted for other qualitative factors. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Allowance for Loan Losses (continued):
An unallocated component may be maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. As part of the risk management program, an independent review is performed on the loan portfolio, which supplements management’s assessment of the loan portfolio and the allowance for loan losses. The result of the independent review is reported directly to the Audit Committee of the Board of Directors. Loans, for which the terms have been modified at the borrower's request, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
A loan is considered impaired when
it is probable, based on current information and events,
it is probable that Cornerstonethe Company will be unable to collect
the scheduledall principal and interest payments
of principal or interest when due
according toin accordance with the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment isImpaired loans are measured
on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the
loan’sloan's effective interest rate, the
loan’sloan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, Cornerstone does not separately identify individual
The Company's homogeneous loan pools include consumer real estate loans, commercial real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for impairment disclosures, unless suchspecific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors. The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans arein the subject of a restructuring agreement duepool.
Troubled Debt Restructurings:
The Company designates loan modifications as troubled debt restructurings ("TDRs") when for economic and legal reasons related to
the borrower's financial difficulties,
it grants a concession to the borrower that it would not otherwise consider. TDRs can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower.
Derivative loan commitments:
Mortgage loan commitments are referred to as derivative loan commitments if In circumstances where the TDR involves charging off a portion of the loan balance, the Company typically classifies these restructurings as nonaccrual.
In connection with restructurings, the decision to maintain a loan that will result from exercisehas been restructured on accrual status is based on a current, well documented credit evaluation of the commitment willborrower's financial condition and prospects for repayment under the modified terms. This evaluation includes consideration of the borrower's current capacity to pay, which among other things may include a review of the borrower's current financial statements, an analysis of global cash flow sufficient to pay all debt obligations, a debt to income analysis, and an evaluation of secondary sources of payment from the borrower and any guarantors. This evaluation also includes an evaluation of the borrower's current willingness to pay, which may include a review of past payment history, an evaluation of the borrower's willingness to provide information on a timely basis, and consideration of offers from the borrower to provide additional collateral or guarantor support. The credit evaluation also reflects consideration of the borrower's future capacity and willingness to pay, which may include evaluation of cash flow projections, consideration of the adequacy of collateral to cover all principal and interest, and trends indicating improving profitability and collectability of receivables.
Restructured nonaccrual loans may be returned to accrual status based on a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment under the modified terms. This evaluation must include consideration of the borrower's sustained historical repayment for a reasonable period, generally a minimum of six months, prior to the date on which the loan is returned to accrual status.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Foreclosed Assets:
Foreclosed assets acquired through, or in lieu of, loan foreclosure are held for sale
upon funding. Loan commitments thatand are
derivatives are recognizedinitially recorded at fair value
onless selling costs. Any write-down to fair value at the
consolidated balance sheet in derivativetime of transfer to foreclosed assets
or derivative liabilities with changes in their fair values recorded in net gains on sales of loans.Cornerstone records a zero valueis charged to the allowance for the loan commitment at inception, when the commitment is issued to a borrower.losses. Subsequent to inception, changes inforeclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less costs to sell. Costs of improvements are capitalized, whereas costs relating to holding foreclosed assets and subsequent write-downs to the loan commitmentvalue are recognized based on changesexpensed. The amount of residential real estate where physical possession had been obtained included within foreclosed assets at December 31, 2017 and 2016 was $545,750 and $1,500, respectively. The amount of residential real estate in the fair valueprocess of the underlying mortgage loan due to interest rate changes, changes in the probability the derivative loan commitment will be exercised,foreclosure at December 31, 2017 and the passage of time. In estimating fair value, Cornerstone assigns a probability to a loan commitment based on an expectation that it will be exercised and the loan will be funded.
December 31, 2016 was $0.
Premises and
equipment:Equipment:
Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation computed on the straight-line
and declining balance methodsmethod over the estimated useful lives of the assets or the expected terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in
noninterest income.current operations. | Years |
| |
| Buildings and leasehold improvements | 10-4015 - 40 years |
Furniture fixtures, and equipment | 3-103-7 years |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Investment
Goodwill and Intangible Assets:
Goodwill represents the cost in partnership:Cornerstone’sexcess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as business combinations. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. FASB ASC 350,
Goodwill and Other, regarding testing goodwill for impairment provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity does a qualitative assessment and determines that this is the case, or if a qualitative assessment is not performed, it is required to perform additional goodwill impairment testing to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). Based on a qualitative assessment, if an entity determines that the fair value of a reporting unit is more than its carrying amount, the two-step goodwill impairment test is not required. The Company performs its annual goodwill impairment test as of December 31 of each year. For 2017, the results of the qualitative assessment provided no indication of potential impairment. Goodwill will continue to be monitored for triggering events that may indicate impairment prior to the next scheduled annual impairment test. Intangible assets consist of core deposit premiums created as a result of Business Combinations by the Company or Bank where deposits are assumed. The core deposit premium is initially recognized based on a valuation performed as of the consummation date. The core deposit premium is amortized over the average remaining life of the acquired customer deposits. Amortization expense relating to these intangible assets was $346,435 and $305,452 for the years ended December 31, 2017 and 2016, respectively. The intangible assets were evaluated for impairment as of December 31, 2017, and based on that evaluation it was determined that there was no impairment.
Transfer of Financial Assets:
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Advertising Costs:
The Company expenses all advertising costs as incurred. Advertising expense was $637,600 and $615,751 for the years ended December 31, 2017 and 2016, respectively.
Income Taxes:
The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. Deferred tax assets may be reduced by deferred tax liabilities and a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law by the President of the United States. TCJA is a tax reform act that among other things, reduced corporate tax rates to 21 percent effective January 1, 2018. FASB ASC 740, Income Taxes, requires deferred tax assets and liabilities to be adjusted for the effect of a change in tax laws or rates in the year of enactment, which is the year in which the change was signed into law. Accordingly, the Company adjusted its deferred tax assets and liabilities at December 31, 2017, using the new corporate tax rate of 21 percent. See Note 8.
Stock Compensation Plans:
At December 31, 2017, the Company had options outstanding under stock-based compensation plans, which are described in more detail in Note 10. The plans have been accounted for under the accounting guidance (FASB ASC 718, Compensation - Stock Compensation) which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and stock or other stock based awards.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees' service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market value of the Company's common stock at the date of grant is used for restrictive stock awards and stock grants.
Employee Benefit Plan:
Employee benefit plan costs are based on the percentage of individual employee's salary, not to exceed the amount that can be deducted for federal income tax purposes.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Variable interest entities:
An entity is referred to as a variable interest entity (VIE) if it meets the criteria outlined in ASC Topic 810, which are: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (2) the entity has equity investors that cannot make significant decisions about the entity's operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that has a majority of the expected losses, expected residual returns, or both. At December 31, 2017, the Company had an investment in Community Advantage Fund, LLC that qualified as an unconsolidated VIE.
The Company’s investment in a partnership consists of an equity interest in a lending partnership for the purposes of
investing inloaning funds to an unrelated entity. This entity will use the
New Market Tax Credit Program. This program permits taxpayers to claim a credit against federal income taxes for Qualified Equity Investments made to acquire stock or a capital interest in designated Community Development Entities (CDEs). These designated CDEs must use substantially all (defined as 85 percent) of these proceedsfunds to make
qualified low-income community investments.Cornerstoneloans through the SBA Community Advantage loan Initiative.
The Company uses the equity method when it owns an interest in a partnership and can exert significant influence over the partnership’s
operations but cannot control the partnership’s operations. Under the equity method,
Cornerstone’sthe Company’s ownership interest in the partnership’s capital is reported as an investment on its consolidated balance sheets
in other assets and
Cornerstone’sthe Company’s allocable share of the income or loss from the partnership is reported in noninterest income or expense in the consolidated statements of income.
CornerstoneThe Company ceases recording losses on an investment in partnership when the cumulative losses and distributions from the partnership exceed the carrying amount of the investment and any advances made by
Cornerstone.the Company. After
Cornerstone’sthe Company’s investment in such partnership reaches zero, cash distributions received from these investments are recorded as income.
Foreclosed assets:
Assets acquired through,
Comprehensive Income:
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Fair Value of Financial Instruments:
Fair values of financial instruments are estimates using relevant market information and other assumptions, as more fully disclosed in Note 15. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in lieumarket conditions could significantly affect the estimates.
Business Combinations:
Business combinations are accounted for using the acquisition method of
loan foreclosureaccounting. Under the acquisition method of accounting, acquired assets and assumed liabilities are
held for sale and are initially recorded at fair value less cost to sell atincluded with the acquirer's accounts as of the date of
foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carriedacquisition at
the lower of carrying amount orestimated fair value,
less cost to sell. Revenues and expenses from operations and changes inwith any excess of purchase price over the
valuation allowance are included in net expenses from foreclosed assets.Securities sold under agreements to repurchase:
Cornerstone enters into sales of securities under agreements to repurchase identical securities the next day. Securities sold under agreements to repurchase amounted to $19,409,506 at December 31, 2014, mature on a daily basis, and are secured by securities available for sale with a fair value of approximately $24,207,000.
Income taxes:
Cornerstone accountsthe net assets acquired (including identifiable intangible assets) capitalized as goodwill. In the event that the fair value of the net assets acquired exceeds the purchase price, an acquisition gain is recorded for income taxesthe difference in accordance with income tax accounting guidance in ASC Topic 740. The income tax accounting guidance results in two componentsconsolidated statements of income tax expense – current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to taxable income or loss. Cornerstone determines deferred income taxes using the liability method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities. Cornerstone’s deferred taxes relate primarily to differences between the basis of the allowance for loan losses, foreclosed assets, and accumulated depreciation. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assetsacquisition occurred. An intangible asset is recognized as an asset apart from goodwill when it arises from contractual or liabilities are expected to be realizedother legal rights or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Cornerstone files consolidated income tax returns with its subsidiary. With few exceptions, Cornerstone is no longer subject to tax examinations by tax authorities for years before 2011.
Cornerstone recognizes deferred tax assets if it is more likely than not, based oncapable of being separated or divided from the technical merits, that the tax position will be realizedacquired entity and sold, transferred, licensed, rented or sustained upon examination. Cornerstone follows the statutory requirements for its income tax accountingexchanged. In addition, acquisition-related costs and generally avoids risks associated with potentially problematic tax positions that may be challenged upon examination. Cornerstone recognizes interest and penalties on income taxesrestructuring costs are recognized as a component of income tax expense.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Transfers of financial assets:
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over assets is deemed to be surrendered when (1) the assets have been isolated from Cornerstone, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) Cornerstone does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity, or the ability to unilaterally cause the holder to return specific assets.
Advertising costs:
Cornerstoneperiod expenses all advertising costs as incurred. Advertising expense was $112,864, $89,859 and $89,068Estimates of fair value are subject to refinement for the years ended December 31, 2014, 2013 and 2012, respectively.
Statements of cash flows:
Cornerstone considers all cash and amounts duea period not to exceed one year from depository institutions, interest-bearing deposits at other financial institutions, and federal funds soldacquisition date as information relative to be cash equivalents for purposes of the statements of cash flows.
Stock option plan:
Cornerstone recognizes compensation cost relating to share-based payment transactions in accordance with ASC Topic 718. Compensation cost has been measured based on the grantacquisition date fair value of the equity or liability instruments issued. Compensation cost is calculated and recognized over the employee service period, generally defined as the vesting period. Cornerstone uses a stock option pricing model to determine the fair value of the award on the grant date.
Segment reporting:
ASC Topic 280, “Segment Reporting,” provides for the identification of reportable segments on the basis of distinct business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). ASC Topic 280 permits aggregation or combination of segments that have similar characteristics. In Cornerstone’s operations, each bank branch is viewed by management as being a separately identifiable business or segment from the perspective of monitoring performance and allocation of financial resources. Although the branches operate independently and are managed and monitored separately, each is substantially similar in terms of business focus, type of customers, products, and services. Accordingly, Cornerstone’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.
values becomes available.
Earnings per common share:
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by
Cornerstonethe Company relate
solely to
restricted stock and outstanding stock options and are determined using the treasury stock
method.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 1. | Summary of Significant Accounting Policies (continued) |
Variable interest entities:
method
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Segment Reporting:
ASC Topic 280, “Segment Reporting,” provides for the identification of reportable segments on the basis of distinct business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). ASC Topic 280 permits aggregation or combination of segments that have similar characteristics. In the Company’s operations, each bank branch is viewed by management as being a separately identifiable business or segment from the perspective of monitoring performance and allocation of financial resources. Although the branches operate independently and are managed and monitored separately, each is substantially similar in terms of business focus, type of customers, products, and services. Accordingly, the Company’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.
Recently Issued Not Yet Effective Accounting Pronouncements:
The following is a summary of recent authoritative pronouncements not yet in effect that could impact the accounting, reporting, and/or disclosure of financial information by the Company.
In January 2016, the FASB issued guidance that primarily affects the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments in ASU No. 2016-1 -Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will be effective in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.
In February 2016, the FASB issued guidance that requires lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability in ASU 2016-2: Leases (Topic 842). For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines. Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model and the new revenue recognition standard. Existing sale-leaseback guidance, including guidance for real estate, is replaced with a new model applicable to both lessees and lessors. The new guidance will be effective for public business entities for annual periods beginning after December 15, 2018 including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.
In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842) Land Easement Practical Expedient Transition to Topic 842 , an amendment to ASU 2016-2: Leases. The amendments in this Update permit an entity to elect an optional transition practical expedient to not evaluate under Topic 842 land easements that exist or expired before the entity’s adoption of Topic 842 and that were not previously accounted for as leases under Topic 840. An entity is referredthat elects this practical expedient should apply the practical expedient consistently to all of its existing or expired land easements that were not previously accounted for as leases under Topic 840. Once an entity adopts Topic 842, it should apply that Topic prospectively to all new (or modified) land easements to determine whether the arrangement should be accounted for as a variable interestlease. An entity (VIE) if it meetsthat does not elect this practical expedient should evaluate all existing or expired land easements in connection with the criteria outlinedadoption of the new lease requirements in ASC Topic 810, which are: (1)842 to assess whether they meet the definition of a lease. An entity has equityshould continue to apply its current accounting policy for accounting for land easements that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (2) the entity has equity investors that cannot make significant decisions aboutexisted before the entity’s operations or that do not absorbadoption of Topic 842. For example, if an entity currently accounts for certain land easements as leases under Topic 840, it should continue to account for those land easements as leases before its adoption of Topic 842. The effective date and transition requirements for the expected losses or receiveamendments are the expected returns ofsame as the entity. A VIE must be consolidated by Cornerstone if it is deemedeffective date and transition requirements in Update 2016-02.
SmartFinancial, Inc. and Subsidiary
Notes to be the primary beneficiary of the VIE, which is the party involved with the VIE that has a majority of the expected losses, expected residual returns, or both. At Consolidated Financial Statements
December 31, 2013, Cornerstone had an investment in Appalachian Fund for Growth II Partnership that qualified as an unconsolidated VIE. This equity investment was distributed to2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Recently Issued Not Yet Effective Accounting Pronouncements (continued):
In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU changed the owners in 2014.Comprehensive income:
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gainscredit loss model on securitiesfinancial instruments measured at amortized cost, available for sale securities and unrealizedcertain purchased financial instruments. Credit losses relatedon financial instruments measured at amortized cost will be determined using a current expected credit loss model which requires the Company to factors other thanmeasure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on debt securities.
Off-balance sheet credit related financial instruments:
In the ordinary course of business, Cornerstone has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.
Subsequent events:
Cornerstone has evaluated subsequent events for potential recognition and/or disclosures in the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K.
| | During 2010, Cornerstone initiated a preferred stock offering, which ended on December 31, 2012. Specifics of the preferred stock offering were as follows: |
| · | Issuance of 600,000 shares of Series A Convertible Preferred Stockassets measured at a price of $25.00 per share. |
| · | The annual cash dividend on each share of Series A Preferred Stock is $2.50, which is equal to 10% of the original issue price of $25.00 per share, and is payable quarterly in arrears, if, as, and when declared on the 15th day of February, May, August, and November thatimmediately follows the end of the dividend period to which such dividends relate. Any dividend payable on shares of Series A Preferred Stock that is not declared by our board of directors or paid will accumulate. |
| · | Each share of Series A Preferred Stock will be convertible at the shareholder’s option at any time into five (5) shares of our common stock reflecting an initial conversion price of $5.00 per share of common stock. The shares of Series A Preferred Stock are also convertible at Cornerstone’s option, in whole or in part, into shares of Cornerstone’s common stock at the conversion rate, at any time on or after July 31, 2015, if the closing price of Cornerstone’s common stock equals or exceeds 150% of the conversion price on each of the thirty (30) consecutive trading days immediately preceding the date Cornerstone gives notice of its election to so convert. |
| | |
| · | Subject to prior regulatory approval, each share of Series A Preferred Stock is redeemable by Cornerstone, in whole or in part, at any time after July 31, 2015, for a redemption price of $25.00 per share plus any accumulated and unpaid dividends. |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 2. | Preferred Stock (continued) |
At December 31, 2014 and 2013, the preferred stock dividends accumulated for each period, which were not declared, totaled $750,000 for each year.
| Note 3. | Restrictions on Cash and Due From Banks |
The Bank is required to maintain balances on hand or with the Federal Reserve Bank based on a percentage of deposits. At December 31, 2014 and 2013, these reserve balances were approximately $672,000 and $724,000, respectively.
Securities have been classified in the balance sheet according to management’s intent as either securities held to maturity or securities available for sale. The amortized cost and approximateapplies to some off-balance sheet credit exposures. Purchased financial assets with more-than-insignificant credit deterioration since origination ("PCD assets" which are currently named "PCI Loans") measured at amortized cost will have an allowance for credit losses established at acquisition as part of the purchase price. Subsequent increases or decreases to the allowance for credit losses on PCD assets will be recognized in the income statement. Interest income should be recognized on PCD assets based on the effective interest rate, determined excluding the discount attributed to credit losses at acquisition. Credit losses relating to available-for-sale debt securities will be recognized through an allowance for credit losses. The amount of the credit loss is limited to the amount by which fair value is below amortized cost of the available-for-sale debt security. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years for the Company and other SEC filers. Early adoption is permitted and if early adopted, all provisions must be adopted in the same period. The amendments should be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the period adopted. A prospective approach is required for securities with other than temporary impairment recognized prior to adoption. The Company is still reviewing the impact the adoption of this guidance will have on its financial statements.
In January 2017, FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of securities at December 31, 2014 and 2013, are as follows:| | | December 31, 2014 | |
| | | | | | Gross | | | Gross | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Debt securities available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government agencies | | $ | 560,183 | | | $ | 2,840 | | | $ | - | | | $ | 563,023 | |
| | | | | | | | | | | | | | | | | |
| State and municipal securities | | | 7,028,388 | | | | 302,697 | | | | - | | | | 7,331,085 | |
| | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | | 16,852,496 | | | | 44,954 | | | | (9,179 | ) | | | 16,888,271 | |
| | | | | | | | | | | | | | | | | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 62,278,948 | | | | 273,571 | | | | (141,989 | ) | | | 62,410,530 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 86,720,015 | | | $ | 624,062 | | | $ | (151,168 | ) | | $ | 87,192,909 | |
| | | | | | | | | | | | | | | | | |
| Debt securities held to maturity: | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | $ | 25,428 | | | $ | 274 | | | $ | - | | | $ | 25,702 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 4. | Securities (continued) |
| | | December 31, 2013 | |
| | | | | | Gross | | | Gross | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Debt securities available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government agencies | | $ | 3,433,216 | | | $ | 48,119 | | | $ | - | | | $ | 3,481,335 | |
| | | | | | | | | | | | | | | | | |
| State and municipal securities | | | 14,908,761 | | | | 425,021 | | | | (84,544 | ) | | | 15,249,238 | |
| | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: Residential mortgage guaranteed by GNMA or FNMA | | | 7,047,076 | | | | 85,203 | | | | - | | | | 7,132,279 | |
| | | | | | | | | | | | | | | | | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 66,408,975 | | | | 205,025 | | | | (268,180 | ) | | | 66,345,820 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 91,798,028 | | | $ | 763,368 | | | $ | (352,724 | ) | | $ | 92,208,672 | |
| | | | | | | | | | | | | | | | | |
| Debt securities held to maturity: | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | $ | 34,165 | | | $ | 862 | | | $ | - | | | $ | 35,027 | |
U.S. Government sponsored agencies include entities such as Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association.
At December 31, 2014 and 2013, securitiesa reporting unit with aits carrying value of approximately $12,612,000 and $14,385,000, respectively, were pledged to secure public deposits andamount. An impairment charge should be recognized for other purposes required or permittedthe amount by law.
At December 31, 2014 and 2013,which the carrying amount exceeds the reporting unit's fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.
In January 2017, FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The ASU clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.
In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Topic 310-20): Premium
Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities
held at a premium. The premium on individual callable debt securities pledgedshall be amortized to secure repurchase agreements was approximately $24,207,000the earliest call date. This guidance
does not apply to securities for which prepayments are estimated on a large number of similar loans where prepayments are
probable and
$25,521,000, respectively.At reasonably estimable. The amendments in this update are effective for fiscal years beginning after December 15,
2018, including interim periods within those fiscal years. Early adoption is permitted. This update should be adopted on a modified
retrospective basis with a cumulative-effect adjustment to retained earnings on the date of adoption. The Company does not expect
these amendments to have a material effect on its financial statements.
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, which amends the
hedge accounting recognition and presentation requirements in Accounting Standards Codification (ASC) 815, Derivatives and
Hedging. The goals of the ASU are to (1) improve the transparency and understandability of information conveyed to financial
statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging
relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge
accounting by preparers. The amendments will be effective for the Company for interim and annual periods beginning after
December 15, 2018. The Company does not expect these amendments to have a material effect on its financial statements.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 1. Summary of Significant Accounting Policies, Continued
Recently Issued Not Yet Effective Accounting Pronouncements (continued):
In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers in ASU No. 2014-9, Revenue from Contracts with Customers (Topic 606). The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and 2013, securities with a carrying value of approximately $18,705,000 and $20,140,000, respectively, were pledgedservices to customers in an amount equal to the Federal Home Loan Bank as collateralconsideration the entity receives or expects to receive. The guidance will be effective for the Bank’s borrowings.At Company for annual periods beginning after December 15, 2017, and interim periods within annual reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.
Reclassifications:
Certain captions and amounts in the 2016 financial statements were reclassified to conform to the 2017 presentation.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 20142017 and 2013,2016
Note 2. Business Combinations
On December 8, 2016, the Bank entered into a purchase and assumption agreement with Atlantic Capital Bank, N.A. that provided for the acquisition and assumption by the Bank of certain assets and liabilities associated with Atlantic Capital Bank’s branch office located at 3200 Keith Street NW, Cleveland, Tennessee 37312. The purchase was completed on May 19, 2017 for total cash consideration of $1,183,007. The assets and liabilities as of the effective date of the transaction were recorded at their respective estimated fair values. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill. In the periods following the acquisition, the financial statements will include the results attributable to the Cleveland branch purchase beginning on the date of purchase. For the twelve months period ended December 31, 2017, the revenues and net income attributable to the Cleveland branch were $903,311 and $63,385, respectively. It is impracticable to determine the pro-forma impact to the 2017 revenues and net income if the acquisition had pledged securitiesoccurred on January 1, 2017 as the Company does not have access to those records for a single branch. The following table details the financial impact of the transaction, including the allocation of the purchase price to the fair values of net assets assumed and goodwill recognized:
|
| | | |
| Allocation of Purchase Price (in thousands) | |
| Total consideration in cash | $ | 1,183 |
|
| Fair value of assets acquired and liabilities assumed: | |
|
| Cash and cash equivalents | 133 |
|
| Loans | 24,073 |
|
| Premises and equipment | 2,839 |
|
| Core deposit intangible | 310 |
|
| Prepaid and other assets | 77 |
|
| Deposits | (26,888 | ) |
| Payables and other liabilities | (21 | ) |
| Total fair value of net assets acquired | 523 |
|
| Goodwill | $ | 660 |
|
As of December 31, 2017 there have not been any changes to the initial fair values recorded as part of the business combination.
On May 22, 2017, the shareholders of the SmartFinancial, Inc (“ SmartFinancial”) approved a merger with Capstone Bancshares, Inc. ("Capstone"), the one bank holding company of Capstone Bank, which became effective November 1, 2017. Capstone shareholders received either: (a) 0.85 shares of SmartFinancial common stock, (b) $18.50 in cash, or (c) a carrying amountcombination of 80% SmartFinancial common stock and 20% cash. Elections were limited by the requirement that 80% of the total shares of Capstone common stock be exchanged for SmartFinancial common stock and 20% be exchanged for cash. Therefore, the allocation of SmartFinancial common stock and cash that a Capstone shareholder received depended on the elections of other Capstone shareholders, and were allocated in accordance with the procedures set forth in the merger agreement. Capstone shareholders also received cash instead of any fractional shares they would have otherwise received in the merger.
After the merger, shareholders of SmartFinancial owned approximately $13,037,00074% of the outstanding common stock of the combined entity on a fully diluted basis, after taking into account the exchange ratio.
The merger is being accounted for using the acquisition method of accounting, in accordance with the provisions of FASB ASC 805-10 Business Combinations. Under this guidance, for accounting purposes, SmartFinancial is considered the acquirer in the merger, and $11,978,000, respectively,as a result the historical financial statements of the combined entity will be the historical financial statements of SmartFinancial.
The merger was effected by the issuance of shares of SmartFinancial stock along with cash consideration to othershareholders of Capstone. The assets and liabilities of Capstone as of the effective date of the merger were recorded at their respective estimated fair values and combined with those of SmartFinancial. The excess of the purchase price over the net estimated fair values of the acquired assets and liabilities was allocated to identifiable intangible assets with the remaining excess allocated to goodwill. Goodwill from the transaction was $38.0 million, none of which is deductible for income tax purposes.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 2. Business Combination, Continued
In periods following the merger, the financial institutionsstatements of the combined entity will include the results attributable to Capstone beginning on the date the merger was completed. In the period ended December 31, 2017, the revenues and net income attributable to Capstone were $5.0 million and $0.2 million, respectively. The pro-forma impact to 2017 revenues and net income if the merger had occurred on December 31, 2016 would have been $24.9 million and $947 thousand, respectively.
The fair value estimates of Capstone’s assets and liabilities recorded are preliminary and subject to refinement as
collateraladditional information becomes available. Under current accounting principles, the Company’s estimates of fair values may be adjusted for
federal funds purchased.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 4. | Securities (continued) |
a period of up to one year from the acquisition date.
The following table details the financial impact of the merger, including the calculation of the purchase price, the allocation of the purchase price to the fair values of net assets assumed, and goodwill recognized:
|
| | | |
| Calculation of Purchase Price | |
| Shares of SMBK common stock issued to Capstone shareholders as of November 1, 2017 | 2,908,094 |
|
| Market price of SMBK common stock on November 1, 2017 | $ | 23.49 |
|
| Estimated fair value of SMBK common stock issued (in thousands) | 68,311 |
|
| Estimated fair value of Capstone stock options (in thousands) | 1,585 |
|
| Cash consideration paid | 15,826 |
|
| Total consideration (in thousands) | $ | 85,722 |
|
|
| | | |
| Allocation of Purchase Price (in thousands) | |
| Total consideration above | $ | 85,722 |
|
| Fair value of assets acquired and liabilities assumed: | |
|
| Cash and cash equivalents | 16,810 |
|
| Investment securities available for sale | 51,638 |
|
| Restricted investments | 1,049 |
|
| Loans | 413,023 |
|
| Premises and equipment | 8,668 |
|
| Bank owned life insurance | 10,031 |
|
| Core deposit intangible | 5,530 |
|
| Other real estate owned | 410 |
|
| Prepaid and other assets | 6,360 |
|
| Deposits | (454,154 | ) |
| FHLB advances and other borrowings | (4,887 | ) |
| Payables and other liabilities | (6,803 | ) |
| Total fair value of net assets acquired | 47,675 |
|
| Goodwill | $ | 38,047 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 3. Securities
The amortized cost and fair value of securities available-for-sale at December 31, 2014,2017 and 2016 are summarized as follow (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | December 31, 2017 |
| | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value |
| U.S. Government-sponsored enterprises (GSEs) | | $ | 26,207 |
| | $ | 1 |
| | $ | (432 | ) | | $ | 25,776 |
|
| Municipal securities | | 9,122 |
| | 28 |
| | (147 | ) | | 9,003 |
|
| Other debt securities | | 974 |
| | — |
| | (24 | ) | | 950 |
|
| Mortgage-backed securities | | 117,263 |
| | 136 |
| | (1,184 | ) | | 116,215 |
|
| Total | | $ | 153,566 |
| | $ | 165 |
| | $ | (1,787 | ) | | $ | 151,944 |
|
|
| | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value |
| U.S. Government-sponsored enterprises (GSEs) | | $ | 18,279 |
| | $ | 8 |
| | $ | (564 | ) | | $ | 17,723 |
|
| Municipal securities | | 8,182 |
| | 16 |
| | (179 | ) | | 8,019 |
|
| Mortgage-backed securities | | 104,585 |
| | 185 |
| | (1,090 | ) | | 103,680 |
|
| Total | | $ | 131,046 |
| | $ | 209 |
| | $ | (1,833 | ) | | $ | 129,422 |
|
The amortized cost and estimated market value of securities at December 31, 2017, by contractual maturity, are shown
below.below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | Securities Available for Sale | | | Securities Held to Maturity | |
| | | Amortized | | | Fair | | | Amortized | | | Fair | |
| | | Cost | | | Value | | | Cost | | | Value | |
| | | | | | | | | | | | | |
| Due in one year or less | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Due from one year to five years | | | 898,930 | | | | 934,341 | | | | - | | | | - | |
| Due from five years to ten years | | | 2,831,489 | | | | 2,931,593 | | | | - | | | | - | |
| Due after ten years | | | 3,858,152 | | | | 4,028,174 | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | |
| | | | 7,588,571 | | | | 7,894,108 | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | | 79,131,444 | | | | 79,298,801 | | | | 25,428 | | | | 25,702 | |
| | | | | | | | | | | | | | | | | |
| | | $ | 86,720,015 | | | $ | 87,192,909 | | | $ | 25,428 | | | $ | 25,702 | |
For the year ended December 31, 2014, there were available for sale securities sold with proceeds totaling $12,240,478 which resulted in gross gains realized of $700,390. For the year ended December 31, 2013, there were available for sale securities sold with proceeds totaling $8,171,961 which resulted in gross gains realized of $652,421. For the year ended December 31, 2012, there were no securities sold.
|
| | | | | | | | |
| | | Amortized
Cost | | Fair
Value |
| Due in one year or less | | $ | 2,174 |
| | $ | 2,175 |
|
| Due from one year to five years | | 21,606 |
| | 21,292 |
|
| Due from five years to ten years | | 8,037 |
| | 7,822 |
|
| Due after ten years | | 4,486 |
| | 4,440 |
|
| | | 36,303 |
| | 35,729 |
|
| Mortgage-backed securities | | 117,263 |
| | 116,215 |
|
| Total | | $ | 153,566 |
| | $ | 151,944 |
|
The following tables present
the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities
available for saleavailable-for-sale have been in a continuous unrealized loss position,
atas of December 31,
20142017 and
2013:| | | As of December 31, 2014 | |
| | | Less than 12 Months | | | 12 Months or Greater | | | Total | |
| | | | | | Gross | | | | | | Gross | | | | | | Gross | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| | | Value | | | Losses | | | Value | | | Losses | | | Value | | | Losses | |
| | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | $ | 7,018,137 | | | $ | (9,179 | ) | | $ | - | | | $ | - | | | $ | 7,018,137 | | | $ | (9,179 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 9,504,525 | | | | (52,831 | ) | | | 17,546,169 | | | | (89,158 | ) | | | 27,050,694 | | | | (141,989 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 16,522,662 | | | $ | (62,010 | ) | | $ | 17,546,169 | | | $ | (89,158 | ) | | $ | 34,068,831 | | | $ | (151,168 | ) |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 4. | Securities (continued) |
| | | As of December 31, 2013 | |
| | | Less than 12 Months | | | 12 Months or Greater | | | Total | |
| | | | | | Gross | | | | | | Gross | | | | | | Gross | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| | | Value | | | Losses | | | Value | | | Losses | | | Value | | | Losses | |
| | | | | | | | | | | | | | | | | | | |
| State and municipal securities | | $ | 3,025,250 | | | $ | (84,544 | ) | | $ | - | | | $ | - | | | $ | 3,025,250 | | | $ | (84,544 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 27,782,942 | | | | (221,827 | ) | | | 8,761,049 | | | | (46,353 | ) | | | 36,543,991 | | | | (268,180 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 30,808,192 | | | $ | (306,371 | ) | | $ | 8,761,049 | | | $ | (46,353 | ) | | $ | 39,569,241 | | | $ | (352,724 | ) |
Upon acquisition of a security, Cornerstone determines the appropriate impairment model that is applicable. If the security is a beneficial interest in securitized financial assets, Cornerstone uses the beneficial interests in securitized financial assets impairment model. If the security is not a beneficial interest in securitized financial assets, Cornerstone uses the debt2016 (in thousands):
SmartFinancial, Inc. and equity securities impairment model. Cornerstone conducts periodic reviewsSubsidiary
Notes to evaluate each security to determine whether an other-than-temporary impairment has occurred. Cornerstone does not have any securities that have been classified as other-than-temporarily impaired at Consolidated Financial Statements
December 31,
2014.2017 and 2016
Note 3. Securities, Continued
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, 2017 |
| | | Less than 12 Months | | 12 Months or Greater | | Total |
| | | Fair
Value | | Gross
Unrealized
Losses | | Fair
Value | | Gross
Unrealized
Losses | | Fair
Value | | Gross
Unrealized
Losses |
| U.S. Government- sponsored enterprises (GSEs) | | $ | 1,358 |
| | $ | (1 | ) | | $ | 13,420 |
| | $ | (431 | ) | | $ | 14,778 |
| | $ | (432 | ) |
| Municipal securities | | 3,418 |
| | (43 | ) | | 2,112 |
| | (104 | ) | | 5,530 |
| | (147 | ) |
| Other debt securities | | 950 |
| | (24 | ) | | — |
| | — |
| | 950 |
| | (24 | ) |
| Mortgage-backed securities | | 61,332 |
| | (407 | ) | | 35,048 |
| | (777 | ) | | 96,380 |
| | (1,184 | ) |
| Total | | $ | 67,058 |
| | $ | (475 | ) | | $ | 50,580 |
| | $ | (1,312 | ) | | $ | 117,638 |
| | $ | (1,787 | ) |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, 2016 |
| | | Less than 12 Months | | 12 Months or Greater | | Total |
| | | Fair
Value | | Gross
Unrealized
Losses | | Fair
Value | | Gross
Unrealized
Losses | | Fair
Value | | Gross
Unrealized
Losses |
| U.S. Government- sponsored enterprises (GSEs) | | $ | 14,702 |
| | $ | (564 | ) | | $ | — |
| | $ | — |
| | $ | 14,702 |
| | $ | (564 | ) |
| Municipal securities | | 6,368 |
| | (179 | ) | | — |
| | — |
| | 6,368 |
| | (179 | ) |
| Mortgage-backed securities | | 67,063 |
| | (690 | ) | | 8,948 |
| | (400 | ) | | 76,011 |
| | (1,090 | ) |
| Total | | $ | 88,133 |
| | $ | (1,433 | ) | | $ | 8,948 |
| | $ | (400 | ) | | $ | 97,081 |
| | $ | (1,833 | ) |
At December 31,
2014,2017, the
significant categories of temporarily impaired securities, and management’s evaluation of those securities, are as follows:
Mortgage-backed securities:
U.S. Government-sponsored enterprises:At December 31, 2014, twelve2017, six investments in U.S. GSE securities had unrealized losses. These unrealized losses related principally to changes in market interest rates. The contractual terms of the investments does not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is more likely than not that the Bank will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other-than temporarily impaired at December 31, 2017.
Municipal securities: At December 31, 2017, thirteen investments in obligations of municipal securities had unrealized losses. The Bank believes the unrealized losses on those investments were caused by the interest rate environment and do not relate to the underlying credit quality of the issuers. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider these investments to be other than temporarily impaired at December 31, 2017.
Other debt securities: At December 31, 2017, one investment in other debt securities had unrealized losses. The Bank believes the unrealized losses on this investment was caused by the interest rate environment and does not relate to the underlying credit quality of the issuers. Because the Bank does not intend to sell the investment and it is not more likely than not that the Bank will be required to sell the investment before recovery of their amortized cost bases, which may be maturity, the Bank does not consider this investment to be other than temporarily impaired at December 31, 2017.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 3. Securities, Continued
Mortgage-backed securities: At December 31, 2017, sixty investments in residential mortgage-backed securities had unrealized losses. This impairment is believed to be caused by the current interest rate environment. The contractual cash flows of those investments are guaranteed or issued by an agency of the U.S. Government. Because the decline in market value is attributable to the current interest rate environment and not credit quality, and because Cornerstonethe Bank does not intend to sell the investments and it is not more likely than not that Cornerstonethe Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, Cornerstonethe Bank does not deem thoseconsider these investments to be other-than-temporarilyother than temporarily impaired at December 31, 2014.2017. Sales of available for sale securities for the years ended December 31, 2017 and 2016, were as follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Proceeds | | $ | 12,614 |
| | $ | 31,599 |
|
| Gains realized | | 145 |
| | 200 |
|
| Losses realized | | 2 |
| | — |
|
Securities with a carrying value of $97,160,059 and $86,351,097 at December 31, 2017 and 2016, respectively, were pledged to secure various deposits, securities sold under agreements to repurchase, as collateral for federal funds purchased from other financial institutions and serve as collateral for borrowings at the Federal Home Loan Bank.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
| Note 5. | Loans and Allowance for Loan Losses |
Note 4. Loans and Allowance for Loan Losses
Portfolio Segmentation:
At December 31,
20142017 and
2013, the Bank's2016, loans
consistconsisted of the following (in thousands):
| | | 2014 | | | 2013 | |
| Commercial real estate-mortgage: | | | | | | | | |
| Owner-occupied | | $ | 68,581 | | | $ | 65,747 | |
| All other | | | 74,587 | | | | 64,052 | |
| Consumer real estate-mortgage | | | 76,907 | | | | 76,315 | |
| Construction and land development | | | 34,449 | | | | 41,597 | |
| Commercial and industrial | | | 37,863 | | | | 38,999 | |
| Consumer and other | | | 2,977 | | | | 2,730 | |
| | | | | | | | | |
| Total loans | | | 295,364 | | | | 289,440 | |
| Less: Allowance for loan losses | | | (3,495 | ) | | | (3,203 | ) |
| | | | | | | | | |
| Loans, net | | $ | 291,869 | | | $ | 286,237 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 5. | Loans and Allowance for Loan Losses (continued) |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 | | December 31, 2016 |
| | | PCI
Loans | | All Other
Loans | | Total | | PCI
Loans | | All Other
Loans | | Total |
| Commercial real estate | | $ | 17,903 |
| | $ | 625,085 |
| | $ | 642,988 |
| | $ | 14,943 |
| | $ | 400,265 |
| | $ | 415,208 |
|
| Consumer real estate | | 7,450 |
| | 286,007 |
| | 293,457 |
| | 9,004 |
| | 178,798 |
| | 187,802 |
|
| Construction and land development | | 5,120 |
| | 130,289 |
| | 135,409 |
| | 1,678 |
| | 116,191 |
| | 117,869 |
|
| Commercial and industrial | | 858 |
| | 237,229 |
| | 238,087 |
| | 1,568 |
| | 83,454 |
| | 85,022 |
|
| Consumer and other | | 1,463 |
| | 11,854 |
| | 13,317 |
| | — |
| | 7,475 |
| | 7,475 |
|
| Total loans | | 32,794 |
| | 1,290,464 |
| | 1,323,258 |
| | 27,193 |
| | 786,183 |
| | 813,376 |
|
| Less: Allowance for loan losses | | (16 | ) | | (5,844 | ) | | (5,860 | ) | | — |
| | (5,105 | ) | | (5,105 | ) |
| | | | | | | | | | | | | |
| Loans, net | | $ | 32,778 |
| | $ | 1,284,620 |
| | $ | 1,317,398 |
| | $ | 27,193 |
| | $ | 781,078 |
| | $ | 808,271 |
|
For purposes of the disclosures required pursuant to the adoption of ASC 310, the loan portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. There are five loan portfolio segments that include commercial real estate, consumer real estate, construction and land development, commercial and industrial, and consumer and other.
The following describe risk characteristics relevant to each of the portfolio segments:
Commercial Real estate:As discussed below, Cornerstone offers various types ofEstate:
Commercial real estate loan products. All loans include owner-occupied commercial real estate loans and loans secured by income-producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. Loans within this portfolio segment are particularly sensitive to the valuation of real estate: | § | Commercial real estate-mortgage loans include owner-occupied commercial real estate loans and other commercial real estate loans. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. Other commercial real estate loans are generally secured by income producing properties. |
| § | Consumer real estate-mortgage loans include loans secured by 1-4 family and multifamily residential properties. These loans are repaid by various means such as a borrower’s income, sale of the property, or rental income derived from the property. |
| § | Construction and land development loans include extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. These loans are repaid through cash flow related to the operations, sale, or refinance of the underlying property. This portfolio segment also includes owner-occupied construction loans for commercial businesses for the development of land or construction of a building. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. |
estate.
Consumer Real Estate: Consumer real estate loans include real estate loans secured by first liens, second liens, or open end real estate loans, such as home equity lines. These are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. One to four family first mortgage loans are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Construction and Land Development: Loans for real estate construction and development are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio segment includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.
Commercial and industrial:Industrial:
The commercial and industrial loan portfolio segment includes commercial, financial, and agricultural loans. These loans include those loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or expansion projects. Loans are repaid by business cash flows. Collection risk in this portfolio is driven by the creditworthiness of the underlying borrower, particularly cash flows from the customers’customers' business operations. Consumer and other:Other:
The consumer loan portfolio segment includes direct consumer installment loans, overdrafts and other revolving credit loans, and educational loans. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| An analysis of the allowance for loan losses follows: | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 3,203,158 | | | $ | 6,141,281 | | | $ | 7,400,049 | |
| | | | | | | | | | | | | |
| Provision for loan losses | | | 515,000 | | | | 300,000 | | | | 430,000 | |
| Charge-offs | | | (1,581,992 | ) | | | (4,708,605 | ) | | | (2,868,576 | ) |
| Recoveries | | | 1,358,963 | | | | 1,470,482 | | | | 1,179,808 | |
| | | | | | | | | | | | | |
| Balance, end of year | | $ | 3,495,129 | | | $ | 3,203,158 | | | $ | 6,141,281 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 5. | Loans and Allowance for Loan Losses (continued) |
Cornerstone follows
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management:
The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan portfolio segments. Credit risk management is guided by credit policies that provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Credit Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans are individually underwritten, risk-rated, approved, and monitored.
Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer real estate and consumer and other portfolio segments, the risk management process focuses on managing customers who become delinquent in their payments. For the other portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit of the portfolios, including a third party review of the largest credits on an annual basis or more frequently as needed. To ensure problem credits are identified on a timely basis, several specific portfolio reviews occur periodically to assess the larger adversely rated credits for proper risk rating and accrual status.
Credit quality and trends in the loan portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by the Senior Credit Officer and the Directors Loan Committee.
The allowance for loan losses is a valuation reserve allowance established through provisions for loan losses charged against income. The allowance for loan losses, which is evaluated quarterly, is maintained at a level that management deems sufficient to absorb probable losses inherent in the loan portfolio. Loans deemed to be uncollectible are charged against the allowance for loan losses, while recoveries of previously charged-off amounts are credited to the allowance for loan losses. The allowance for loan losses is comprised of specific valuation allowances for loans evaluated individually for impairment accounting guidance in ASC Topic 310. Aand general allocations for pools of homogeneous loans with similar risk characteristics and trends.
The allowance for loan losses related to specific loans is based on management's estimate of potential losses on impaired loans as determined by (1) the present value of expected future cash flows; (2) the fair value of collateral if the loan is considered impaired when,determined to be collateral dependent or (3) the loan's observable market price. The Company's homogeneous loan pools include commercial real estate loans, consumer real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on current informationthe historical loss rates for specific loan types and events, it is probable that Cornerstone will be unable to collect all amounts due from the borrowerinternal risk grade, if applicable, adjusted for both internal and external qualitative risk factors.
The qualitative factors considered by management include, among other factors, (1) changes in accordance withlocal and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the contractual termscomposition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the loan. ImpairedCompany's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans include nonperforming loansin the pool.
SmartFinancial, Inc. and loans modified in troubled debt restructurings where concessions have been grantedSubsidiary
Notes to
borrowers experiencing financial difficulties. These concessions could include a reduction in interest rates, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collections.Consolidated Financial Statements
December 31, 2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
The composition of loans by loan classification for impaired and performing
loansloan status at December 31,
20142017 and
2013,2016, is summarized in the tables below
(in(amounts in thousands):
As of December 31, 2014:
| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Performing loans | | $ | 138,711 | | | $ | 74,828 | | | $ | 33,696 | | | $ | 36,314 | | | $ | 2,977 | | | $ | 286,526 | |
| Impaired loans | | | 4,457 | | | | 2,079 | | | | 753 | | | | 1,549 | | | | - | | | | 8,838 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 143,168 | | | $ | 76,907 | | | $ | 34,449 | | | $ | 37,863 | | | $ | 2,977 | | | $ | 295,364 | |
As of December 31, 2013:
| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Performing loans | | $ | 121,817 | | | $ | 72,868 | | | $ | 41,228 | | | $ | 37,007 | | | $ | 2,730 | | | $ | 275,650 | |
| Impaired loans | | | 7,982 | | | | 3,447 | | | | 369 | | | | 1,992 | | | | - | | | | 13,790 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 129,799 | | | $ | 76,315 | | | $ | 41,597 | | | $ | 38,999 | | | $ | 2,730 | | | $ | 289,440 | |
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Performing loans | | $ | 624,638 |
| | $ | 284,585 |
| | $ | 129,742 |
| | $ | 237,016 |
| | $ | 11,842 |
| | $ | 1,287,823 |
|
| Impaired loans | | 447 |
| | 1,422 |
| | 547 |
| | 213 |
| | 12 |
| | 2,641 |
|
| | | 625,085 |
| | 286,007 |
| | 130,289 |
| | 237,229 |
| | 11,854 |
| | 1,290,464 |
|
| PCI loans | | 17,903 |
| | 7,450 |
| | 5,120 |
| | 858 |
| | 1,463 |
| | 32,794 |
|
| Total | | $ | 642,988 |
| | $ | 293,457 |
| | $ | 135,409 |
| | $ | 238,087 |
| | $ | 13,317 |
| | $ | 1,323,258 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Performing loans | | $ | 400,146 |
| | $ | 177,977 |
| | $ | 115,326 |
| | $ | 83,244 |
| | $ | 7,475 |
| | $ | 784,168 |
|
| Impaired loans | | 119 |
| | 821 |
| | 865 |
| | 210 |
| | — |
| | 2,015 |
|
| | | 400,265 |
| | 178,798 |
| | 116,191 |
| | 83,454 |
| | 7,475 |
| | 786,183 |
|
| PCI loans | | 14,943 |
| | 9,004 |
| | 1,678 |
| | 1,568 |
| | — |
| | 27,193 |
|
| Total loans | | $ | 415,208 |
| | $ | 187,802 |
| | $ | 117,869 |
| | $ | 85,022 |
| | $ | 7,475 |
| | $ | 813,376 |
|
The following tables show the allowance for loan losses allocation by loan classification for impaired and performing loans as of December 31,
20142017 and
2013 (in2016 (amounts in thousands):
As of
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2017 |
| | | | | | | Construction | | Commercial | | Consumer | | |
| | | Commercial | | Consumer | | and Land | | and | | and | | |
| | | Real Estate | | Real Estate | | Development | | Industrial | | Other | | Total |
| Performing loans | | $ | 2,444 |
| | $ | 1,340 |
| | $ | 521 |
| | $ | 890 |
| | $ | 204 |
| | $ | 5,399 |
|
| PCI loans | | 16 |
| | — |
| | — |
| | — |
| | — |
| | 16 |
|
| Impaired loans | | 5 |
| | 256 |
| | — |
| | 172 |
| | 12 |
| | 445 |
|
| Total | | $ | 2,465 |
| | $ | 1,596 |
| | $ | 521 |
| | $ | 1,062 |
| | $ | 216 |
| | $ | 5,860 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
2014:| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| Allowance related to: | | | | | | | | | | | | | | | | | | | | | | | | |
| Performing loans | | $ | 1,191 | | | $ | 1,082 | | | $ | 130 | | | $ | 361 | | | $ | 35 | | | $ | 2,799 | |
| Impaired loans | | | 404 | | | | 15 | | | | - | | | | 277 | | | | - | | | | 696 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,595 | | | $ | 1,097 | | | $ | 130 | | | $ | 638 | | | $ | 35 | | | $ | 3,495 | |
As of December 31, 2013:
| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| Allowance related to: | | | | | | | | | | | | | | | | | | | | | | | | |
| Performing loans | | $ | 1,051 | | | $ | 927 | | | $ | 319 | | | $ | 297 | | | $ | 45 | | | $ | 2,639 | |
| Impaired loans | | | 498 | | | | 11 | | | | - | | | | 55 | | | | - | | | | 564 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,549 | | | $ | 938 | | | $ | 319 | | | $ | 352 | | | $ | 45 | | | $ | 3,203 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 5. | Loans and Allowance for Loan Losses (continued) |
2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2016 |
| | | | | | | Construction | | Commercial | | Consumer | | |
| | | Commercial | | Consumer | | and Land | | and | | and | | |
| | | Real Estate | | Real Estate | | Development | | Industrial | | Other | | Total |
| Performing loans | | $ | 2,369 |
| | $ | 1,382 |
| | $ | 717 |
| | $ | 516 |
| | $ | 117 |
| | $ | 5,101 |
|
| PCI Loans | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| Impaired loans | | — |
| | — |
| | — |
| | 4 |
| | — |
| | 4 |
|
| Total | | $ | 2,369 |
| | $ | 1,382 |
| | $ | 717 |
| | $ | 520 |
| | $ | 117 |
| | $ | 5,105 |
|
The following tables detail the changes in the allowance for loan losses
duringfor the year ending December 31,
20142017 and
2013,December 31, 2016, by loan classification
(in(amounts in thousands):
As of
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2017 |
| | | Commercial
Real Estate | | Consumer
Real
Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Beginning balance | | $ | 2,369 |
| | $ | 1,382 |
| | $ | 717 |
| | $ | 520 |
| | $ | 117 |
| | $ | 5,105 |
|
| Loans charged off | | — |
| | (111 | ) | | — |
| | (24 | ) | | (141 | ) | | (276 | ) |
| Recoveries of loans charged off | | 8 |
| | 99 |
| | 13 |
| | 67 |
| | 61 |
| | 248 |
|
| Provision (reallocation) charged to operating expense | | 88 |
| | 226 |
| | (209 | ) | | 499 |
| | 179 |
| | 783 |
|
| Ending balance | | $ | 2,465 |
| | $ | 1,596 |
| | $ | 521 |
| | $ | 1,062 |
| | $ | 216 |
| | $ | 5,860 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2016 |
| | | Commercial
Real Estate | | Consumer
Real
Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Beginning balance | | $ | 1,906 |
| | $ | 1,015 |
| | $ | 627 |
| | $ | 777 |
| | $ | 29 |
| | $ | 4,354 |
|
| Loans charged off | | — |
| | (102 | ) | | (14 | ) | | (35 | ) | | (155 | ) | | (306 | ) |
| Recoveries of loans charged off | | 45 |
| | 76 |
| | 22 |
| | 58 |
| | 68 |
| | 269 |
|
| Provision (reallocation) charged to operating expense | | 418 |
| | 393 |
| | 82 |
| | (280 | ) | | 175 |
| | 788 |
|
| Ending balance | | $ | 2,369 |
| | $ | 1,382 |
| | $ | 717 |
| | $ | 520 |
| | $ | 117 |
| | $ | 5,105 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
2014:| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 1,549 | | | $ | 938 | | | $ | 319 | | | $ | 352 | | | $ | 45 | | | $ | 3,203 | |
| Provision for loan losses | | | 360 | | | | 731 | | | | (902 | ) | | | 336 | | | | (10 | ) | | | 515 | |
| Charge-offs | | | (470 | ) | | | (896 | ) | | | (58 | ) | | | (108 | ) | | | (50 | ) | | | (1,582 | ) |
| Recoveries | | | 156 | | | | 324 | | | | 771 | | | | 58 | | | | 50 | | | | 1,359 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, end of year | | $ | 1,595 | | | $ | 1,097 | | | $ | 130 | | | $ | 638 | | | $ | 35 | | | $ | 3,495 | |
As2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued):
A description of
December 31, 2013:| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Balance, beginning of year | | $ | 2,549 | | | $ | 1,528 | | | $ | 1,241 | | | $ | 809 | | | $ | 14 | | | $ | 6,141 | |
| Provision for loan losses | | | 811 | | | | 11 | | | | (787 | ) | | | 143 | | | | 122 | | | | 300 | |
| Charge-offs | | | (1,879 | ) | | | (842 | ) | | | (1,193 | ) | | | (699 | ) | | | (96 | ) | | | (4,709 | ) |
| Recoveries | | | 68 | | | | 241 | | | | 1,058 | | | | 99 | | | | 5 | | | | 1,471 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, end of year | | $ | 1,549 | | | $ | 938 | | | $ | 319 | | | $ | 352 | | | $ | 45 | | | $ | 3,203 | |
Credit quality indicators:
Federal regulations require the Bank to review and classify its assets on a regular basis. To fulfill this requirement,general characteristics of the Bank systematically reviews its loan portfolio to ensure the Bank’s large loan relationships are being maintained within its loan policy guidelines, remain properly underwritten, and are properly classified by loan grade. This review process is performedrisk grades used by the Bank's management, internal and external loan review, internal auditors, and state and federal regulators.
The Bank’s loan grading processCompany is as follows:
| § | All loans are assigned a loan grade at the time of origination by the relationship manager. Typically, a loan is assigned a loan grade of “pass” at origination. |
| § | Loans relationships greater than or equal to $500 thousand are reviewed by the Bank’s external loan review provider on an annual basis. |
| § | Additionally, the Bank's external loan review provider samples other loan relationships between $100 thousand and $500 thousand with an emphasis on commercial and commercial real estate loans and insider loans. |
| § | The Bank’s internal loan review department samples approximately 33 percent of all loan relationships less than $500 thousand on an annual basis for review. |
| § | If a loan is delinquent 60 days or more or a pattern of delinquency exists, the loan will be selected for review. |
| § | Generally, all loans on the Bank’s internal watchlist are reviewed annually by internal loan review or external loan review providers. |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 5. | Loans and Allowance for Loan Losses (continued) |
Credit
Pass: Loans in this risk category involve borrowers of acceptable-to-strong credit quality indicators: (continued)Ifand risk who have the apparent ability to satisfy their loan obligations. Loans in this risk grade would possess sufficient mitigating factors, such as adequate collateral or strong guarantors possessing the capacity to repay the debt if required, for any weakness that may exist.
Watch: Loans in this risk category involve borrowers that exhibit characteristics, or are operating under conditions that, if not successfully mitigated as planned, have a loan is classified asreasonable risk of resulting in a problem asset, it will be assigned onedowngrade within the next six to twelve months. Loans may remain in this risk category for six months and then are either upgraded or downgraded upon subsequent evaluation.
Special Mention: Loans in this risk grade are the equivalent of the following loan grades: substandard, doubtful,regulatory definition of "Other Assets Especially Mentioned" classification. Loans in this category possess some credit deficiency or potential weakness, which requires a high level of management attention. Potential weaknesses include declining trends in operating earnings and loss. “Substandard” assets mustcash flows and /or reliance on the secondary source of repayment. If left uncorrected, these potential weaknesses may result in noticeable deterioration of the repayment prospects for the asset or in the Company's credit position.
Substandard: Loans in this risk grade are inadequately protected by the borrower's current financial condition and payment capability or of the collateral pledged, if any. Loans so classified have onea well-defined weakness or more defined weaknesses andthat jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that wethe Company will sustain some loss if the deficiencies are not corrected. “Doubtful” assets
Doubtful: Loans in this risk grade have all the weaknesses ofinherent in those classified as substandard, assets with the additionaladded characteristic that the weaknesses make collection or liquidationorderly repayment in full, on the basis of currentlycurrent existing facts, conditions and values, highly questionable and thereimprobable. Possibility of loss is aextremely high, possibilitybut because of loss. An asset classified “loss”certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined.
Uncollectible: Loans in this risk grade are considered uncollectibleto be non-collectible and of such little value that their continuance as an asset of the institutionbankable assets is not warranted. The regulations also provide for a “special mention” category, described as assets which doThis does not currently expose an institutionmean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving close attention. Whendefer writing off the Bank classifies an asset as substandard or doubtful, a specificloan, even though partial recovery may be obtained in the future. Charge-offs against the allowance for loan losses may be established.are taken in the period in which the loan becomes uncollectible. Consequently, the Company typically does not maintain a recorded investment in loans within this category.
The following tables outline the amount of each loan classification and the amount categorized into each risk rating as of December 31,
20142017 and
2013 (in2016 (amounts in thousands):
As of
Non PCI Loans
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Pass | | $ | 616,028 |
| | $ | 279,464 |
| | $ | 129,359 |
| | $ | 233,942 |
| | $ | 11,624 |
| | $ | 1,270,417 |
|
| Watch | | 7,673 |
| | 2,543 |
| | 383 |
| | 3,007 |
| | 62 |
| | 13,668 |
|
| Special mention | | 1,006 |
| | 2,627 |
| | — |
| | 64 |
| | 155 |
| | 3,852 |
|
| Substandard | | 378 |
| | 1,159 |
| | 547 |
| | 157 |
| | — |
| | 2,241 |
|
| Doubtful | | — |
| | 214 |
| | — |
| | 59 |
| | 13 |
| | 286 |
|
| Total | | $ | 625,085 |
| | $ | 286,007 |
| | $ | 130,289 |
| | $ | 237,229 |
| | $ | 11,854 |
| | $ | 1,290,464 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
2014:| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Pass | | $ | 135,586 | | | $ | 72,753 | | | $ | 33,201 | | | $ | 32,684 | | | $ | 2,977 | | | $ | 277,201 | |
| Special mention | | | 3,096 | | | | 1,452 | | | | 17 | | | | 3,187 | | | | - | | | | 7,752 | |
| Substandard | | | 4,486 | | | | 2,702 | | | | 1,231 | | | | 1,992 | | | | - | | | | 10,411 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 143,168 | | | $ | 76,907 | | | $ | 34,449 | | | $ | 37,863 | | | $ | 2,977 | | | $ | 295,364 | |
As of December 31, 2013:
| | | Commercial | | | Consumer | | | Construction | | | Commercial | | | | | | | |
| | | Real Estate- | | | Real Estate- | | | and Land | | | and | | | Consumer | | | | |
| | | Mortgage | | | Mortgage | | | Development | | | Industrial | | | and Other | | | Total | |
| | | | | | | | | | | | | | | | | | | |
| Pass | | $ | 119,398 | | | $ | 67,444 | | | $ | 40,850 | | | $ | 33,394 | | | $ | 2,730 | | | $ | 263,816 | |
| Special mention | | | 3,538 | | | | 3,536 | | | | 73 | | | | 3,468 | | | | - | | | | 10,615 | |
| Substandard | | | 6,863 | | | | 5,335 | | | | 674 | | | | 2,137 | | | | - | | | | 15,009 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 129,799 | | | $ | 76,315 | | | $ | 41,597 | | | $ | 38,999 | | | $ | 2,730 | | | $ | 289,440 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 5. | Loans and Allowance for Loan Losses (continued) |
After the Bank’s independent loan review department completes the loan grade assignment, a loan impairment analysis is performed on loans graded substandard or worse. The following tables present summary information pertaining to impaired loans by loan classification as of December 31, 2014, 2013,2017 and 2012 (in thousands):
| | | | | | For the Year Ended | |
| | | At December 31, 2014 | | | December 31, 2014 | |
| | | | | | Unpaid | | | | | | Average | | | Interest | |
| | | Recorded | | | Principal | | | Related | | | Recorded | | | Income | |
| | | Investment | | | Balance | | | Allowance | | | Investment | | | Recognized | |
| Impaired loans without a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | $ | 2,428 | | | $ | 2,480 | | | $ | - | | | $ | 4,386 | | | $ | 127 | |
| Consumer real estate – mortgage | | | 1,738 | | | | 1,742 | | | | - | | | | 1,880 | | | | 114 | |
| Construction and land development | | | 753 | | | | 766 | | | | - | | | | 462 | | | | 44 | |
| Commercial and industrial | | | 1,033 | | | | 1,085 | | | | - | | | | 1,186 | | | | 41 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 5,952 | | | | 6,073 | | | | - | | | | 7,914 | | | | 326 | |
| | | | | | | | | | | | | | | | | | | | | |
| Impaired loans with a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | | 2,029 | | | | 2,029 | | | | 404 | | | | 683 | | | | 98 | |
| Consumer real estate – mortgage | | | 341 | | | | 476 | | | | 15 | | | | 676 | | | | 24 | |
| Construction and land development | | | - | | | | - | | | | - | | | | - | | | | - | |
| Commercial and industrial | | | 516 | | | | 516 | | | | 277 | | | | 401 | | | | 52 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 2,886 | | | | 3,021 | | | | 696 | | | | 1,760 | | | | 174 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total impaired loans | | $ | 8,838 | | | $ | 9,094 | | | $ | 696 | | | $ | 9,674 | | | $ | 500 | |
| | | | | | For the Year Ended | |
| | | At December 31, 2013 | | | December 31, 2013 | |
| | | | | | Unpaid | | | | | | Average | | | Interest | |
| | | Recorded | | | Principal | | | Related | | | Recorded | | | Income | |
| | | Investment | | | Balance | | | Allowance | | | Investment | | | Recognized | |
| | | | | | | | | | | | | | | | |
| Impaired loans without a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | $ | 5,786 | | | $ | 5,854 | | | $ | - | | | $ | 4,657 | | | $ | 340 | |
| Consumer real estate – mortgage | | | 2,177 | | | | 2,202 | | | | - | | | | 2,669 | | | | 96 | |
| Construction and land development | | | 369 | | | | 383 | | | | - | | | | 358 | | | | 23 | |
| Commercial and industrial | | | 1,563 | | | | 1,621 | | | | - | | | | 1,857 | | | | 60 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 9,895 | | | | 10,060 | | | | - | | | | 9,541 | | | | 519 | |
| | | | | | | | | | | | | | | | | | | | | |
| Impaired loans with a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | | 2,196 | | | | 2,285 | | | | 498 | | | | 4,869 | | | | 118 | |
| Consumer real estate – mortgage | | | 1,270 | | | | 1,281 | | | | 11 | | | | 1,353 | | | | 90 | |
| Construction and land development | | | - | | | | - | | | | - | | | | 177 | | | | - | |
| Commercial and industrial | | | 429 | | | | 430 | | | | 55 | | | | 597 | | | | 53 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 3,895 | | | | 3,996 | | | | 564 | | | | 6,996 | | | | 261 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total impaired loans | | $ | 13,790 | | | $ | 14,056 | | | $ | 564 | | | $ | 16,537 | | | $ | 780 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
2016
Note 5.4. Loans and Allowance for Loan Losses, Continued
Credit Risk Management (continued)
| | | | | | For the Year Ended | |
| | | At December 31, 2012 | | | December 31, 2012 | |
| | | | | | Unpaid | | | | | | Average | | | Interest | |
| | | Recorded | | | Principal | | | Related | | | Recorded | | | Income | |
| | | Investment | | | Balance | | | Allowance | | | Investment | | | Recognized | |
| Impaired loans without a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | $ | 3,406 | | | $ | 3,453 | | | $ | - | | | $ | 4,389 | | | $ | 180 | |
| Consumer real estate – mortgage | | | 513 | | | | 540 | | | | - | | | | 1,538 | | | | 52 | |
| Construction and land development | | | 244 | | | | 251 | | | | - | | | | 358 | | | | 19 | |
| Commercial and industrial | | | 2,111 | | | | 2,155 | | | | - | | | | 2,277 | | | | 55 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 6,274 | | | | 6,399 | | | | - | | | | 8,562 | | | | 306 | |
| | | | | | | | | | | | | | | | | | | | | |
| Impaired loans with a valuation allowance: | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate – mortgage | | | 5,807 | | | | 5,848 | | | | 2,230 | | | | 6,616 | | | | 215 | |
| Consumer real estate – mortgage | | | 1,353 | | | | 1,353 | | | | 576 | | | | 2,606 | | | | 61 | |
| Construction and land development | | | 706 | | | | 706 | | | | 460 | | | | 642 | | | | 49 | |
| Commercial and industrial | | | 1,049 | | | | 1,049 | | | | 780 | | | | 700 | | | | 132 | |
| Consumer and other | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Total | | | 8,915 | | | | 8,956 | | | | 4,046 | | | | 10,564 | | | | 457 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total impaired loans | | $ | 15,189 | | | $ | 15,355 | | | $ | 4,046 | | | $ | 19,126 | | | $ | 763 | |
The following tables present an aged analysis of past due loans as of :
PCI Loans
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Pass | | $ | 14,386 |
| | $ | 4,151 |
| | $ | 4,134 |
| | $ | 68 |
| | $ | 819 |
| | $ | 23,558 |
|
| Watch | | 261 |
| | 1,345 |
| | 649 |
| | 120 |
| | 262 |
| | 2,637 |
|
| Special mention | | — |
| | 456 |
| | — |
| | 58 |
| | 24 |
| | 538 |
|
| Substandard | | 3,084 |
| | 1,192 |
| | 337 |
| | 588 |
| | 107 |
| | 5,308 |
|
| Doubtful | | 172 |
| | 306 |
| | — |
| | 24 |
| | 251 |
| | 753 |
|
| Total | | $ | 17,903 |
| | $ | 7,450 |
| | $ | 5,120 |
| | $ | 858 |
| | $ | 1,463 |
| | $ | 32,794 |
|
| Total loans | | $ | 642,988 |
| | $ | 293,457 |
| | $ | 135,409 |
| | $ | 238,087 |
| | $ | 13,317 |
| | $ | 1,323,258 |
|
Non PCI Loans
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Pass | | $ | 399,505 |
| | $ | 177,466 |
| | $ | 115,237 |
| | $ | 82,992 |
| | $ | 7,238 |
| | $ | 782,438 |
|
| Watch | | 640 |
| | 550 |
| | 89 |
| | 252 |
| | — |
| | 1,531 |
|
| Special mention | | — |
| | 104 |
| | — |
| | — |
| | 237 |
| | 341 |
|
| Substandard | | 120 |
| | 678 |
| | 865 |
| | 210 |
| | — |
| | 1,873 |
|
| Doubtful | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
| Total | | $ | 400,265 |
| | $ | 178,798 |
| | $ | 116,191 |
| | $ | 83,454 |
| | $ | 7,475 |
| | $ | 786,183 |
|
PCI Loans
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | Commercial
Real Estate | | Consumer
Real Estate | | Construction
and Land
Development | | Commercial
and
Industrial | | Consumer
and Other | | Total |
| Pass | | $ | 11,836 |
| | $ | 6,811 |
| | $ | 1,019 |
| | $ | 1,507 |
| | $ | — |
| | $ | 21,173 |
|
| Watch | | 1,045 |
| | 1,577 |
| | 645 |
| | 22 |
| | — |
| | 3,289 |
|
| Special mention | | — |
| | — |
| | — |
| | 12 |
| | — |
| | 12 |
|
| Substandard | | 2,062 |
| | 616 |
| | 14 |
| | — |
| | — |
| | 2,692 |
|
| Doubtful | | — |
| | — |
| | — |
| | 27 |
| | — |
| | 27 |
|
| Total | | $ | 14,943 |
| | $ | 9,004 |
| | $ | 1,678 |
| | $ | 1,568 |
| | $ | — |
| | $ | 27,193 |
|
| Total loans | | $ | 415,208 |
| | $ | 187,802 |
| | $ | 117,869 |
| | $ | 85,022 |
| | $ | 7,475 |
| | $ | 813,376 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
20142017 and
2013 (in thousands):As of December 31, 2014:
| | | 30-89 Days | | | Past Due 90 | | | | | | | | | | | | | |
| | | Past Due and | | | Days or More | | | | | | Total | | | Current | | | Total | |
| | | Accruing | | | and Accruing | | | Nonaccrual | | | Past Due | | | Loans | | | Loans | |
| Commercial real estate-mortgage: | | | | | | | | | | | | | | | | | | | | | | | | |
| Owner-occupied | | $ | 664 | | | $ | - | | | $ | 496 | | | $ | 1,160 | | | $ | 67,421 | | | $ | 68,581 | |
| All other | | | - | | | | - | | | | - | | | | - | | | | 74,587 | | | | 74,587 | |
| Consumer real estate-mortgage | | | 419 | | | | - | | | | 1,134 | | | | 1,553 | | | | 75,354 | | | | 76,907 | |
| Construction and land development | | | 521 | | | | - | | | | 40 | | | | 561 | | | | 33,888 | | | | 34,449 | |
| Commercial and industrial | | | 54 | | | | - | | | | 1,195 | | | | 1,249 | | | | 36,614 | | | | 37,863 | |
| Consumer and other | | | 8 | | | | - | | | | - | | | | 8 | | | | 2,969 | | | | 2,977 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 1,666 | | | $ | - | | | $ | 2,865 | | | $ | 4,531 | | | $ | 290,833 | | | $ | 295,364 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
2016
Note 5.4. Loans and Allowance for Loan Losses, Continued
Past Due Loans:
A loan is considered past due if any required principal and interest payments have not been received as of the date such payments were required to be made under the terms of the loan agreement. Generally, management places a loan on nonaccrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due.
The following tables present the aging of the recorded investment in loans and leases as of December 31, 2017 and 2016 (amounts in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2017 |
| | | 30-89 Days
Past Due and
Accruing | | Past Due 90
Days or More
and Accruing | | Nonaccrual | | Total
Past Due | | PCI Loans | | Current
Loans | | Total
Loans |
| Commercial real estate | | $ | 517 |
| | $ | 728 |
| | $ | 128 |
| | $ | 1,373 |
| | $ | 17,903 |
| | $ | 623,712 |
| | $ | 642,988 |
|
| Consumer real estate | | 963 |
| | 33 |
| | 991 |
| | 1,987 |
| | 7,450 |
| | 284,020 |
| | 293,457 |
|
| Construction and land development | | 65 |
| | 326 |
| | 547 |
| | 938 |
| | 5,120 |
| | 129,351 |
| | 135,409 |
|
| Commercial and industrial | | 286 |
| | 131 |
| | 85 |
| | 502 |
| | 858 |
| | 236,727 |
| | 238,087 |
|
| Consumer and other | | 165 |
| | 291 |
| | 13 |
| | 469 |
| | 1,463 |
| | 11,385 |
| | 13,317 |
|
| Total | | $ | 1,996 |
| | $ | 1,509 |
| | $ | 1,764 |
| | $ | 5,269 |
| | $ | 32,794 |
| | $ | 1,285,195 |
| | $ | 1,323,258 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2016 |
| | | 30-89 Days
Past Due and
Accruing | | Past Due 90
Days or More
and Accruing | | Nonaccrual | | Total
Past Due | | PCI
Loans | | Current
Loans | | Total
Loans |
| Commercial real estate | | $ | 395 |
| | $ | — |
| | $ | — |
| | $ | 395 |
| | $ | 14,943 |
| | $ | 399,870 |
| | $ | 415,208 |
|
| Consumer real estate | | 695 |
| | 699 |
| | 386 |
| | 1,780 |
| | 9,004 |
| | 177,018 |
| | 187,802 |
|
| Construction and land development | | 690 |
| | — |
| | 865 |
| | 1,555 |
| | 1,678 |
| | 114,636 |
| | 117,869 |
|
| Commercial and industrial | | 257 |
| | — |
| | 164 |
| | 421 |
| | 1,568 |
| | 83,033 |
| | 85,022 |
|
| Consumer and other | | 17 |
| | — |
| | — |
| | 17 |
| | — |
| | 7,458 |
| | 7,475 |
|
| Total | | $ | 2,054 |
| | $ | 699 |
| | $ | 1,415 |
| | $ | 4,168 |
| | $ | 27,193 |
| | $ | 782,015 |
| | $ | 813,376 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Impaired Loans:
A loan held for investment is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
The following is an analysis of the impaired loan portfolio detailing the related allowance recorded as of and for the years ended December 31, 2017 and 2016 (amounts in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | For the year ended |
| | | At December 31, 2017 | | December 31, 2017 |
| | | Recorded Investment | | Unpaid Principal Balance | | Related Allowance | | Average Recorded Investment | | Interest Income Recognized |
| Impaired loans without a valuation allowance: | | |
| | |
| | |
| | |
| | |
|
| Non PCI Loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate | | $ | 424 |
| | $ | 454 |
| | $ | — |
| | $ | 204 |
| | $ | 44 |
|
| Consumer real estate | | 415 |
| | 420 |
| | — |
| | 401 |
| | 16 |
|
| Construction and land development | | 547 |
| | 547 |
| | — |
| | 628 |
| | — |
|
| Commercial and industrial | | 41 |
| | 41 |
| | — |
| | 44 |
| | 3 |
|
| Consumer and other | | — |
| | — |
| | — |
| | — |
| | — |
|
| | | 1,427 |
| | 1,462 |
| | — |
| | 1,277 |
| | 63 |
|
| | | | | | | | | | | |
| PCI loans: None in 2017 | | |
| | |
| | |
| | |
| | |
|
| | | | | | | | | | | |
| Impaired loans with a valuation allowance: | | |
| | |
| | |
| | |
| | |
|
| Non PCI Loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate | | 23 |
| | 23 |
| | 5 |
| | 5 |
| | 1 |
|
| Consumer real estate | | 1,007 |
| | 1,033 |
| | 256 |
| | 601 |
| | 38 |
|
| Construction and land development | | — |
| | — |
| | — |
| | — |
| | — |
|
| Commercial and industrial | | 172 |
| | 172 |
| | 172 |
| | 117 |
| | 10 |
|
| Consumer and other | | 12 |
| | 13 |
| | 12 |
| | 2 |
| | 1 |
|
| | | 1,214 |
| | 1,241 |
| | 445 |
| | 725 |
| | 50 |
|
| PCI loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate | | 16 |
| | 123 |
| | 16 |
| | 3 |
| | 16 |
|
| | | | | | | | | | | |
| Total impaired loans | | $ | 2,657 |
| | $ | 2,826 |
| | $ | 461 |
| | $ | 2,005 |
| | $ | 129 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Impaired Loans (continued)
:
|
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | For the year ended |
| | | At December 31, 2016 | | December 31, 2016 |
| | | Recorded Investment | | Unpaid Principal Balance | | Related Allowance | | Average Recorded Investment | | Interest Income Recognized |
| Impaired loans without a valuation allowance: | | |
| | |
| | |
| | |
| | |
|
| Non PCI Loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate | | $ | 119 |
| | $ | 119 |
| | $ | — |
| | $ | 1,311 |
| | $ | 73 |
|
| Consumer real estate | | 821 |
| | 849 |
| | — |
| | 2,334 |
| | 100 |
|
| Construction and land development | | 865 |
| | 865 |
| | — |
| | 967 |
| | 3 |
|
| Commercial and industrial | | 46 |
| | 46 |
| | — |
| | 47 |
| | 4 |
|
| Consumer and other | | — |
| | — |
| | — |
| | — |
| | — |
|
| | | 1,851 |
| | 1,879 |
| | — |
| | 4,659 |
| | 180 |
|
| | | | | | | | | | | |
| PCI loans: None in 2016 | | |
| | |
| | |
| | |
| | |
|
| | | | | | | | | | | |
| Impaired loans with a valuation allowance: | | |
| | |
| | |
| | |
| | |
|
| Non PCI Loans: | | |
| | |
| | |
| | |
| | |
|
| Commercial real estate | | — |
| | — |
| | — |
| | — |
| | — |
|
| Consumer real estate | | — |
| | — |
| | — |
| | — |
| | — |
|
| Construction and land development | | — |
| | — |
| | — |
| | — |
| | — |
|
| Commercial and industrial | | 164 |
| | 243 |
| | 4 |
| | 306 |
| | 70 |
|
| Consumer and other | | — |
| | — |
| | — |
| | — |
| | — |
|
| | | 164 |
| | 243 |
| | 4 |
| | 306 |
| | 70 |
|
| PCI loans: None in 2016 | | |
| | |
| | |
| | |
| | |
|
| Total impaired loans | | $ | 2,015 |
| | $ | 2,122 |
| | $ | 4 |
| | $ | 4,965 |
| | $ | 250 |
|
Troubled Debt Restructurings:
At December 31, 2017 and 2016, impaired loans included loans that were classified as Troubled Debt Restructurings ("TDRs"). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.
In assessing whether or not a borrower is experiencing financial difficulties, the Company considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy; and (iv) the debtor's projected cash flow is sufficient to satisfy contractual payments due under the original terms of the loan without a modification.
The Company considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Company include the debtor's ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 4. Loans and Allowance for Loan Losses, Continued
Troubled Debt Restructurings (continued):
The most common concessions granted by the Company generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt; (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk; (iii) a temporary period of interest-only payments; and (iv) a reduction in the contractual payment amount for either a short period or remaining term of the loan. As of December 31,
2013:| | | 30-89 Days | | | Past Due 90 | | | | | | | | | | | | | |
| | | Past Due and | | | Days or More | | | | | | Total | | | Current | | | Total | |
| | | Accruing | | | and Accruing | | | Nonaccrual | | | Past Due | | | Loans | | | Loans | |
| Commercial real estate-mortgage: | | | | | | | | | | | | | | | | | | | | | | | | |
| Owner-occupied | | $ | 678 | | | $ | - | | | $ | 838 | | | $ | 1,516 | | | $ | 64,231 | | | $ | 65,747 | |
| All other | | | 867 | | | | - | | | | 44 | | | | 911 | | | | 63,141 | | | | 64,052 | |
| Consumer real estate-mortgage | | | 419 | | | | - | | | | 1,006 | | | | 1,425 | | | | 74,890 | | | | 76,315 | |
| Construction and land development | | | 50 | | | | - | | | | 47 | | | | 97 | | | | 41,500 | | | | 41,597 | |
| Commercial and industrial | | | 201 | | | | - | | | | 1,631 | | | | 1,832 | | | | 37,167 | | | | 38,999 | |
| Consumer and other | | | 35 | | | | - | | | | - | | | | 35 | | | | 2,695 | | | | 2,730 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 2,250 | | | $ | - | | | $ | 3,566 | | | $ | 5,816 | | | $ | 283,624 | | | $ | 289,440 | |
Impaired loans also include2017 and 2016, management had approximately $41,000 and $608,000, respectively, in loans that met the Bank has electedcriteria for restructured. No restructured loans were on nonaccrual as of December 31, 2017. There were $442,000 restructured loans on nonaccrual at December 31, 2016. A loan is placed back on accrual status when both principal and interest are current and it is probable that management will be able to formally restructure when,collect all amounts due (both principal and interest) according to the weakening credit statusterms of a borrower, the restructuring may facilitate a repayment plan that seeks to minimizeloan agreement.
There were no loans modified as troubled debt restructurings during the
potential losses that the Bank may have to otherwise incur. Atyear ended December 31,
2014 and 2013, the Bank has loans of approximately $4,956,000 and $5,753,000, respectively, that were modified in troubled debt restructurings. Troubled commercial loans are restructured by specialists within our Special Asset department and all restructurings are approved by committees and credit officers separate and apart from the normal loan approval process. These specialists are trained to reduce the Bank’s overall risk and exposure to loss in the event of a restructuring through obtaining either or all of the following: improved documentation, additional guaranties, increase in curtailments, reduction in collateral terms, additional collateral, or other similar strategies.2017.
The following tables presenttable presents a summary of loans that were modified as troubled debt restructurings during the year ended December 31, 2016 (amounts in thousands):
|
| | | | | | | | | | |
| December 31, 2016 | | Number of Contracts | | Pre-Modification Outstanding Recorded Investment | | Post-Modification Outstanding Recorded Investment |
| Construction and land development | | 1 | | $ | 278 |
| | $ | 278 |
|
| Commercial and industrial | | 1 | | 164 |
| | 164 |
|
There were no loans that were modified as troubled debt restructurings during the past twelve months and for which there was a subsequent payment default.
Purchased Credit Impaired Loans:
The Company has acquired loans which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans at for the years ended December 31,
2014, 2013,2017 and
2012 (amounts in2016 is as follows (in thousands):
During
|
| | | | | | |
| | 2017 | 2016 |
| Commercial real estate | $ | 23,366 |
| $ | 18,473 |
|
| Consumer real estate | 10,764 |
| 12,111 |
|
| Construction and land development | 6,285 |
| 2,553 |
|
| Commercial and industrial | 1,452 |
| 2,482 |
|
| Consumer and other | 1,710 |
| — |
|
| Total loans | $ | 43,577 |
| $ | 35,619 |
|
| Less remaining purchase discount | (10,783 | ) | (8,426 | ) |
| Total, gross | 32,794 |
| 27,193 |
|
| Less: Allowance for loan losses | (16 | ) | — |
|
| Carrying amount, net of allowance | $ | 32,778 |
| $ | 27,193 |
|
The following is a summary of the
yearaccretable discount on acquired loans for the years ended December 31,
2014:| | | Pre-Modification | | | Post-Modification | | | | |
| | | Number of | | | Outstanding Recorded | | | Outstanding Recorded | |
| | | Contracts | | | Investment | | | Investment | |
| | | | | | | | | | |
| Commercial real estate-mortgage | | | 3 | | | $ | 902 | | | $ | 902 | |
| Consumer real estate-mortgage | | | 1 | | | | 65 | | | | 65 | |
During the year ended 2017 and 2016 (in thousands):
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
2013:| | | Pre-Modification | | | Post-Modification | | | | |
| | | Number of | | | Outstanding Recorded | | | Outstanding Recorded | |
| | | Contracts | | | Investment | | | Investment | |
| | | | | | | | | | |
| Commercial real estate-mortgage | | | 2 | | | $ | 2,073 | | | $ | 2,073 | |
| Consumer real estate-mortgage | | | 2 | | | | 239 | | | | 239 | |
| Construction and land development | | | 3 | | | | 728 | | | | 728 | |
| Commercial and industrial | | | 3 | | | | 2,389 | | | | 2,389 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note
5.4. Loans and Allowance for Loan Losses,
(continued)DuringContinued
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Accretable yield, beginning of period | | $ | 8,950 |
| | $ | 10,217 |
|
| Additions | | 2,581 |
| | — |
|
| Accretion income | | (4,217 | ) | | (2,588 | ) |
| Reclassification from nonaccretable | | 926 |
| | 1,585 |
|
| Other changes, net | | 1,047 |
| | (264 | ) |
| Accretable yield, end of period | | $ | 9,287 |
| | $ | 8,950 |
|
The Company increased the allowance for loan losses on purchase credit impaired loans in the amount of approximately $16,000 during the year ended December 31,
2012:| | | Pre-Modification | | | Post-Modification | | | | |
| | | Number of | | | Outstanding Recorded | | | Outstanding Recorded | |
| | | Contracts | | | Investment | | | Investment | |
| | | | | | | | | | |
| Commercial real estate-mortgage | | | 5 | | | $ | 5,971 | | | $ | 5,971 | |
| Consumer real estate-mortgage | | | 1 | | | | 65 | | | | 65 | |
| Construction and land development | | | 3 | | | | 1,178 | | | | 1,178 | |
| Commercial and industrial | | | 5 | | | | 2,432 | | | | 2,432 | |
The Bank did not have any loans modified as troubled debt restructurings over the last twelve months that subsequently defaulted2017 and no increases were made during the yearsyear ended December 31, 2014, 2013 and 2012.
2016.
Purchased credit impaired loans acquired from Capstone during the year ended December 31, 2017 for which it was probable at acquisition that all contractually required payments would not be collected are as follows (in thousands):
|
| | | | |
| | | 2017 |
| Contractual principal and interest at acquisition | | $ | 25,288 |
|
| Nonaccretable difference | | 5,725 |
|
| Expected cash flows at acquisition | | 19,563 |
|
| Accretable yield | | 2,581 |
|
| Basis in PCI loans at acquisition-estimated fair value | | $ | 16,982 |
|
Related Party Loans:
In the ordinary course of business, the
BankCompany has granted loans to
principalcertain related parties, including directors, executive officers,
and directors and their affiliates.
Annual activity ofThe interest rates on these
related party loans were
substantially the same as
follows:| | | 2014 | | | 2013 | |
| | | | | | | |
| Beginning balance | | $ | 1,380,170 | | | $ | 1,833,982 | |
| New loans | | | 3,780,391 | | | | 50,384 | |
| Repayments | | | (1,653,406 | ) | | | (504,196 | ) |
| | | | | | | | | |
| Ending balance | | $ | 3,507,155 | | | $ | 1,380,170 | |
Note 6. Bank Premisesrates prevailing at the time of the transaction and Equipment
repayment terms are customary for the type of loan. A summary of bankactivity in loans to related parties is as follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Balance, beginning of year | | $ | 12,999 |
| | $ | 10,851 |
|
| Disbursements | | 14,533 |
| | 855 |
|
| Removal of credit lines | | — |
| | (1,153 | ) |
| Changes in ownership | | — |
| | 4,830 |
|
| Repayments | | (9,202 | ) | | (2,384 | ) |
| Balance, end of year | | $ | 18,330 |
| | $ | 12,999 |
|
At December 31, 2017, the Company had pre-approved but unused lines of credit totaling approximately $5,833,000 to related parties.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 5. Premises and Equipment
A summary of premises and equipment at December 31,
20142017 and
2013,2016, is as
follows:| | | 2014 | | | 2013 | |
| | | | | | | |
| Land | | $ | 2,145,003 | | | $ | 2,145,003 | |
| Buildings and improvements | | | 4,343,643 | | | | 4,297,565 | |
| Furniture, fixtures and equipment | | | 3,315,766 | | | | 3,313,948 | |
| | | | | | | | | |
| | | | 9,804,412 | | | | 9,756,516 | |
| Accumulated depreciation | | | (4,976,289 | ) | | | (4,764,067 | ) |
| | | | | | | | | |
| | | $ | 4,828,123 | | | $ | 4,992,449 | |
follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Land and land improvements | | $ | 10,854 |
| | $ | 8,354 |
|
| Building and leasehold improvements | | 28,576 |
| | 18,507 |
|
| Furniture, fixtures and equipment | | 10,073 |
| | 7,043 |
|
| Construction in progress | | 1,495 |
| | 2,789 |
|
| Total, gross | | 50,998 |
| | 36,693 |
|
| Accumulated depreciation | | (7,998 | ) | | (6,157 | ) |
| Total, net | | $ | 43,000 |
| | $ | 30,536 |
|
At December 31, 2017 management estimates the cost necessary to complete the construction in progress will be approximately $3.04 million.
The Company leases several branch locations and also has three ground leases under non-cancelable operating lease agreements. The leases expire between January 2018 and November 2023. Lease expense under the leases was $721,534 and $728,004 in 2017 and 2016, respectively. At December 31, 2017, the remaining minimum lease payments relating to these leases were as follows (in thousands):
|
| | | |
| 2018 | $ | 608 |
|
| 2019 | 500 |
|
| 2020 | 487 |
|
| 2021 | 344 |
|
| 2022 | 124 |
|
| 2023 | 40 |
|
Depreciation expense was $1,841,524 and $1,435,090 for the years ended December 31, 2014, 20132017 and 2012, amounted to $365,377, $420,287,2016, respectively.
Note 6. Deposits
The aggregate amount of time deposits in denominations of $250,000 or more was approximately $171,529,000 and
$461,905, respectively.Certain bank facilities and equipment are leased under various operating leases. Total rent expense on these leases for the years ended$123,053,000 at December 31, 2014, 20132017 and 2012, was $382,719, $390,464, and $390,571,2016, respectively.
Future minimum rental commitments under non-cancelable leases are as follows:
| 2015 | | $ | 348,455 | |
| 2016 | | | 284,152 | |
| 2017 | | | 83,570 | |
| 2018 | | | 7,452 | |
| 2019 | | | 6,831 | |
| Total | | $ | 730,460 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 7. Time and Related-Party Deposits
At December 31, 2014,2017, the scheduled maturities of time deposits are as follows (in thousands):
| 2015 | | $ | 95,107 | |
| 2016 | | | 23,981 | |
| 2017 | | | 13,399 | |
| 2018 | | | 7,833 | |
| 2019 | | | 3,974 | |
| | | | | |
| Total | | $ | 144,294 | |
Deposits from related parties held by the Bank at December 31, 2014 and 2013, amounted to approximately $1,191,000 and $779,000, respectively.
|
| | | |
| 2018 | $ | 290,093 |
|
| 2019 | 84,906 |
|
| 2020 | 36,170 |
|
| 2021 | 14,353 |
|
| 2022 | 16,039 |
|
| Thereafter | 120 |
|
| Total | $ | 441,681 |
|
As of December 31, 20142017 and 2013, certificates2016, there was a fair value adjustment of $1,092,456 and $303,981, respectively, to time deposits as a result of business combinations.
At December 31, 2017 and 2016, the Company had $155,000 and $76,380, respectively, of deposit equalaccounts in overdraft status that have been reclassified to loans on the accompanying consolidated balance sheets. From time to time, the Company engages in deposit transactions with its directors, executive officers and their related interests (collectively referred to as "related parties"). Such deposits are made in the ordinary course of business and on substantially the same terms as those for comparable transactions prevailing at the time and do not present other unfavorable features. The total amount of related party deposits was $16.7 million and $15.1 millionat December 31, 2017 and 2016, respectively.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 7. Goodwill and Intangible Assets
Goodwill and intangible assets
Past business combinations have created $42,873,689 in goodwill for the Company.
Finite lived intangible assets of the Company represent a core deposit premium recorded upon the purchase of certain assets and liabilities from other financial institutions. The Company reviews the carrying value of this intangible on an annual basis and on an interim basis if certain events or greater than $100,000 amountedcircumstances indicate that an impairment loss may have been incurred. Management has determined that no impairment has occurred on this asset.
The following table presents information about our core deposit premium intangible asset at December 31 (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | 2017 | | 2016 |
| | | Gross
Carrying
Amount | | Accumulated
Amortization | | Gross
Carrying
Amount | | Accumulated
Amortization |
| Amortized intangible asset: | | |
| | |
| | |
| | |
|
| Core deposit intangible | | $ | 8,589 |
| | $ | 626 |
| | $ | 2,750 |
| | $ | 280 |
|
The following table presents information about aggregate amortization expense for 2017 and 2016 and for the succeeding fiscal years as follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Aggregate amortization expense of core deposit premium intangible | | $ | 346 |
| | $ | 305 |
|
Estimated aggregate amortization expense of the core deposit premium intangible for the year ending December 31 (in thousands):
|
| | | |
| 2018 | $ | 772 |
|
| 2019 | 772 |
|
| 2020 | 717 |
|
| 2021 | 670 |
|
| 2022 | 670 |
|
| Thereafter | 4,362 |
|
| Total | $ | 7,963 |
|
SmartFinancial, Inc. and Subsidiary
Notes to approximately $87,166,000Consolidated Financial Statements
December 31, 2017 and
$81,234,000, respectively.2016
Note 8. Income Taxes
Cornerstone files consolidated income tax returns with its subsidiary. Under the terms of a tax-sharing agreement, the subsidiary’s allocated portion of the consolidated tax liability is computed as if they were reporting income and expenses to the Internal Revenue Service as a separate entity.
Income tax expense in the consolidated statements of income for the years ended December 31,
2014, 20132017 and
2012, consists of2016, includes the
following:| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| Current tax expense | | $ | 473,257 | | | $ | 937,460 | | | $ | 960,750 | |
| Deferred tax (benefit) expense related to: | | | | | | | | | | | | |
| Allowance for loan losses | | | (110,983 | ) | | | 244,565 | | | | (255,287 | ) |
| Foreclosed assets | | | 669,694 | | | | (219,483 | ) | | | (58,692 | ) |
| Other | | | (17,963 | ) | | | 80,258 | | | | (69,171 | ) |
| | | | | | | | | | | | | |
| Income tax expense | | $ | 1,014,005 | | | $ | 1,042,800 | | | $ | 577,600 | |
Incomefollowing (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Current tax expense | | |
| | |
|
| Federal | | $ | 1,962 |
| | $ | 2,503 |
|
| State | | 428 |
| | 531 |
|
| Deferred tax expense (benefit) related to: | | |
| | |
|
| Provision for loan losses | | (355 | ) | | (320 | ) |
| Depreciation | | 374 |
| | 203 |
|
| Fair value adjustments | | 1,611 |
| | 356 |
|
| Nonaccrual interest | | (26 | ) | | (26 | ) |
| Foreclosed real estate | | 55 |
| | 117 |
|
| Core deposit intangible | | (123 | ) | | (117 | ) |
| Other | | 63 |
| | 115 |
|
| Change in tax rate | | 2,440 |
| | — |
|
| Total income tax expense | | $ | 6,429 |
| | $ | 3,362 |
|
The income tax expense is different from
the expected tax expense computed by multiplying income before income tax expense by the statutory
federal income tax rates.
These differencesThe reasons for this difference are
reconciled as
follows:| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| Expected tax at statutory rates | | $ | 901,778 | | | $ | 926,027 | | | $ | 673,085 | |
| Increase (decrease) resulting from tax effect of: | | | | | | | | | | | | |
| State income taxes, net of federal tax benefit | | | 113,783 | | | | 116,843 | | | | 84,928 | |
| New market tax credits | | | - | | | | - | | | | (180,000 | ) |
| Other | | | (1,556 | ) | | | (70 | ) | | | (413 | ) |
| | | | | | | | | | | | | |
| Income tax expense | | $ | 1,014,005 | | | $ | 1,042,800 | | | $ | 577,600 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 8. Income Taxes (continued)
follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Federal income tax expense computed at the statutory rate | | $ | 3,891 |
| | $ | 3,115 |
|
| State income taxes, net of federal tax benefit | | 491 |
| | 393 |
|
| Nondeductible acquisition expenses | | 364 |
| | — |
|
| Change in tax rate | | 2,440 |
| | — |
|
| Other | | (757 | ) | | (146 | ) |
| Total income tax expense | | $ | 6,429 |
| | $ | 3,362 |
|
The components of the net deferred tax asset
included in other assets, are as
follows:| | | 2014 | | | 2013 | |
| | | | | | | |
| Deferred tax assets: | | | | | | | | |
| Deferred compensation | | $ | 71,791 | | | $ | 87,383 | |
| Deferred loan fees | | | 41,861 | | | | 43,838 | |
| Allowance for loan losses | | | 1,337,472 | | | | 1,226,489 | |
| Foreclosed assets | | | 776,278 | | | | 1,445,972 | |
| Other | | | 40,890 | | | | - | |
| | | | | | | | | |
| | | | 2,268,292 | | | | 2,803,682 | |
| | | | | | | | | |
| Deferred tax liabilities: | | | | | | | | |
| Depreciation | | | 74,353 | | | | 76,884 | |
| Life insurance | | | 201,503 | | | | 205,443 | |
| Net unrealized gain on securities available for sale | | | 191,004 | | | | 167,349 | |
| Other | | | - | | | | 11,826 | |
| | | | | | | | | |
| | | | 466,860 | | | | 461,502 | |
| | | | | | | | | |
| Net deferred tax asset | | $ | 1,801,432 | | | $ | 2,342,180 | |
ASC Topic 740, “Income Taxes,” clarifies the accounting for uncertainty inof December 31, 2017 and 2016, were as follows (in thousands):
|
| | | | | | | | |
| | | 2017 | | 2016 |
| Deferred tax assets: | | |
| | |
|
| Allowance for loan losses | | $ | 1,561 |
| | $ | 1,932 |
|
| Fair value adjustments | | 4,829 |
| | 3,744 |
|
| Foreclosed real estate | | 301 |
| | 539 |
|
| Deferred compensation | | 849 |
| | 415 |
|
| State net operating loss carryforward | | — |
| | — |
|
| Other | | 849 |
| | 561 |
|
| Total deferred tax assets | | 8,389 |
| | 7,191 |
|
| Deferred tax liabilities: | | |
| | |
|
| Accumulated depreciation | | 1,194 |
| | 1,903 |
|
| Core deposit intangible | | 1,945 |
| | 946 |
|
| Other | | 223 |
| | 639 |
|
| Total deferred tax liabilities | | 3,362 |
| | 3,488 |
|
| Net deferred tax asset | | $ | 5,027 |
| | $ | 3,703 |
|
The income tax positions. ASC Topic 740 requires that Cornerstone recognize in its financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical meritsreturns of the position. Cornerstone recognized no interestCompany for 2016, 2015, and penalties assessed2014 are subject to examination by the federal and state taxing authorities, on any underpayment of income taxgenerally for 2014, 2013, or 2012.three years after they were filed.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 9. Federal Home Loan Bank Advances and Other Borrowings
Line of Credit:
On August 28, 2015, the Company entered into a loan agreement (the “Loan Agreement”) with CapStar Bank (the “Lender”) providing for a revolving line of credit of up to $8,000,000. The line of credit was paid in full in March 2016 after which the line matured on February 28, 2017.
On October 31, 2017, the Company entered into a loan agreement (the “Loan Agreement No. 2 ”) with CapStar Bank (the “Lender”) providing for a revolving line of credit of up to $15,000,000. The Company may borrow and reborrow under the revolving line of credit until the line of credit termination date of January 15, 2019, after which no advances under the revolving line of credit may be reborrowed. The term loan commencement date would begin on January 16, 2019. Line of Credit borrowings and the term loan will accrue interest at the Lender’s prime rate minus .25%, subject to a 3.50% floor.
Beginning 90 days after the effective date of the revolving line of credit, the Company is required to pay quarterly payments of interest. In addition, commencing on January 15, 2019, the Company must pay quarterly principal amortization payments of $262,500 for each fiscal quarter in 2019, $287,500 for each fiscal quarter in 2020, $312,500 for each fiscal quarter in 2021 and $337,500 for each fiscal quarter in 2022 until and including the maturity date. The scheduled principal amortization payments are based upon the assumption that the revolving line of credit is fully drawn, and the required payments will be reduced on a pro-rata basis relative to the amount borrowed if the revolving line of credit is not fully drawn. The loan will mature on October 15, 2022, at which time all outstanding amounts under the loan agreement no. 2 will become due and payable. In connection with entering into the Loan Agreement No. 2, the Company issued to the Lender a line of credit note dated as of October 31, 2017.
The Loan Agreement No. 2 contains typical representations, warranties and covenants for a revolving line of credit, and the loan agreement has certain financial covenants and capital ratio requirements. Pursuant to the Loan Agreement No. 2, the Bank may not permit non-performing assets to be greater than 3.25% of total assets. The Bank must not permit its Texas ratio (nonperforming assets divided by the sum of tangible equity plus the allowance for loan and lease losses) to be greater than 35.00%, and must not permit its liquidity ratio to be less than 9.00% (or less than 10.00% for two consecutive quarters). The Bank will not permit, at the end of each quarter, its returns on average assets to be less than .45% from December 31, 2017 through and including September 30, 2018 and .50% at December 31, 2018 and thereafter. The Bank will not permit the debt service coverage ratio, as of June 30 and December 31 of each fiscal year, commencing on December 31, 2017, to be less than 1.25:1.00.
The regulatory covenant states the Company will be "well capitalized," or such other successor term with a similar meaning, for all applicable state and federal regulatory purposes at all times, and will not be subject to any written agreement, order, capital directive or prompt corrective action directive by any Governmental Authority having regulatory authority over the Company, except where such order, capital directive or prompt corrective action directive does not result in, nor could reasonably be expected to result in, a Material Adverse Effect, or if required by any Governmental Authority having regulatory authority over the Borrower in order to remain "well capitalized" and in compliance with all applicable regulatory requirements, will have such higher amounts of Total Risk-based Capital and Tier 1 Risk-based Capital and/or such greater Tier 1 Leverage Ratio as specified by such Governmental Authority. Each Financial Institution Subsidiary of the Company will be "well capitalized," or such other successor term with a similar meaning, for all applicable state and federal regulatory purposes at all times, and such Financial Institution Subsidiary (i) will have a Total Risk-based Capital Ratio of 10.50% or greater, a Tier 1 Risk based Capital Ratio of 9.50% or greater, and a Tier 1 Leverage Ratio of 8.00% or greater (each as defined by applicable federal and state regulations or orders) and not be subject to any written agreement, order, capital directive or prompt corrective action directive by any Governmental Authority having regulatory authority over such Financial Institution Subsidiary, except where such order, capital directive or prompt corrective action directive does not result in, nor could reasonably be expected to result in, a Material Adverse Effect, or (ii) if required by any Governmental Authority having regulatory authority over such Financial Institution Subsidiary in order to remain "well capitalized" and in compliance with all applicable regulatory requirements, will have such higher amounts of Total Risk-based Capital and Tier 1 Risk-based Capital and/or such greater Tier 1 Leverage Ratio as specified by such Governmental Authority. Notwithstanding the foregoing, if at any time any such Governmental Authority changes the definition of "well capitalized" either by amending such ratios or otherwise, such amended definition, and any such amended or new ratios, shall automatically, and in lieu of the existing definitions and ratios set forth in this Section, be incorporated by reference into this Agreement as the minimum standard for the Company or any Financial Institution Subsidiary, as the case may be, on and as of the date that any such amendment becomes effective by applicable statute, regulation, order or otherwise.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 9. Federal Home Loan Bank Advances and Other Borrowings, Continued
Line of Credit(continued):
The interest coverage ratio covenant states the Company will not permit, as of June 30 and December 31 of each fiscal year, commencing December 31, 2017, its interest coverage ratio to be less than 2.50:1.00.
As of December 31, 2017, the Company and the Bank were in compliance with all of the loan covenants except for the return on assets. The return on assets covenant was not met due to the tax law enacted in December 2017 which caused the Company to write down the deferred tax asset to the new tax rate. Capstar has waived the covenant for December 2017 since the non-compliance was due to the tax law change and not caused by operations of the Company or Bank.
The Loan Agreement No. 2 has standard and commercially reasonable events of default, such as non-payment, failure to perform any covenant or agreement, breach of any representation or warranty, failure to pay other material indebtedness, bankruptcy, insolvency, any ERISA event, any material judgment, any material adverse effect, any change in control, any failure to be insured by the FDIC or any action by a governmental or regulatory authority, etc. The Lender has the right to accelerate the indebtedness upon an event of default.
The obligations of the Company under the Loan Agreement No. 2 are secured by a pledge of all of the capital stock of the Bank pursuant to stock pledge and security agreements. In the event of a default by the Company under the loan Agreement, the lender may terminate the commitments made under the loan agreement, declare all amounts outstanding to be payable immediately, and exercise or pursue any other remedy permitted under the loan agreement or the pledge agreements, or conferred to the lender by operation of law. As of December 31, 2017, the outstanding borrowings under the line of credit were $10,000,000 and the rate was 4.25%.
The primary source of liquidity for the Company is the payment of dividends from the Bank. As of December 31, 2016 and 2017, the Bank was under no dividend restrictions that requires regulatory approval prior to the payment of a dividend from the Bank to the Company.
FHLB borrowings:
The Bank has agreements with the Federal Home Loan Bank of Cincinnati (FHLB) that can provide advances to the Bank in an amount up to $49,387,988.$36,224,294. All of the Bank’s loans are secured by first mortgages on 1-4 family residential, multi-family properties and commercial properties and are pledged as collateral for these advances. Additionally, the Bank had pledged securities to FHLB with a carrying amount of approximately $18,705,000 as$16,252,434 at December 31, 2017 and $14,844,441 at December 31, 2016.
At December 31, 2017, there were no advances from the FHLB. At December 31, 2016, FHLB advances consisted of the following (amounts in thousands):
|
| | | |
| Long-term advance dated January 10, 2007, requiring monthly interest payments, fixed at 4.25%, with a put option exercisable in January 2008 and then quarterly thereafter, principal due in January 2017 | $ | 5,000 |
|
As of December 31,
20142017 and
$20,140,000 as of December 31,
2013.At December 31, 20142016, there was a fair value adjustment of $0 and 2013,$5,765 , respectively, to FHLB advances consistborrowings as a result of the following:
| | | 2014 | | | 2013 | |
| | | | | | | |
| Long-term advance dated August 13, 2007, requiring monthly interest payments, fixed at 4.43%, with a put option exercisable in February 2009 and then quarterly thereafter, principal due in August 2014 | | $ | - | | | $ | 5,000,000 | |
| | | | | | | | | |
| Long-term advance dated January 7, 2008, requiring monthly interest payments, fixed at 3.52%, with a put option exercisable in January 2011 and then quarterly thereafter, principal due in January 2015 | | | 5,000,000 | | | | 5,000,000 | |
| | | | | | | | | |
| Short-term advance dated July 30, 2014, requiring monthly interest payments, fixed at 0.23%, principal due in January 2015 | | | 8,000,000 | | | | - | |
| | | | | | | | | |
| Long-term advance dated February 9, 2005, requiring monthly interest payments, fixed at 3.86%, convertible on February 2010, principal due in February 2015 | | | 5,000,000 | | | | 5,000,000 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 9. Federal Home Loan Bank Advances and Other Borrowings (continued)
| | | 2014 | | | 2013 | |
| | | | | | | |
| Short-term advance dated November 20, 2014, requiring monthly interest payments, fixed at 0.36%, principal due in November 2015 | | | 8,000,000 | | | | - | |
| | | | | | | | | |
| Long-term advance dated January 20, 2006, requiring monthly interest payments, fixed at 4.18%, with a put option exercisable in January 2009 and then quarterly thereafter, principal due in January 2016 | | | 5,000,000 | | | | 5,000,000 | |
| | | | | | | | | |
| Long-term advance dated January 10, 2007, requiring monthly interest payments, fixed at 4.25%, with a put option exercisable in January 2008 and then quarterly thereafter, principal due in January 2017 | | | 5,000,000 | | | | 5,000,000 | |
| | | | | | | | | |
| | | $ | 36,000,000 | | | $ | 25,000,000 | |
a business combination.
During the fixed rate term, the advances may be prepaid subject to a prepayment penalty as defined in the agreements. On
convertible agreements, the FHLB has the right to convert the fixed rate on the above advances at the end of the initial fixed rate period and on a quarterly basis thereafter. If the conversion option is exercised, the advances will bear interest at the three-month London Interbank Offered Rate (LIBOR) adjusted quarterly at a spread of zero basis points to the LIBOR index. Subsequent to any conversion, the Bank has the option to prepay the advances, in full or in part, without penalty on the conversion date or any subsequent quarterly repricing date. On agreements with put options, the FHLB has the right, at its discretion, to terminate
only the entire advance prior to the stated maturity date. The termination option may only be exercised on the expiration date of the predetermined lockout period and on a quarterly basis thereafter.
As of December 31, 2013, Cornerstone had a borrowing outstanding of $1,740,000 with a correspondent financial institution. The loan was fully secured with cash collateral and required quarterly interest payments at an annual rate of two percent. Principal and all accrued interest not yet paid was due upon maturity in March 2014. At maturity, Cornerstone elected to renew the existing debt with the correspondent financial institution with the same terms and a new maturity date of March 2015. On June 30, 2014, Cornerstone elected to repay the loan plus accrued interest in full. As of December 31, 2014, there were no amounts outstanding under this borrowing.
The primary source of liquidity for Cornerstone is the payment of dividends from the Bank. As of December 31, 2014, the Bank was under a dividend restriction that requires regulatory approval prior to the payment of a dividend from the Bank to Cornerstone.
At December 31,
2014,2017, scheduled maturities of the Federal Home Loan Bank advances,
federal funds purchased of $33,600,000, and other borrowings are as
follows:| 2015 | | $ | 26,000,000 | |
| 2016 | | | 5,000,000 | |
| 2017 | | | 5,000,000 | |
| | | | | |
| Total | | $ | 36,000,000 | |
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 9. Federal Home Loan Bank Advances and Other Borrowings, Continued
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 10. Employee Benefit Plans
401(k)
plan:Cornerstone hasPlan:
The Company provides a 401(k) employee benefitdeferred salary reduction plan (“Plan”) under Section 401 (k) of the Internal Revenue Code covering substantially all employees that have completed at least 30 daysemployees. After one year of service the Company matches 100 percent of employee contributions up to 3 percent of compensation and met minimum age requirements. Cornerstone’s50 percent of employee contributions on the next 2 percent of compensation. The Company's contribution to the Plan was $427,975 in 2017 and $403,309 in 2016.
Stock Option Plans:
The Company has one currently active equity incentive plan administered by the Board of Directors, and three plans or programs, pursuant to which the Company has outstanding prior grants. These plans are described below:
Legacy Cornerstone Bancshares, Inc. 2002 Long Term Incentive Plan – The plan provided Cornerstone Bancshares, Inc. officers and employees incentive stock options or non-qualified stock options to purchase shares of common stock. The exercise price for incentive stock options was not less than 100 percent of the fair market value of the common stock on the date of the grant. The exercise price of the non-qualified stock options was equal to or more or less than the fair market value of the common stock on the date of the grant. This plan expired in 2012.
Legacy Cornerstone Non-Qualified Plan Options — During 2013 and 2014, Cornerstone issued non-qualified options to employees and directors. The options were originally documented in 2013 as being issued out of the Cornerstone Bancshares, Inc. 2002 Long Term Incentive Plan but that plan expired in 2012. The non-qualified options are governed by the grant document issued to the holders which incorporate the terms of the plan by reference.
Legacy SmartFinancial, Inc. 2010 Incentive Plan - This plan was assumed by the Company on August 31, 2015. This plan provides for incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance awards, dividend equivalents and stock or other stock-based awards. The maximum number of common shares that could be sold or optioned under the plan is discretionary. Cornerstone elected525,000 shares. Under the plan, the exercise price of each option could not be less than 100 percent of the fair market value of the common stock on the date of grant.
2015 Stock Incentive Plan – This plan provides for incentive stock options, nonqualified stock options, and restricted stock. The maximum number of shares of common stock that can be sold or optioned under the plan is 2,000,000 shares. The term of each option shall be no more than ten years from the date of grant. In the case of an incentive stock option granted to make a contributionparticipant who, at the time the option is granted, owns stock representing more than ten percent of the voting power of all classes of stock of the Company or any parent or subsidiary thereof, the term of the option shall be five years from the date of grant or such shorter term as may be provided in the award agreement.
The per share exercise price for the shares to be issued upon exercise of an option shall be such price as is determined by the plan administrator, subject to the following: In the case of an incentive stock option: (1) granted to an employee who, at the time of grant of such option, owns stock representing more than ten percent of the voting power of all classes of stock of the company or any parent or subsidiary thereof, the exercise price shall be no less than one hundred and ten percent of the fair market value per share on the date of grant; or (2) granted to any other employee, the per share exercise price shall be no less than one hundred percent of the fair market value per share on the date of grant. In the case of a nonstatutory stock option, the per share exercise price shall be no less than one hundred percent of the fair market value per share on the date of grant, unless otherwise determined by the Administrator.
The incentive stock options vest 30 percent on the second anniversary of the grant date, 30 percent on the third anniversary of the grant date and 40 percent on the fourth anniversary of the grant date. Director non-qualified stock options vest 50 percent on the first anniversary of the grant date and 50 percent on the second anniversary of the grant date.
Legacy Capstone Stock Option Plan - This plan was assumed by the Company on November 3, 2017 and subsequently closed. The plan provided for 2014, 2013incentive stock options and 2012.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
nonqualified stock options. Under the plan, the exercise price of each option could not be less than 100 percent of the fair market value of the common stock on the date of grant.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 10. Employee Benefit Plans,
(continued)Employee Continued
Stock
Ownership Plan:Cornerstone has a non-leveraged employee stock ownership plan (ESOP) to which Cornerstone makes 100%Option Plans (continued):
A summary of the contributionsstatus of these stock option plans is presented in the following table:
|
| | | | | | | |
| | | Number | | Weighted Average Exercisable Price |
| Outstanding at December 31, 2016 | | 717,524 |
| | $ | 10.57 |
|
| Granted | | — |
| | — |
|
| Exercised | | (506,923 | ) | | 9.64 |
|
| Forfeited | | (24,496 | ) | | 19.90 |
|
| Capstone options assumed in business combination | | 130,469 |
| | 11.76 |
|
| Outstanding at December 31, 2017 | | 316,574 |
| | $ | 11.82 |
|
|
| | | | | | | |
| | | Number | | Weighted Average Exercisable Price |
| Outstanding at December 31, 2015 | | 817,414 |
| | $ | 10.62 |
|
| Granted | | — |
| | — |
|
| Exercised | | (89,556 | ) | | 8.98 |
|
| Forfeited | | (10,334 | ) | | 28.49 |
|
| Outstanding at December 31, 2016 | | 717,524 |
| | $ | 10.57 |
|
Information pertaining to options outstanding at December 31, 2017, is as follows:
|
| | | | | | | | | | | | | | | |
| | | Options Outstanding | | Options Exercisable |
| | | | | Weighted- Average Remaining | | Weighted- Average | | | | Weighted- Average |
| Exercise | | Number | | Contractual | | Exercise | | Number | | Exercise |
| Prices | | Outstanding | | Life | | Price | | Exercisable | | Price |
| 6.60 |
| | 37,500 |
| | 4.2 years | | 6.60 |
| | 37,500 |
| | 6.60 |
|
| 6.80 |
| | 16,875 |
| | 3.2 years | | 6.80 |
| | 16,875 |
| | 6.80 |
|
| 9.48 |
| | 26,875 |
| | 5.2 years | | 9.48 |
| | 26,875 |
| | 9.48 |
|
| 9.60 |
| | 35,625 |
| | 6.2 years | | 9.60 |
| | 35,625 |
| | 9.60 |
|
| 11.67 |
| | 2,000 |
| | 3.1 years | | 11.67 |
| | 2,000 |
| | 11.67 |
|
| 11.76 |
| | 130,469 |
| | 1.9 years | | 11.76 |
| | 130,469 |
| | 11.76 |
|
| 14.40 |
| | 12,805 |
| | 1.2 years | | 14.40 |
| | 12,805 |
| | 14.40 |
|
| 15.05 |
| | 41,259 |
| | 7.8 years | | 15.05 |
| | 17,804 |
| | 15.05 |
|
| 31.96 |
| | 13,166 |
| | 0.2 years | | 31.96 |
| | 13,166 |
| | 31.96 |
|
| Outstanding, end of year | | 316,574 |
| | 3.7 years | | 11.82 |
| | 293,119 |
| | 11.56 |
|
The Company recognized stock option compensation expense of $97,966 and $132,635 for purchasing Cornerstone’sthe periods ended December 31, 2017 and 2016, respectively. Stock appreciation rights compensation expense of $21,829 was recognized for the period ended December 31, 2017. There was no stock appreciated rights compensation expense recognized for the period ended December 31, 2016. Direct stock grant expense issued to local advisory board members of $31,791 was included in salary and benefit expense for the period ended December 31, 2017. There was no direct stock grant expense for the period ended December 31, 2016. The total fair value of shares underlying the options which vested during the periods ended December 31, 2017 and 2016, was $313,977
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 10. Employee Benefit Plans, Continued
and $95,658, respectively. The income tax benefit recognized for the exercise of options for the periods ended December 31, 2017 and 2016 was $1,331,689 and $252,931 respectively.
Stock Option Plans (continued):
The intrinsic value of options exercised during the periods ended December 31, 2017 and 2016 was $5,468,780 and $660,476, respectively. The aggregate intrinsic value of total options outstanding and exercisable options at December 31, 2017 was $3,261,940 and $3,105,964, respectively. Cash received from options exercised under all share-based payment arrangements for the period ended December 31, 2017 was $4,885,646.
Information related to non-vested options for the period ended December 31, 2017, is as follows:
|
| | | | | | | |
| | | Number | | Weighted Average Grant-Date Fair Value |
| Nonvested at December 31, 2016 | | 47,970 |
| | $ | 12.31 |
|
| Granted | | — |
| | — |
|
| Vested | | (14,469 | ) | | 12.31 |
|
| Forfeited/expired | | (10,046 | ) | | 12.31 |
|
| Nonvested at December 31, 2017 | | 23,455 |
| | $ | 12.31 |
|
As of December 31, 2017, there was approximately $258,000 of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Plans. The cost is expected to be recognized over a weighted-average period of 1.0 years. There were no stock options granted during the twelve months period ended December 31, 2017 and December 31, 2016.
Restricted Stock Awards:
On August 4, 2017, the the Board of Directors of the Company made grants of 27,500 shares of restricted stock under the Company’s 2015 Stock Incentive Plan to certain executives of the Company. The restricted shares of stock, which are subject to the terms of a Restricted Stock Grant Agreement between the Company and each recipient, will fully vest on the fifth anniversary of the grant date. Prior to vesting, the recipient will be entitled to vote the shares and receive dividends, if any, declared by the Company with respect to its common stock. Compensation expense for restricted stock is based on the fair value of the restricted stock awards at the time of the grant, which is equal to the market value of the Company’s common stock on the date of grant. The value of the restricted stock grants that are expected to vest is amortized monthly into compensation expense over the five year vesting period. The restricted shares had a fair value of $24.58 per share on the date of issuance.
For the period ended December 31, 2017, compensation expense of $56,330 was recognized related to non-vested restricted stock awards. There was no compensation expenses related to these awards in 2016. As of December 31, 2017 , there was $619,620 of unrecognized compensation cost related to non-vested restricted stock awards granted under the plan.
The following table summarizes activity relating to non-vested restricted stock awards:
|
| | | |
| | Number |
| Nonvested at December 31, 2016 | | — |
|
| Granted | | 27,500 |
|
| Vested | | — |
|
| Forfeited/expired | | — |
|
| Nonvested at December 31, 2017 | | 27,500 |
|
SmartFinancial, Inc. and allocatesSubsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 11. Securities Sold Under Agreements to Repurchase
Securities sold under repurchase agreements, which are secured borrowings, generally mature within one to four days from the contributions amongtransaction date. Securities sold under repurchase agreements are reflected at the participantsamount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on regulatory guidelines. Cornerstone’s contribution is discretionary, as determined by the Compensation Committee. Employer contributions are available to all employees after 1,000 hours of service. There are certain age and years-of-service requirements before contributions can be made for the benefitfair value of the employee.underlying securities. The ESOP plan also provides forCompany monitors the fair value of the underlying securities on a three year 100% vesting requirement; therefore, employees terminating employment before their third anniversary date will forfeit their accrued benefitdaily basis.
At December 31, 2017 and 2016, the Company had securities sold under the ESOP. agreements to repurchase of $24,054,730 and $26,621,984, respectively, with commercial checking customers.
Note 12. Commitments and Contingencies
Loan Commitments:
The
forfeitureCompany is
re-allocated among the remaining ESOP participants. Contributions were madea party to
the ESOP of $10,000financial instruments with off-balance sheet risk in
2014 and $3,500 in 2012. No contributions were made in 2013.Note 11. Financial Instruments With Off-Balance-Sheet Risk
In the normal course of business to meet the Bank has outstanding commitmentsfinancing and contingent liabilities, such asdepository needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit which are not includedrisk and interest rate risk in excess of the amount recognized in the accompanying financial statements.balance sheets. The Bank’smajority of all commitments to extend credit are variable rate instruments while the standby letters of credit are primarily fixed rate instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The BankCompany uses the same credit policies in making such commitments as it does for instruments that are included inon-balance sheet instruments.
A summary of the
balance sheet. AtCompany's total contractual amount for all off-balance sheet commitments at December 31,
2014 and 2013, undisbursed loan commitments aggregated approximately $46,478,000 and $33,664,000, respectively. In addition, there were outstanding standby letters of credit totaling approximately $330,000 and $396,000, respectively.2017 is as follows:
|
| | |
| Commitments to extend credit | 292.8 | million |
| Standby letters of credit, issued by the Company | 5.5 | million |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The
Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the
BankCompany upon extension of credit, is based on
management’smanagement's credit
evaluation.evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property and equipment,
residential real estate, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the BankCompany are conditional commitments to guarantee the performance of a customer to a third party. StandbyThose letters of credit generally have fixed expiration dates or other termination clausesare primarily issued to support public and may require payment of a fee.private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilitiesloans to customers. Collateral held varies and is required in instances which the Company deems necessary.
At December 31, 2017 and 2016, the carrying amount of liabilities related to the Company's obligation to perform under standby letters of credit was insignificant. The Bank’s policy for obtaining collateral,Company has not been required to perform on any standby letters of credit, and the natureCompany has not incurred any losses on standby letters of such collateral, is essentiallycredit for the same as thatyears ended December 31, 2017 and 2016.
Contingencies:
In the normal course of business, the Company may become involved in making commitmentsvarious legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material effect on the Company's financial statements.
SmartFinancial, Inc. and Subsidiary
Notes to
extend credit.Consolidated Financial Statements
December 31, 2017 and 2016
Note 13. Regulatory Matters
Regulatory Capital Requirements:
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgements by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (Basel III rules) became effective for the Company on January 1, 2015, with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Under Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk‑based capital ratios. The capital conservation buffer is being phased in at the rate of 0.625% per year from 0.0% in 2015 to 2.50% on January 1, 2019. The capital conservation buffer for 2017 is 1.25% and for 2016 is 0.625%. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2017, the Company and Bank meet all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year end 2017 and 2016, the most recent regulatory notifications categorized both the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company's or the Bank's category. Management currently believes, based on internal capital analysis and earnings projections, the Company's and the Bank's capital position is adequate to meet current and future regulatory minimum capital requirements.
Regulatory Restrictions on Dividends:
Pursuant to Tennessee banking law, the Bank may not, without the prior consent of the Commissioner of the Tennessee Department of Financial Institutions (TDFI), pay any dividends to the Company in a calendar year in excess of the total of the Bank's retained net income for that year plus the retained net income for the preceding two years. During the year ended December 31, 2017, SmartBank paid no dividends to the Company. As of December 31, 2017, the Bank could pay approximately $11.5 million of additional dividends to the Company without prior approval of the Commissioner of the TDFI.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 13. Regulatory Matters, Continued
Regulatory Capital Levels:
Actual and required capital levels at December 31, 2017 and 2016 are presented below (dollars in thousands):
|
| | | | | | | | | | | | | | | | | | | | | |
| | | Actual | | Minimum for capital adequacy purposes | | Minimum to be well capitalized under prompt corrective action provisions (1) |
| | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| December 31, 2017 | | |
| | |
| | |
| | |
| | |
| | |
|
| SmartFinancial, Inc. | | |
| | |
| | |
| | |
| | |
| | |
|
| Total Capital (to Risk-Weighted Assets) | | $ | 163,683 |
| | 10.98 | % | | $ | 119,257 |
| | 8.00 | % | | | | |
| Tier 1 Capital (to Risk-Weighted Assets) | | 157,823 |
| | 10.59 | % | | 89,442 |
| | 6.00 | % | | | | |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | | 157,823 |
| | 10.59 | % | | 67,082 |
| | 4.50 | % | | | | |
| Tier 1 Capital (to Average Assets) | | 157,823 |
| | 10.78 | % | | 58,562 |
| | 4.00 | % | | | | |
| | | | | | | | | | | | | |
| SmartBank | | | | | | | | | | | | |
| Total Capital (to Risk-Weighted Assets) | | $ | 168,148 |
| | 11.29 | % | | $ | 119,111 |
| | 8.00 | % | | $ | 148,889 |
| | 10.00 | % |
| Tier 1 Capital (to Risk-Weighted Assets) | | 162,288 |
| | 10.90 | % | | 89,333 |
| | 6.00 | % | | 119,111 |
| | 8.00 | % |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | | 162,288 |
| | 10.90 | % | | 67,000 |
| | 4.50 | % | | 96,778 |
| | 6.50 | % |
| Tier 1 Capital (to Average Assets) | | 162,288 |
| | 11.26 | % | | 57,656 |
| | 4.00 | % | | 72,070 |
| | 5.00 | % |
(1) The prompt corrective action provisions are applicable at the Bank level only.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 13. Regulatory Matters, Continued
Regulatory Capital Levels (continued):
|
| | | | | | | | | | | | | | | | | | | | | |
| | | Actual | | Minimum for capital
adequacy purposes | | Minimum to be well
capitalized under prompt
corrective action provisions (1) |
| | | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| December 31, 2016 | | |
| | |
| | |
| | |
| | |
| | |
|
| SmartFinancial, Inc. | | |
| | |
| | |
| | |
| | |
| | |
|
| Total Capital (to Risk-Weighted Assets) | | $ | 105,756 |
| | 11.99 | % | | $ | 70,553 |
| | 8.00 | % | | | | |
| Tier 1 Capital (to Risk-Weighted Assets) | | 100,651 |
| | 11.42 | % | | 52,915 |
| | 6.00 | % | | | | |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | | 88,651 |
| | 10.05 | % | | 39,686 |
| | 4.50 | % | | | | |
| Tier 1 Capital (to Average Assets) | | 100,651 |
| | 9.81 | % | | 41,052 |
| | 4.00 | % | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| SmartBank | | |
| | |
| | |
| | |
| | |
| | |
|
| Total Capital (to Risk-Weighted Assets) | | $ | 104,705 |
| | 11.88 | % | | $ | 70,535 |
| | 8.00 | % | | $ | 88,169 |
| | 10.00 | % |
| Tier 1 Capital (to Risk-Weighted Assets) | | 99,600 |
| | 11.30 | % | | 52,901 |
| | 6.00 | % | | 70,535 |
| | 8.00 | % |
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | | 99,600 |
| | 11.30 | % | | 39,676 |
| | 4.50 | % | | 57,310 |
| | 6.50 | % |
| Tier 1 Capital (to Average Assets) | | 99,600 |
| | 9.71 | % | | 41,041 |
| | 4.00 | % | | 51,301 |
| | 5.00 | % |
(1) The prompt corrective action provisions are applicable at the Bank level only.
Note 14. Concentrations of Credit Risk
The Company originates primarily commercial, residential, and consumer loans to customers in Tennessee, Florida, Georgia and Alabama. The ability of the majority of the Company's customers to honor their contractual loan obligations is dependent on the economy in these areas.
Eighty-one percent of the Company's loan portfolio is concentrated in loans secured by real estate, of which a substantial portion is secured by real estate in the Company's primary market areas. Commercial real estate, including commercial construction loans, represented 56 percent of the loan portfolio at December 31, 2017, and 61 percent of the loan portfolio at December 31, 2016. Accordingly, the ultimate collectability of the loan portfolio and recovery of the carrying amount of foreclosed assets is susceptible to changes in real estate conditions in the Company's primary market areas. The other concentrations of credit by type of loan are set forth in Note 4.
The Bank, incurred insignificant losses on its commitments during 2014, 2013,as a matter of policy, does not generally extend credit to any single borrower or group of related borrowers in excess of 25% of statutory capital, or approximately $42,325,000.
SmartFinancial, Inc. and
2012.Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note
12.15. Fair Value
DisclosuresCornerstoneof Assets and Liabilities
Determination of Fair Value:
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with ASC Topic 820, “FairFair Value Measurements and Disclosures” topic (FASB ASC 820), the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 12. Fair Value Disclosures (continued)
ASC Topic 820
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction
(that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
ASC Topic 820 also establishes a three-tier
Fair Value Hierarchy:
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value
hierarchyin three levels, based on the markets in which
requires an entitythe assets and liabilities are traded and the reliability of the assumptions used to
maximize the use of observable inputs and minimize the use of unobservable inputs when measuringdetermine fair
value, as follows:value.
Level 1 - QuotedValuation is based on quoted prices (unadjusted) in active markets for identical assets or liabilities that Cornerstonethe reporting entity has the ability to access.access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Significant other observable Valuation is based on inputs other than quoted prices included within Level 1 prices, such asI that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities in active markets,liabilities; quoted prices in markets that are not active, andactive; or other inputs that are observable or can be corroborated by observable market data.data for substantially the full term of the asset or liability.
Level 3 - Significant Valuation is based on unobservable inputs that reflect a company’s own assumptions aboutare supported by little or no market activity and that are significant to the assumptions that market participants would use infair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing an assetmodels, discounted cash flow methodologies, or liability.similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
A financial instrument’sinstrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. There have been no changes in the methodologies used at
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31,
20142017 and
2013.2016
Note 15. Fair Value of Assets and Liabilities, Continued
Fair Value Hierarchy (continued):
The following methods and assumptions were used by
Cornerstonethe Company in estimating fair value disclosures for financial instruments:
Cash and cash equivalents:The carrying amounts ofCash Equivalents:
For cash and cash equivalents approximatedue from banks, interest-bearing deposits, and federal funds sold, the carrying amount is a reasonable estimate of fair valuesvalue based on the short-term nature of the assets. Cashassets and cash equivalents are classified asconsidered Level 1 inputs. Securities Available for Sale: Where quoted prices are available in an active market, management classifies the securities within Level 1 of the valuation hierarchy. If quoted market prices are not available, management estimates fair value hierarchy.Securities:
Fair values are estimated using pricing models and discounted cash flows that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, and credit spreads. SecuritiesExamples of such instruments, which would generally be classified as available for sale are reported at fair value utilizingwithin Level 2 inputs.
The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank. Federal Home Loan Bank stockvaluation hierarchy, including GSE obligations, corporate bonds, and other securities. Mortgage-backed securities are included in Level 2 if observable inputs are available. In certain cases where there is classified aslimited activity or less transparency around inputs to the valuation, management classifies those securities in Level 3 of3.
Restricted Investments: It is not practicable to determine the fair value hierarchy.of restricted investments due the restrictions placed on its transferability.
Loans:For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair valuesvalue for fixed-ratefixed rate loans are estimated using discounted cash flow analysis,analyses, using market interest rates for comparable loans. LoansFair values for which it is probable that payment ofnonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. These methods are considered Level 3 inputs. Deposits:The fair values disclosed for demand deposits (for example, interest and principal will not be made in accordance with the contractual termsnoninterest checking, savings, and certain types of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310, “Accounting by Creditors for Impairment of a Loan.”CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 12. Fair Value Disclosures (continued)
Deposits:
The fair value of deposits with no stated maturity, such as noninterest-bearing and interest-bearing demand deposits, savings deposits, and money market accounts, isaccounts) are, by definition, equal to the amount payable on demand at the reporting date. Thedate (that is, their carrying amounts of variable-rate, fixed-term certificates of deposit approximate their fair values at the reporting date.amounts) and are considered Level 1 inputs. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates on comparable instruments to a schedule of aggregated expected monthly maturities on time deposits. Generally,deposits, and are considered Level 3 inputs are utilized in this estimate.
Federal funds purchased and securities sold under agreements2 inputs.
Securities Sold Under Agreement to repurchase:Repurchase:
The carrying value of these liabilities approximates their estimated fair value. These liabilities are included in Level 3 of the fair value, hierarchy.and are considered Level 1 inputs.
Federal Home Loan Bank advancesAdvances and other borrowings:Other Borrowings:
The fair value of thesethe FHLB fixed rate advances isborrowings are estimated using discounted cash flows, based on discounted contractual cash flows usingthe current incremental borrowing rates for similar typetypes of borrowing arrangements. These liabilitiesarrangements, and are included inconsidered Level 32 inputs. Commitments to Extend Credit and Standby Letters of Credit: Because commitments to extend credit and standby letters of credit are made using variable rates and have short maturities, the carrying value and the fair value hierarchy.Accrued interest:
The carrying amountsare immaterial for disclosure.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 15. Fair Value of
accrued interest approximate fair value. Accrued interest is included in Level 3 of the fair value hierarchy.Commitments to extend credit, letters of credit,Assets and lines of credit:
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.
The tables below present theLiabilities, Continued
Assets Measured at Fair Value on a Recurring Basis:
Assets recorded
amount of assets and liabilities measured at fair value on a recurring
basis.| | | | | | Quoted Prices in | | | Significant | | | Significant | |
| | | | | | Active Markets | | | Other | | | Other | |
| | | Balance as of | | | for Identical | | | Observable | | | Unobservable | |
| | | December 31, | | | Assets | | | Inputs | | | Inputs | |
| | | 2014 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| Debt securities available for sale: | | | | | | | | | | | | | | | | |
| U.S. Government agencies | | $ | 563,023 | | | $ | - | | | $ | 563,023 | | | $ | - | |
| State and municipal securities | | | 7,331,085 | | | | - | | | | 7,331,085 | | | | - | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | | 16,888,271 | | | | - | | | | 16,888,271 | | | | - | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 62,410,530 | | | | - | | | | 62,410,530 | | | | - | |
| | | | | | | | | | | | | | | | | |
| Total securities available for sale | | $ | 87,192,909 | | | $ | - | | | $ | 87,192,909 | | | $ | - | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 12. Fair Value Disclosures (continued)
| | | | | | Quoted Prices in | | | Significant | | | Significant | |
| | | | | | Active Markets | | | Other | | | Other | |
| | | Balance as of | | | for Identical | | | Observable | | | Unobservable | |
| | | December 31, | | | Assets | | | Inputs | | | Inputs | |
| | | 2013 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| | | | | | | | | | | | | |
| Debt securities available for sale: | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| U.S. Government agencies | | $ | 3,481,335 | | | $ | - | | | $ | 3,481,335 | | | $ | - | |
| State and municipal securities | | | 15,249,238 | | | | - | | | | 15,249,238 | | | | - | |
| Mortgage-backed securities: | | | | | | | | | | | | | | | | |
| Residential mortgage guaranteed by GNMA or FNMA | | | 7,132,279 | | | | - | | | | 7,132,279 | | | | - | |
| Collateralized mortgage obligations issued or guaranteed by U.S. Government agencies or sponsored agencies | | | 66,345,820 | | | | - | | | | 66,345,820 | | | | - | |
| | | | | | | | | | | | | | | | | |
| Total securities available for sale | | $ | 92,208,672 | | | $ | - | | | $ | 92,208,672 | | | $ | - | |
Cornerstonebasis are as follows, in thousands
|
| | | | | | | | | | | | | | | | |
| | | Balance as of
December 31,
2017 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Other Unobservable Inputs (Level 3) |
| Securities available-for-sale: | | |
| | |
| | |
| | |
|
| U.S. Government-sponsored enterprises (GSEs) | | $ | 25,776 |
| | $ | — |
| | $ | 25,776 |
| | $ | — |
|
| Municipal securities | | 9,003 |
| | — |
| | 9,003 |
| | — |
|
| Other debt securities | | 950 |
| | — |
| | 950 |
| | — |
|
| Mortgage-backed securities | | 116,215 |
| | — |
| | 116,215 |
| | — |
|
| Total securities available-for-sale | | $ | 151,944 |
| | $ | — |
| | $ | 151,944 |
| | $ | — |
|
|
| | | | | | | | | | | | | | | | |
| | | Balance as of
December 31,
2016 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Other Unobservable Inputs (Level 3) |
| Securities available-for-sale: | | |
| | |
| | |
| | |
|
| U.S. Government-sponsored enterprises (GSEs) | | $ | 17,723 |
| | $ | — |
| | $ | 17,723 |
| | $ | — |
|
| Municipal securities | | 8,019 |
| | — |
| | 8,019 |
| | — |
|
| Mortgage-backed securities | | 103,680 |
| | — |
| | 103,680 |
| | — |
|
| Total securities available-for-sale | | $ | 129,422 |
| | $ | — |
| | $ | 129,422 |
| | $ | — |
|
The Company has no assets or liabilities whose fair values are measured on a recurring basis using Level 3 inputs. Additionally, there were no transfers between Level 1 and Level 2 in the fair value hierarchy.
Certain
Assets Measured at Fair Value on a Nonrecurring Basis:
Under certain circumstances management makes adjustments to fair value for assets and liabilities
are measured at fair value on a nonrecurring basis, which means the assets and liabilitiesalthough they are not measured at fair value on an ongoing
basis but are subject tobasis. The following tables present the financial instruments carried on the consolidated balance sheets by caption and by level in the fair value
adjustments in certain circumstances (for example, when there is evidence of impairment). The tables below present information about assets and liabilities on the balance sheet at December 31, 2014 and 2013,hierarchy, for which a nonrecurring change in fair value
was recorded.| | | | | | Quoted Prices in | | | Significant | | | Significant | |
| | | | | | Active Markets | | | Other | | | Other | |
| | | Balance as of | | | for Identical | | | Observable | | | Unobservable | |
| | | December 31, | | | Assets | | | Inputs | | | Inputs | |
| | | 2014 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| | | | | | | | | | | | | |
| Impaired loans | | $ | 2,190,522 | | | $ | - | | | $ | - | | | $ | 2,190,522 | |
| Foreclosed assets | | | 8,000,365 | | | | - | | | | - | | | | 8,000,365 | |
| | | | | | Quoted Prices in | | | Significant | | | Significant | |
| | | | | | Active Markets | | | Other | | | Other | |
| | | Balance as of | | | for Identical | | | Observable | | | Unobservable | |
| | | December 31, | | | Assets | | | Inputs | | | Inputs | |
| | | 2013 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| | | | | | | | | | | | | |
| Impaired loans | | $ | 3,331,680 | | | $ | - | | | $ | - | | | $ | 3,331,680 | |
| Foreclosed assets | | | 12,925,748 | | | | - | | | | - | | | | 12,925,748 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
has been recorded (in thousands):
|
| | | | | | | | | | | | | | | | |
| | | Balance as of
December 31,
2017 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Other Unobservable Inputs (Level 3) |
| Impaired loans | | $ | 769 |
| | $ | — |
| | $ | — |
| | $ | 769 |
|
| Foreclosed assets | | 3,254 |
| | — |
| | — |
| | 3,254 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 12.15. Fair Value Disclosuresof Assets and Liabilities, Continued
Assets Measured at Fair Value on a Nonrecurring Basis (continued)
:
|
| | | | | | | | | | | | | | | | |
| | | Balance as of
December 31,
2016 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Other Unobservable Inputs (Level 3) |
| Impaired loans | | $ | 239 |
| | $ | — |
| | $ | — |
| | $ | 239 |
|
| Foreclosed assets | | 2,386 |
| | — |
| | — |
| | 2,386 |
|
For Level 3 assets measured at fair value on a non-recurring basis as of December 31, 2017 and 2016, the significant unobservable inputs used in the fair value measurements are presented below.
|
| | | | | | | | | | | |
| | | Balance as of
December 31,
2017
(in thousands) | | Valuation Technique | | Significant Other Unobservable Input | | Weighted Average of Input |
| Impaired loans | | $ | 769 |
| | Third Party Appraisal | | Appraisal Discounts | | 35.5 | % |
| Foreclosed assets | | 3,254 |
| | Third Party Appraisal | | Appraisal Discounts | | 17.8 | % |
|
| | | | | | | | | | | |
| | | Balance as of
December 31,
2016
(in thousands) | | Valuation Technique | | Significant Other Unobservable Input | | Weighted Average of Input |
| Impaired loans | | $ | 239 |
| | Cash Flow | | Discounted Cash Flow / Appraisal Discounts | | 2.4 | % |
| Foreclosed assets | | 2,386 |
| | Appraisal | | Appraisal Discounts | | 12.2 | % |
Impaired Loans:Loans considered impaired under ASC 310-10-35, “Receivables”Receivables, are loans for which, based on current information and events, it is probable that Cornerstonethe Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent. The fair value of impaired loans were
primarily measured based on the value of the collateral securing these
loans.loans or the discounted cash flows of the loans, as applicable. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable.
CornerstoneThe Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 15. Fair Value of Assets and Liabilities, Continued
Assets Measured at Fair Value on a Nonrecurring Basis (continued):
Foreclosed assets:Foreclosed assets, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less estimated costs to sell upon transfer of the loans to foreclosed assets.other real estate. Subsequently, foreclosed assets areother real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, a loss is recognized in noninterest expense.For Level 3 assets measured at
Carrying value and estimated fair
value on a nonrecurring basis as of December 31, 2014, the significant unobservable inputs used in the fair value measurements are presented below.| | | | | | | | | Significant Other | | Weighted | |
| | | Balance as of | | | Valuation | | | Unobservable | | Average | |
| | | December 31, 2014 | | | Technique | | | Input | | of Input | |
| | | | | | | | | | | | |
| Impaired loans | | $ | 2,190,522 | | | | Appraisal | | | Appraisal discounts (%) | | | 28.9 | % |
| Foreclosed assets | | | 8,000,365 | | | | Appraisal | | | Appraisal discounts (%) | | | 14.5 | % |
value:
The carrying amount and estimated fair value of the
Cornerstone'sCompany’s financial instruments at December 31,
20142017 and
2013,December 31, 2016 are as follows (in thousands):
| | | 2014 | | | 2013 | |
| | | Carrying | | | Estimated | | | Carrying | | | Estimated | |
| | | Amount | | | Fair Value | | | Amount | | | Fair Value | |
| Assets: | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 15,528 | | | $ | 15,528 | | | $ | 24,852 | | | $ | 24,852 | |
| Securities | | | 87,218 | | | | 87,219 | | | | 92,243 | | | | 92,244 | |
| Federal Home Loan Bank stock | | | 2,323 | | | | 2,323 | | | | 2,323 | | | | 2,323 | |
| Loans, net | | | 291,869 | | | | 292,490 | | | | 286,237 | | | | 287,411 | |
| Accrued interest receivable | | | 1,143 | | | | 1,143 | | | | 978 | | | | 978 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 12.
|
| | | | | | | | | | | | | | | | |
| | | December 31, 2017 | | December 31, 2016 |
| | | Carrying Amount | | Estimated Fair Value | | Carrying Amount | | Estimated Fair Value |
| Assets: | | |
| | |
| | |
| | |
|
| Cash and cash equivalents | | $ | 113,027 |
| | $ | 113,027 |
| | $ | 68,748 |
| | $ | 68,748 |
|
| Securities available for sale | | 151,944 |
| | 151,944 |
| | 129,422 |
| | 129,422 |
|
| Restricted investments | | 6,431 |
| | N/A |
| | 5,628 |
| | N/A |
|
| Loans, net | | 1,317,398 |
| | 1,292,303 |
| | 808,271 |
| | 803,057 |
|
| | | | | | | | | |
| Liabilities: | | |
| | |
| | |
| | |
|
| Noninterest-bearing demand deposits | | 220,520 |
| | 220,520 |
| | 153,483 |
| | 153,483 |
|
| Interest-bearing demand deposits | | 231,644 |
| | 231,644 |
| | 162,702 |
| | 162,702 |
|
| Savings deposits | | 543,645 |
| | 543,645 |
| | 274,605 |
| | 274,605 |
|
| Time deposits | | 442,774 |
| | 443,547 |
| | 316,275 |
| | 316,734 |
|
| Securities sold under agreements to repurchase | | 24,055 |
| | 24,055 |
| | 26,622 |
| | 26,622 |
|
| Federal Home Loan Bank advances and other borrowings | | 43,600 |
| | 43,600 |
| | 18,505 |
| | 18,505 |
|
Limitations
Fair
Value Disclosures (continued)| | | 2014 | | | 2013 | |
| | | Carrying | | | Estimated | | | Carrying | | | Estimated | |
| | | Amount | | | Fair Value | | | Amount | | | Fair Value | |
| | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | | |
| Noninterest-bearing demand deposits | | $ | 57,035 | | | $ | 57,035 | | | $ | 75,207 | | | $ | 75,207 | |
| Interest-bearing demand deposits | | | 26,464 | | | | 26,464 | | | | 24,564 | | | | 24,564 | |
| Savings deposits and money market accounts | | | 80,861 | | | | 80,861 | | | | 86,330 | | | | 86,330 | |
| Time deposits | | | 144,294 | | | | 145,907 | | | | 155,314 | | | | 156,698 | |
| Federal funds purchased and securities sold under agreements to repurchase | | | 29,410 | | | | 29,410 | | | | 22,974 | | | | 22,974 | |
| Federal Home Loan Bank advances and other borrowings | | | 36,000 | | | | 36,321 | | | | 26,740 | | | | 27,449 | |
| Accrued interest payable | | | 72 | | | | 72 | | | | 82 | | | | 82 | |
| | | | | | | | | | | | | | | | | |
| Unrecognized financial instruments | | | | | | | | | | | | | | | | |
| (net of contract amount): | | | | | | | | | | | | | | | | |
| Commitments to extend credit | | | - | | | | - | | | | - | | | | - | |
| Letters of credit | | | - | | | | - | | | | - | | | | - | |
| Lines of credit | | | - | | | | - | | | | - | | | | - | |
Note 13. Contingencies
The Bank is involvedvalue estimates are made at a specific point in certain claims arisingtime, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from normal business activities. Management believes thatoffering for sale at one time the impactCompany’s entire holdings of those claims are without merit and thata particular financial instrument. Because no market exists for a significant portion of the ultimate liability, if any, resulting from them will not materially affect the Bank’sCompany’s financial condition or Cornerstone’s consolidated financial position, results of operations, or cash flows.
Note 14. Stock Option Plans
Cornerstone has stock option plans which are more fully described below. For the years ended December 31, 2014, 2013 and 2012, Cornerstone recognized $160,500, $129,056 and $74,048, respectively, in compensation expense for all stock options.
For the years ended December 31, 2014, 2013, and 2012, theinstruments, fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
| | | Years Ended December 31, | |
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| Dividend yield | | | 0.0 | % | | | 0.0 | % | | | 0.0 | % |
| Expected life | | | 8.5 years | | | | 7.0 years | | | | 7.0 years | |
| Expected volatility | | | 45.73 | % | | | 47.60 | % | | | 44.62 | % |
| Risk-free interest rate | | | 2.32 | % | | | 1.23 | % | | | 1.44 | % |
The expected volatility is based upon historical volatility. The risk-free interest rates for periods within the contractual life of the awardsestimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 16. Small Business Lending Fund
In connection with the Company's merger with Legacy SmartFinancial, Inc. in 2015, the Company assumed Legacy SmartFinancial's obligations under a stock purchase agreement with the U.S.
Treasury yield curve in effect at the timeDepartment of the
grant. The expected life is based on historical exercise experience. The dividend yield assumption is based on Cornerstone’s historyTreasury and
expectation of dividend payouts.CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 14. Stock Option Plans (continued)
Board of Directors Plan:
Cornerstone has a stock option plan under which members of the Board of Directors, at the formation of the Bank, were granted options to purchase a total of up to 600,000issued 12,000 shares of common stock. Only non-qualifiedpreferred stock options could be grantedat $1,000 per share under the Plan. In addition, members of the Board of Directors could be issued options under the Cornerstone 2002 Long-Term Incentive Plan to purchase up to 1,200,000 shares of Cornerstone stock. The options available for issuance to Board members under the 2002 Long-Term Incentive Plan are shared with officers and employees of Cornerstone. The exercise price of each option equals the market price of Cornerstone’s stock on the date of grant and the option’s maximum term is ten years,Small Business Lending Fund Program (the "SBLF Program").The Company paid cash dividends at which point they expire. Vesting for options granted during 2014, 2013, and 2012 are 50% on each of the first and second anniversary of the grant date with full vesting occurring at the second anniversary date. At December 31, 2014, the total remaining compensation cost to be recognized on non-vested options is approximately $130,000. An analysis of this stock option plan is presented in the following table:
| | | Years Ended December 31, | |
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | Average | | | Aggregate | | | | | | Average | | | | | | Average | |
| | | | | | Exercise | | | Intrinsic | | | | | | Exercise | | | | | | Exercise | |
| | | Shares | | | Price | | | Value(1) | | | Shares | | | Price | | | Shares | | | Price | |
| | | | | | | | | | | | | | | | | | | | | | |
| Outstanding at beginning of year | | | 190,250 | | | $ | 3.07 | | | | 145,250 | | | $ | 3.30 | | | | 55,250 | | | $ | 5.98 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Granted | | | 80,000 | | | | 2.40 | | | | 45,000 | | | $ | 2.37 | | | | 90,000 | | | $ | 1.65 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercised | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Forfeited | | | 16,000 | | | | 5.44 | | | | - | | | | - | | | | - | | | | - | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Outstanding at end of year | | | 254,250 | | | $ | 2.71 | | | $ | 264,500 | | | | 190,250 | | | $ | 3.07 | | | | 145,250 | | | $ | 3.30 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Options exercisable at year-end | | | 151,750 | | | $ | 2.93 | | | $ | 170,550 | | | | 100,250 | | | $ | 4.03 | | | | 55,250 | | | $ | 5.98 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average fair value of options granted during the year | | $ | 1.30 | | | | | | | | | | | $ | 1.17 | | | | | | | $ | 0.78 | | | | | |
| (1) | The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. This amount changes based on changes in the market value of Cornerstone's stock. |
Information pertaining to options outstanding at December 31, 2014, is as follows:
| | | | | | | Options Outstanding | | Options Exercisable | |
| | | | | | | Weighted | | Weighted | | | | | | Weighted | |
| | | | | | | Average | | Average | | | | | | Average | |
| Exercise | | | Number | | | Remaining | | Exercise | | | Number | | | Exercise | |
| Prices | | | Outstanding | | | Life | | Price | | | Exercisable | | | Price | |
| | | | | | | | | | | | | | | | |
| $ | 9.23 | | | | 8,000 | | | 0.2 Years | | $ | 9.23 | | | | 8,000 | | | $ | 9.23 | |
| | 7.99 | | | | 12,800 | | | 3.2 Years | | | 7.99 | | | | 12,800 | | | | 7.99 | |
| | 3.60 | | | | 18,450 | | | 4.2 Years | | | 3.60 | | | | 18,450 | | | | 3.60 | |
| | 2.40 | | | | 80,000 | | | 9.2 Years | | | 2.40 | | | | - | | | | 2.40 | |
| | 2.37 | | | | 45,000 | | | 8.2 Years | | | 2.37 | | | | 22,500 | | | | 2.37 | |
| | 1.65 | | | | 90,000 | | | 7.2 Years | | | 1.65 | | | | 90,000 | | | | 1.65 | |
| | | | | | | | | | | | | | | | | | | | | |
| Outstanding at end of year | | | | 254,250 | | | 7.4 Years | | $ | 2.71 | | | | 151,750 | | | $ | 2.93 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
Note 14. Stock Option Plans (continued)
Board of Directors Plan: (continued)
Information pertaining to non-vested optionsa one percent rate or $120,000 for the year ended December 31, 2014, is as follows:
| | | | | | Weighted Average | |
| | | Number | | | Grant Date | |
| | | of Shares | | | Fair Value | |
| | | | | | | |
| Non-vested options, December 31, 2013 | | | 90,000 | | | $ | 0.98 | |
| Granted | | | 80,000 | | | | 1.30 | |
| Vested | | | (67,500 | ) | | | 0.91 | |
| Forfeited | | | - | | | | - | |
| | | | | | | | | |
| Non-vested options, December 31, 2014 | | | 102,500 | | | $ | 1.27 | |
The total fair value of shares that vested during 2014 and 2013 was approximately $179,000 and $102,600, respectively.
Officer and Employee Plans:
Cornerstone has two stock option plans, the 1996 Cornerstone Statutory and Non-statutory Option Plan and the Cornerstone 2002 Long-Term Incentive Plan, under which officers and employees could be granted incentive stock options or non-qualified stock options to purchase a total of up to 220,000 and 1,200,000 shares, respectively, of Cornerstone’s common stock. The option price for incentive stock options shall be not less than 100 percent of the fair market value of the common stock2015 on the datepreferred shares. On February 4, 2016 the dividend rate for the preferred shares increased to nine percent and as a result the Company incurred preferred stock dividends of the grant. The non-qualified stock options may be equal to or more or less than the fair market value of the common stock on the date of the grant. The stock options vest at 30 percent on the second and third anniversaries of the grant date and 40 percent on the fourth anniversary of the grant date. These options expire ten years from the grant date. At December 31, 2014, the total remaining compensation cost to be recognized on non-vested options is approximately $658,000. An analysis of the activity for each of the years ended December 31, 2014, 2013 and 2012, for this stock option plan follows:
| | | Years Ended December 31, | |
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | Average | | | Aggregate | | | | | | Average | | | | | | Average | |
| | | | | | Exercise | | | Intrinsic | | | | | | Exercise | | | | | | Exercise | |
| | | Shares | | | Price | | | Value(1) | | | Shares | | | Price | | | Shares | | | Price | |
| | | | | | | | | | | | | | | | | | | | | | |
| Outstanding at beginning of year | | | 810,825 | | | $ | 3.51 | | | | 670,300 | | | $ | 3.86 | | | | 572,600 | | | $ | 4.63 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Granted | | | 207,000 | | | $ | 2.40 | | | | 203,000 | | | $ | 2.37 | | | | 202,000 | | | $ | 1.65 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercised | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Forfeited | | | (77,990 | ) | | $ | 4.89 | | | | (62,475 | ) | | $ | 3.40 | | | | (104,300 | ) | | $ | 3.89 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Outstanding at end of year | | | 939,835 | | | $ | 3.15 | | | $ | 953,940 | | | | 810,825 | | | $ | 3.51 | | | | 670,300 | | | $ | 3.86 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Options exercisable at year-end | | | 345,735 | | | $ | 4.88 | | | $ | 264,144 | | | | 307,025 | | | $ | 6.10 | | | | 274,680 | | | $ | 6.82 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average fair value of options granted during the year | | $ | 1.30 | | | | | | | | | | | $ | 1.17 | | | | | | | $ | 0.78 | | | | | |
| (1) | The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. This amount changes based on changes in the market value of Cornerstone's stock. |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 14. | Stock Option Plans (continued) |
Officer and Employee Plans: (continued)
Information pertaining to options outstanding at December 31, 2014, is as follows:
| | | | Options Outstanding | | | Options Exercisable | |
| | | | | | | Weighted | | Weighted | | | | | | Weighted | |
| | | | | | | Average | | Average | | | | | | Average | |
| Exercise | | | Number | | | Remaining | | Exercise | | | Number | | | Exercise | |
| Prices | | | Outstanding | | | Life | | Price | | | Exercisable | | | Price | |
| | | | | | | | | | | | | | | | | | | | | |
| $ | 9.23 | | | | 39,910 | | | 0.2 Years | | $ | 9.23 | | | | 39,910 | | | $ | 9.23 | |
| | 13.25 | | | | 16,800 | | | 1.2 Years | | | 13.25 | | | | 16,800 | | | | 13.25 | |
| | 15.25 | | | | 11,825 | | | 2.2 Years | | | 15.25 | | | | 11,825 | | | | 15.25 | |
| | 15.20 | | | | 2,750 | | | 2.3 Years | | | 15.20 | | | | 2,750 | | | | 15.20 | |
| | 7.99 | | | | 45,000 | | | 3.2 Years | | | 7.99 | | | | 45,000 | | | | 7.99 | |
| | 3.60 | | | | 69,550 | | | 4.2 Years | | | 3.60 | | | | 69,550 | | | | 3.60 | |
| | 1.70 | | | | 167,000 | | | 6.2 Years | | | 1.70 | | | | 100,200 | | | | 1.70 | |
| | 1.55 | �� | | | 3,000 | | | 6.3 Years | | | 1.55 | | | | 1,800 | | | | 1.55 | |
| | 1.10 | | | | 5,000 | | | 6.6 Years | | | 1.10 | | | | 3,000 | | | | 1.10 | |
| | 1.02 | | | | 5,000 | | | 6.8 Years | | | 1.02 | | | | 3,000 | | | | 1.02 | |
| | 1.65 | | | | 173,000 | | | 7.2 Years | | | 1.65 | | | | 51,900 | | | | 1.65 | |
| | 2.37 | | | | 190,000 | | | 8.2 Years | | | 2.37 | | | | - | | | | - | |
| | 2.40 | | | | 206,000 | | | 9.2 Years | | | 2.40 | | | | - | | | | - | |
| | 2.50 | | | | 5,000 | | | 8.6 Years | | | 2.50 | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Outstanding at end of year | | | | 939,835 | | | 6.8 Years | | $ | 3.15 | | | | 345,735 | | | $ | 4.88 | |
Information pertaining to non-vested options$1,022,000 for the year ended December 31, 2014, is as follows:
| | | | | | Weighted Average | |
| | | Number | | | Grant Date | |
| | | of Shares | | | Fair Value | |
| | | | | | | |
| Non-vested options, December 31, 2013 | | | 503,800 | | | $ | 0.98 | |
| Granted | | | 207,000 | | | | 1.30 | |
| Vested | | | (107,400 | ) | | | 0.87 | |
| Forfeited | | | (9,300 | ) | | | 1.01 | |
| | | | | | | | | |
| Non-vested options, December 31, 2014 | | | 594,100 | | | $ | 1.11 | |
2016 .
On January 30, 2017, the Company completed a public offering of 2,010,084 million shares of its common stock, par value $1.00 per share, with the gross proceeds to the Company of approximately $33.2 million. On March 6, 2017, the Company used proceeds from the offering to redeem the $12 million of preferred stock and pay the $195 thousand accrued dividend.
Note 17. Concentration in Deposits
The
total fair valueCompany had a concentration in its deposits of
shares that vested during 2014, 2013 and 2012, wastwo customers totaling approximately
$281,000, $190,000, and $73,000, respectively. | Note 15. | Liquidity and Capital Resources |
Cornerstone’s primary source of funds with which to pay its future obligations is the receipt of dividends from its subsidiary Bank. Banking regulations provide that the Bank must maintain capital sufficient to enable it to operate as a viable institution and, as a result, has limited the amount of dividends the Bank may pay without prior approval.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 16. | Minimum Regulatory Capital Requirements |
Cornerstone (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the Tennessee Department of Financial Institutions and the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Cornerstone’s and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Cornerstone and the Bank must meet specific capital guidelines that involve quantitative measures of Cornerstone’s and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Cornerstone’s and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require Cornerstone and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of$60,153,000 at December 31, 20142016 and 2013, that Cornerstone and the Bank meet all capital adequacy requirements to which they are subject.
During 2013, the Federal Reserve released final United States Basel III regulatory capital rules implementing the global regulatory capital reformsthree customers totaling approximately $116,121,000 concentration of Basel III and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The FDIC and OCC also approved the final rule during 2013. The rule applies to all banking organizations that are currently subject to regulatory capital requirements, as well as certain savings and loan holding companies. The rule strengthens the definition of regulatory capital, increases risk-based capital requirements, and makes selected changes to the calculation of risk-weighted assets. The rule becomes effective January 1, 2015, for Cornerstone and most banking organizations subject to a transition period for several aspects of the rule including the new minimum capital ratio requirements, the capital conservation buffer, and the regulatory capital adjustments and deductions.
As ofdeposits at December 31, 2014, the most recent notification from the Federal Deposit Insurance Corporation (FDIC) categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total-risk based, Tier I risk-based, and Tier I leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Bank's prompt corrective action category. Cornerstone’s and the Bank's capital amounts and ratios are also presented in the table. Dollar amounts are presented in thousands.
| | | | | | | | | | | | To be Well
Capitalized Under | |
| | | | | | | | | For Capital | | | Prompt Corrective | |
| | | Actual | | | Adequacy Purposes | | | Action Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| As of December 31, 2014: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 36,107 | | | | 11.6 | % | | $ | 24,817 | | | | 8.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 41,670 | | | | 13.5 | % | | | 24,784 | | | | 8.0 | % | | $ | 30,981 | | | | 10.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier I capital to risk-weighted assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 32,612 | | | | 10.5 | % | | | 12,408 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 38,175 | | | | 12.3 | % | | | 12,392 | | | | 4.0 | % | | | 18,588 | | | | 6.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier I capital to average assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 32,612 | | | | 8.0 | % | | | 16,304 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 38,175 | | | | 9.4 | % | | | 16,287 | | | | 4.0 | % | | | 20,359 | | | | 5.0 | % |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 16. | Minimum Regulatory Capital Requirements (continued) |
| | | | | | | | | | | | | | | To be Well | |
| | | | | | | | | | | | | | | Capitalized Under | |
| | | | | | | | | For Capital | | | Prompt Corrective | |
| | | Actual | | | Adequacy Purposes | | | Action Provisions | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| | | | | | | | | | | | | | | | | | | |
| As of December 31, 2013: | | | | | | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 34,820 | | | | 11.3 | % | | $ | 24,634 | | | | 8.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 39,342 | | | | 12.8 | % | | | 24,552 | | | | 8.0 | % | | $ | 30,691 | | | | 10.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier I capital to risk-weighted assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 31,617 | | | | 10.3 | % | | | 12,317 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 36,139 | | | | 11.8 | % | | | 12,276 | | | | 4.0 | % | | | 18,414 | | | | 6.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Tier I capital to average assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 31,617 | | | | 7.5 | % | | | 16,885 | | | | 4.0 | % | | | N/A | | | | N/A | |
| Cornerstone Community Bank | | | 36,139 | | | | 8.6 | % | | | 16,870 | | | | 4.0 | % | | | 21,087 | | | | 5.0 | % |
| Note 17. | Earnings per Common Share |
2017.
Note 18. Earnings Per Share
Basic earnings per share
representsis computed by dividing net income available to common stockholders
divided by the
weighted-averageweighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding
during the period. Diluted earnings perand dilutive common share
reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.Potential common shares that may be issued by Cornerstone relate to outstanding stock options, determinedequivalents using the treasury stock method.
Earnings per Dilutive common share have been computed based on the following:
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| Net income | | $ | 1,638,282 | | | $ | 1,680,809 | | | $ | 1,402,063 | |
| Less: Preferred stock dividend requirements | | | 1,500,000 | | | | 1,500,000 | | | | 1,229,780 | |
| Less: Preferred stock accretion | | | 71,382 | | | | 71,381 | | | | 63,924 | |
| | | | | | | | | | | | | |
| Net income applicable to common stock | | $ | 66,900 | | | $ | 109,428 | | | $ | 108,359 | |
| | | | | | | | | | | | | |
| Average number of common shares outstanding | | | 6,614,414 | | | | 6,547,074 | | | | 6,500,396 | |
| | | | | | | | | | | | | |
| Effect of dilutive stock options | | | 222,373 | | | | 115,213 | | | | 50,136 | |
| | | | | | | | | | | | | |
| Average number of common shares outstanding used to calculate diluted earnings per common share | | | 6,836,787 | | | | 6,662,287 | | | | 6,550,532 | |
The effectsequivalents include common shares issuable upon exercise of outstanding antidilutive stock options are excludedand restricted stock. The effect from the computation of diluted earningsstock options on incremental shares from the assumed conversions for net income per common share.share-basic and net income per share-diluted are presented below. There were 217,435, 358,550,antidilutive shares of 13,166 and 358,550, antidilutive stock options for 2014, 2013 and2012, respectively.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 18. | Recent Accounting Pronouncements |
In January 2014, the FASB issued Accounting Standards Update (ASU) 2014-04, "Receivables-Troubled Debt Restructurings by Creditors: Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." The amendments in this ASU reduce diversity in practice by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this ASU using either a modified retrospective transition method or a prospective transition method. Cornerstone does not believe the adoption of this ASU will have a significant impact on the consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." This update is a joint project with the International Accounting Standards Board initiated to clarify the principles for recognizing revenue and to develop a common revenue standard that is meant to remove inconsistencies and weaknesses in revenue requirements, provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices, provide more useful information to users of financial statements and simplify the preparation of financial statements. The guidance in this update supersedes the revenue recognition requirements in ASC Topic 605, "Revenue Recognition" and most industry-specific guidance throughout the Industry Topics of Codification. This update is effective for annual and interim periods beginning after December 15, 2016. Cornerstone does not believe this update will have a significant impact on the consolidated financial statements.
In June 2014, the FASB issued ASU 2014-11, "Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures." The amendments in this ASU require two accounting changes. First, the amendments in this ASU change the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting17,649 for the repurchase agreement. This ASU also includes new disclosure requirements. The accounting changes in this ASU are effective for public business entities for the first interim or annual period beginning afteryears ended December 15, 2014. An entity is required to present changes in accounting for transactions outstanding on the effective date as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Earlier application for a public business entity is prohibited. Cornerstone is currently reviewing this ASU to determine if it will have an impact on the consolidated financial statements.
In August 2014, the FASB issued ASU 2014-14, "Receivables—Troubled Debt Restructurings by Creditors: Classification of Certain Government—Guaranteed Mortgage Loans upon Foreclosure." The amendments in this ASU require that a mortgage loan be derecognized31, 2017 and that a separate other receivable be recognized upon foreclosure if (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of this guidance is not expected to have a significant impact on the Cornerstone’s consolidated financial statements.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 19. | Equity Investment |
During 2006, Cornerstone invested $3,000,000 for a 25% share of the Appalachian Fund for Growth II Partnership (AFG), which was managed by the Southeast Local Development Corporation (General Partner). AFG was targeting high job creation and retention businesses and businesses providing important community services. The funds were deployed to help: 1) attract new businesses to under-served service areas by offering creative financing; 2) supply creative financing for businesses to rehabilitate existing distressed properties to facilitate community development; and 3) leverage other private investment into its targeted communities. In return for its investment in AFG, Cornerstone and other investors received new market tax credits of approximately $180,000 during 2012. No new market tax credit was received in 2013 or 2014. During 2014, Cornerstone received approximately $2,393,600 in equity distributions to facilitate the winding down of the fund. AFG was dissolved during 2014.
AFG met the criteria of a VIE outlined in ASC Topic 810, “Consolidation”. AFG was not consolidated by Cornerstone, as Cornerstone was not the primary beneficiary.
| Note 20. | Agreement and Plan of Merger |
On December 5, 2014, Cornerstone, the Bank, 2016, respectively.
|
| | | | | | | | |
| (Dollars in thousands, except share amounts) | | 2017 | | 2016 |
| Basic earnings per share computation: | | |
| | |
|
| Net income available to common stockholders | | $ | 4,820 |
| | $ | 4,777 |
|
| Average common shares outstanding – basic | | 8,639,212 |
| | 5,838,574 |
|
| Basic earnings per share | | $ | 0.56 |
| | $ | 0.82 |
|
| Diluted earnings per share computation: | | |
| | |
|
| Net income available to common stockholders | | $ | 4,820 |
| | $ | 4,777 |
|
| Average common shares outstanding – basic | | 8,639,212 |
| | 5,838,574 |
|
| Incremental shares from assumed conversions: | | |
| | |
|
| Stock options | | 154,315 |
| | 280,369 |
|
| Average common shares outstanding - diluted | | 8,793,527 |
| | 6,118,943 |
|
| Diluted earnings per share | | $ | 0.55 |
| | $ | 0.78 |
|
SmartFinancial, Inc. (SmartFinancial), and SmartFinancial’s wholly owned subsidiary, SmartBank, entered into an AgreementSubsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and
Plan of Merger (the Merger Agreement), pursuant to which SmartFinancial will be merged with and into Cornerstone (the Merger), and the entity surviving the Merger (the Surviving Company) will be renamed SmartFinancial, Inc. The banks will initially remain separate and operate under their respective names in their respective markets.Under the terms of the Merger Agreement, each outstanding share of SmartFinancial common stock will be converted into 4.20 shares of Cornerstone common stock, subject to adjustment based on an anticipated reverse stock split of Cornerstone’s common stock. Additionally, each outstanding share of SmartFinancial preferred stock will be converted into a share of Cornerstone preferred stock with similar rights and preferences. Current holders of Cornerstone’s preferred stock will be asked to vote on an amendment to Cornerstone’s charter to allow Cornerstone to redeem its outstanding preferred stock prior to the completion of the Merger.
Based on consideration of all the relevant facts and circumstances of the Merger, for accounting purposes, SmartFinancial will be considered to have acquired Cornerstone. As a result, following the completion of the Merger, the historical financial statements of the Surviving Company will be the historical financial statements of SmartFinancial. The Merger will be effected by the issuance of shares of Cornerstone stock to SmartFinancial shareholders. The assets and liabilities of Cornerstone as of the effective date of the Merger will be recorded at their estimated fair values and added to those of SmartFinancial. Any excess of purchase price over the net estimated fair values of the acquired assets and liabilities of Cornerstone will be allocated to all identifiable intangible assets. Any remaining excess will then be allocated to goodwill. The goodwill resulting from the Merger will not be amortized to expense, but instead will be reviewed for impairment at least annually. To the extent goodwill were impaired, its carrying value would be written down to its implied fair value and a charge would be made to earnings. Intangibles with definite useful lives will be amortized to expense over their estimated useful lives.
The Merger Agreement contains customary representations, warranties and covenants by all parties. Conditions to each party’s obligation to consummate the Merger include the following, as well as other customary conditions: (1) approval of the Merger Agreement by shareholders of Cornerstone and SmartFinancial, (2) approval of the Merger by regulatory authorities, (3) action by no more than 7% of the outstanding shares of SmartFinancial common stock and Cornerstone common stock taken together that would establish the right to dissent from the Merger under Tennessee law, (4) redemption of outstanding shares of Cornerstone’s preferred stock and (5) the completion by Cornerstone of financing transactions that may be necessary to obtain regulatory approval of the Merger. Conditions to SmartFinancial’s obligation to consummate the Merger include the following: (1) evidence that Cornerstone has amended its charter to allow the redemption of its outstanding preferred stock, the conversion of SmartFinancial’s outstanding preferred stock and the reverse stock split, (2) approval by Cornerstone shareholders of an amended and restated charter, (3) approval by Cornerstone shareholders of amended and restated bylaws and (4) adoption by Cornerstone board of directors and approval by Cornerstone shareholders of an incentive compensation plan.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 20. | Agreement and Plan of Merger (continued) |
The Merger Agreement provides certain termination rights for both Cornerstone and SmartFinancial and further provides that, upon termination of the Merger Agreement under certain circumstances, Cornerstone or SmartFinancial, as applicable, will be obligated to pay the other party a termination fee of $1,200,000 plus expenses.
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
2016
| Note 21. | Condensed Parent Information |
| BALANCE SHEETS | | | | | | |
| | | December 31, | | | December 31, | |
| | | 2014 | | | 2013 | |
| | | | | | | |
| ASSETS | | | | | | | | |
| Cash | | $ | 637,635 | | | $ | 3,376,410 | |
| Investment in subsidiary | | | 39,733,504 | | | | 38,096,440 | |
| Other assets | | | 334,115 | | | | 435,972 | |
| | | | | | | | | |
| Total assets | | $ | 40,705,254 | | | $ | 41,908,822 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| Other liabilities | | $ | 43,149 | | | $ | 35,094 | |
| Other borrowings | | | - | | | | 1,740,000 | |
| | | | | | | | | |
| Total liabilities | | | 43,149 | | | | 1,775,094 | |
| | | | | | | | | |
| Stockholders’ equity | | | 40,662,105 | | | | 40,133,728 | |
| | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 40,705,254 | | | $ | 41,908,822 | |
| STATEMENTS OF INCOME | | | | | | | | | |
| | | | | | | | | | |
| | | Years Ended December 31, | |
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| INCOME | | | | | | | | | | | | |
| Dividends | | $ | - | | | $ | - | | | $ | - | |
| Interest income | | | 665 | | | | 956 | | | | - | |
| | | | | | | | | | | | | |
| | | | 665 | | | | 956 | | | | - | |
| | | | | | | | | | | | | |
| EXPENSES | | | | | | | | | | | | |
| Interest expense | | | 19,802 | | | | 49,836 | | | | 170,872 | |
| Other operating expenses | | | 476,894 | | | | 286,105 | | | | 436,283 | |
| | | | | | | | | | | | | |
| Loss before equity in undistributed earnings | | | (496,031 | ) | | | (334,985 | ) | | | (607,155 | ) |
| | | | | | | | | | | | | |
| Equity in undistributed earnings of subsidiary | | | 1,942,913 | | | | 1,887,294 | | | | 1,775,918 | |
| | | | | | | | | | | | | |
| Income tax benefit | | | 191,400 | | | | 128,500 | | | | 233,300 | |
| | | | | | | | | | | | | |
| Net income | | | 1,638,282 | | | | 1,680,809 | | | | 1,402,063 | |
| | | | | | | | | | | | | |
| Preferred stock dividend requirements | | | 1,500,000 | | | | 1,500,000 | | | | 1,229,780 | |
| Accretion on preferred stock discount | | | 71,382 | | | | 71,381 | | | | 63,924 | |
| | | | | | | | | | | | | |
| Net income available to common shareholders | | $ | 66,900 | | | $ | 109,428 | | | $ | 108,359 | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 21. | Condensed Parent Information (continued) |
| | | 2014 | | | 2013 | | | 2012 | |
| | | | | | | | | | |
| STATEMENTS OF CASH FLOWS | | | | | | | | | |
| | | | | | | | | | |
| CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | | | | | |
| Net income | | $ | 1,638,282 | | | $ | 1,680,809 | | | $ | 1,402,063 | |
| Adjustments to reconcile net income to net cash | | | | | | | | | | | | |
| used in operating activities: | | | | | | | | | | | | |
| Stock compensation expense | | | - | | | | - | | | | 74,048 | |
| Equity in undistributed income of subsidiary | | | (1,152,913 | ) | | | (1,887,294 | ) | | | (1,775,918 | ) |
| Other | | | 15,856 | | | | 110,651 | | | | 1,719,222 | |
| | | | | | | | | | | | | |
| Net cash used in operating activities | | | 501,225 | | | | (95,834 | ) | | | 1,419,415 | |
| | | | | | | | | | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | | | | | | | | | | | |
| Net repayments under other borrowings | | | (1,740,000 | ) | | | (435,000 | ) | | | (870,000 | ) |
| Issuance of preferred stock | | | - | | | | - | | | | 4,858,078 | |
| Payment of preferred dividends | | | (1,500,000 | ) | | | (1,433,893 | ) | | | (985,917 | ) |
| | | | | | | | | | | | | |
| Net cash (used in) provided by financing activities | | | (3,240,000 | ) | | | (1,868,893 | ) | | | 3,002,161 | |
| | | | | | | | | | | | | |
| NET (DECREASE) INCREASE IN CASH AND CASH | | | | | | | | | | | | |
| EQUIVALENTS | | | (2,738,775 | ) | | | (1,964,727 | ) | | | 4,421,576 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS, beginning of year | | | 3,376,410 | | | | 5,341,137 | | | | 919,561 | |
| | | | | | | | | | | | | |
| CASH AND CASH EQUIVALENTS, end of year | | $ | 637,635 | | | $ | 3,376,410 | | | $ | 5,341,137 | |
| | | | | | | | | | | | | |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW | | | | | | | | | | | | |
| INFORMATION | | | | | | | | | | | | |
| Cash paid during the year for: | | | | | | | | | | | | |
| Interest | | $ | 19,802 | | | $ | 85,236 | | | $ | 174,473 | |
| Income taxes | | | - | | | | - | | | | - | |
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY |
|
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS |
December 31, 2014, 2013, and 2012 |
|
| Note 22. Quarterly Data (unaudited) |
| | | Years Ended December 31, | |
| | | 2014 | | | 2013 | |
| | | Fourth | | | Third | | | Second | | | First | | | Fourth | | | Third | | | Second | | | First | |
| | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest income | | $ | 4,520,241 | | | $ | 4,502,258 | | | $ | 4,581,744 | | | $ | 4,533,121 | | | $ | 4,513,506 | | | $ | 4,760,392 | | | $ | 4,576,019 | | | $ | 4,603,114 | |
| Interest expense | | | 650,170 | | | | 691,727 | | | | 725,324 | | | | 722,634 | | | | 772,240 | | | | 869,041 | | | | 919,565 | | | | 961,705 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income, before provision for loan losses | | | 3,870,071 | | | | 3,810,531 | | | | 3,856,420 | | | | 3,810,487 | | | | 3,741,266 | | | | 3,891,351 | | | | 3,656,454 | | | | 3,641,409 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | - | | | | - | | | | 350,000 | | | | 165,000 | | | | - | | | | - | | | | - | | | | 300,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income, after provision for loan losses | | | 3,870,071 | | | | 3,810,531 | | | | 3,506,420 | | | | 3,645,487 | | | | 3,741,266 | | | | 3,891,351 | | | | 3,656,454 | | | | 3,341,409 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest income | | | 458,774 | | | | 503,766 | | | | 534,488 | | | | 322,313 | | | | 616,747 | | | | 269,968 | | | | 697,305 | | | | 355,499 | |
| Noninterest expenses | | | 3,664,483 | | | | 3,659,106 | | | | 3,374,925 | | | | 3,301,049 | | | | 3,704,211 | | | | 3,464,571 | | | | 3,701,728 | | | | 2,975,880 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 664,362 | | | | 655,191 | | | | 665,983 | | | | 666,751 | | | | 653,802 | | | | 696,748 | | | | 652,031 | | | | 721,028 | |
| Income tax expense | | | 253,405 | | | | 249,500 | | | | 256,500 | | | | 254,600 | | | | 249,700 | | | | 268,200 | | | | 256,000 | | | | 268,900 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | 410,957 | | | | 405,691 | | | | 409,483 | | | | 412,151 | | | | 404,102 | | | | 428,548 | | | | 396,031 | | | | 452,128 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Preferred stock dividend requirement | | | 375,000 | | | | 375,000 | | | | 375,000 | | | | 375,000 | | | | 375,000 | | | | 375,000 | | | | 375,000 | | | | 375,000 | |
| Accretion on preferred stock dividends | | | 17,845 | | | | 17,846 | | | | 17,845 | | | | 17,846 | | | | 17,846 | | | | 17,845 | | | | 17,845 | | | | 17,845 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income available to common shareholders | | $ | 18,112 | | | $ | 12,845 | | | $ | 16,638 | | | $ | 19,305 | | | $ | 11,256 | | | $ | 35,703 | | | $ | 3,186 | | | $ | 59,283 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Earnings per common share: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.01 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 0.01 | | | $ | - | | | $ | 0.01 | |
| Diluted | | $ | 0.01 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 0.01 | | | $ | - | | | $ | 0.01 | |
Note 19. Condensed Parent Information
(Dollars in thousands)
|
| | | | | | | | |
| CONDENSED BALANCE SHEETS | | | | |
| | | December 31, | | December 31, |
| | | 2017 | | 2016 |
| ASSETS | | |
| | |
|
| Cash | | $ | 3,936 |
| | $ | 2,068 |
|
| Investment in subsidiaries | | 168,104 |
| | 100,023 |
|
| Other assets | | 42,766 |
| | 4,392 |
|
| | | | | |
| Total assets | | $ | 214,806 |
| | $ | 106,483 |
|
| | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | |
| | |
|
| Other liabilities | | $ | (1,046 | ) | | $ | 1,243 |
|
| Other borrowings | | 10,000 |
| | — |
|
| | | | | |
| Total liabilities | | 8,954 |
| | 1,243 |
|
| | | | | |
| Stockholders’ equity | | 205,852 |
| | 105,240 |
|
| | | | | |
| Total liabilities and stockholders’ equity | | $ | 214,806 |
| | $ | 106,483 |
|
|
| | | | | | | | |
| CONDENSED STATEMENTS OF INCOME | | | | |
| | | Years Ended December 31, |
| | | 2017 | | 2016 |
| INCOME | | |
| | |
|
| Dividends | | $ | — |
| | $ | 3,000 |
|
| Interest income | | — |
| | — |
|
| | | — |
| | 3,000 |
|
| | | | | |
| EXPENSES | | |
| | |
|
| Interest expense | | 69 |
| | 17 |
|
| Other operating expenses | | 2,657 |
| | 1,146 |
|
| | | | | |
| (Loss) income before equity in undistributed earnings of subsidiaries and income tax benefit | | (2,726 | ) | | 1,837 |
|
| | | | | |
| Equity in undistributed earnings of subsidiaries | | 7,134 |
| | 3,520 |
|
| | | | | |
| Income tax benefit | | 607 |
| | 442 |
|
| | | | | |
| Net income | | 5,015 |
| | 5,799 |
|
| | | | | |
| Preferred stock dividend requirements | | 195 |
| | 1,022 |
|
| | | | | |
| Net income available to common stockholders | | $ | 4,820 |
| | $ | 4,777 |
|
SmartFinancial, Inc. and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
Note 19. Condensed Parent Information, Continued
|
| | | | | | | | |
| STATEMENTS OF CASH FLOWS | | Years Ended December 31, |
| | | 2017 | | 2016 |
| CASH FLOWS FROM OPERATING ACTIVITIES | | |
| | |
|
| Net income | | $ | 5,015 |
| | $ | 5,799 |
|
| Adjustments to reconcile net income to net cash (used in) provided by operating activities: | | |
| | |
|
| Equity in undistributed income of subsidiary | | (7,134 | ) | | (3,520 | ) |
| Other | | (2,449 | ) | | 1,234 |
|
| | | | | |
| Net cash (used in) provided by operating activities | | (4,568 | ) | | 3,513 |
|
| | | | | |
| CASH FLOWS FROM FINANCING ACTIVITIES | | |
| | |
|
| Proceeds from issuance of note payable | | 10,000 |
| | — |
|
| Repayment of note payable | | — |
| | (2,000 | ) |
| Redemption of preferred stock | | (12,000 | ) | | — |
|
| Proceeds from issuance of common stock | | 37,853 |
| | 804 |
|
| Payment of dividends on preferred stock | | (195 | ) | | (752 | ) |
| | | | | |
| Net cash provided by (used in) financing activities | | 35,658 |
| | (1,948 | ) |
| | | | | |
| CASH FLOWS FROM INVESTING ACTIVITIES | | |
| | |
|
| Net cash for purchase of Capstone Bancshares, Inc. | | (14,222 | ) | | — |
|
| Capital injection in subsidiary | | (15,000 | ) | | |
| | | | | |
| Net cash used in investing activities | | (29,222 | ) | | — |
|
| | | | | |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | | 1,868 |
| | 1,565 |
|
| | | | | |
| CASH AND CASH EQUIVALENTS, beginning of year | | 2,068 |
| | 503 |
|
| | | | | |
| CASH AND CASH EQUIVALENTS, end of year | | $ | 3,936 |
| | $ | 2,068 |
|
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
| ITEM 9A. | CONTROLS AND PROCEDURES |
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Cornerstone
SmartFinancial maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”“Exchange Act”), that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and that such information is accumulated and communicated to Cornerstone’sSmartFinancial’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. CornerstoneSmartFinancial carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of December 31, 2014.2017. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2014, Cornerstone’s2017, SmartFinancial’s disclosure controls and procedures were effective. Management’s Report on Internal Control over Financial Reporting
The report of
Cornerstone’sSmartFinancial’s management on internal control over financial reporting is set forth in Item 8 of this Annual Report on Form 10-K and incorporated herein by reference.
Changes in Internal Controls
There were no changes in
Cornerstone’sSmartFinancial’s internal control over financial reporting during
Cornerstone’sSmartFinancial’s fiscal quarter ended December 31,
20142017 that have materially affected, or are reasonably likely to materially affect,
Cornerstone’sSmartFinancial’s internal control over financial reporting.
| ITEM 9B. | OTHER INFORMATION |
None
ITEM 9B. OTHER INFORMATION
None.
| ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
Information about Director Nominees
Set forth below with respect
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The response to
this Item is incorporated by reference to SmartFinancial's proxy statement for the
nominees for directorannual meeting of
the Company is information regarding their business experience during the past five years and other information. In addition, the individual experiences, qualifications, attributes and/or skills of each nominee for director that ledstockholders to
his or her nomination and contribute to the Board’s effectiveness as a whole are discussed below.Name | | Age | | Principal Occupation and Qualifications |
Monique P. Berke | | 48 | | Vice President, Investment Operations of Unum Group, a global provider of financial protection benefits. She previously served as Vice President, Human Resources, Global Services for Unum. Prior to 2009, she owned and operated Berke Coaching & Consulting, providing consulting services to Fortune 500 companies. Ms. Berke has extensive experience in the financial services industry with specializations in human resources and operational effectiveness. Her corporate and consulting backgrounds add extensive experience to the Board in matters concerning human resources, process and change management and strategic planning. She has served on several community non-profit boards and committees and is the recipient of many professional awards. |
B. Kenneth Driver | | 79 | | Vice Chairman and Co-CEO of Fillauer Companies, Inc., a Chattanooga based prosthetic manufacturer since 1914. He previously served as President and Chief Operations Officer of Fillauer Companies, Inc. from 1994 to 2007. Since 2007 he has served as the Vice Chairman and Vice CEO of the Fillauer Companies. He has been a director of the Company since 1997. Mr. Driver has extensive experience in matters involved in running a large public company, has served in several capacities from CFO to President and has expertise in finance and accounting, corporate governance, employee matters, and mergers and acquisitions. |
Karl Fillauer | | 67 | | Chairman and Co-CEO of Fillauer Companies, Inc., a Chattanooga based prosthetic manufacturer since 1914. He has been a director of the Company since 1997. Mr. Fillauer brings significant executive management experience and insight to the Board and is proficient in matters relating to finance and accounting, corporate governance, employee matters, and mergers and acquisitions. |
Nathaniel F. Hughes | | 56 | | President and Chief Executive Officer of the Company since November 2009. He previously served as President and CEO of the Company’s sole banking subsidiary, Cornerstone Community Bank (the “Bank”), from March 2012 to February 2015. Prior to that Mr. Hughes served as President and Interim Chief Executive Officer of the Bank from November 2009 to March 2012. Prior to that time Mr. Hughes served as President and Chief Financial Officer of the Company and President and Chief Operating Officer of the Bank from June 2004 to November 2009; President and Chief Financial Officer of the Company and the Bank from April 2003 to June 2004; and Executive Vice President and Chief Financial Officer of the Company and the Bank from February 1999 to April 2003. Mr. Hughes has been a director of the Company since April 2003. He has over 30 years experience in the banking and financial services industry, including expertise in finance and accounting. Mr. Hughes possesses extensive knowledge of the Company’s business and regulatory environment, including matters affecting public companies. As chief executive, he is intimately involved in the Company’s strategic vision and direction and interacts with key executives and constituents within and outside the organization. He also serves on the boards of several non-profit organizations. |
Name | | Age | | Principal Occupation and Qualifications |
Frank S. McDonald | | 63 | | President of FMA Architects, PLLC, a Chattanooga based architectural firm, for more than twenty-five years. He has been a director of the Company since September 2005. Mr. McDonald’s extensive experience in the development and real estate industry assists the Bank’s loan origination process and credit risk management. In addition, he has vast experience in board governance and has served as Chairman of several non-profit organizations. |
Doyce G. Payne, M.D. | | 64 | | Dr. Payne practiced obstetrics and gynecology in the Chattanooga area for more than twenty years prior to his redirecting his practice to International Medical Missions in 2003. He has been a director of the Company since 1997. As a resident of Chattanooga, his knowledge of the Chattanooga market fits well with the Company’s strategy of focusing on its core banking franchise in Hamilton County. He also serves on the boards of several non-profit organizations. |
Wesley M. Welborn | | 56 | | Chairman of the Board of Directors of the Company and the Bank since November 2009. Mr. Welborn is a Partner with the Lamp Post Group, a Chattanooga based small business incubator. Mr. Welborn also has served as President of Welborn & Associates, Inc., a Chattanooga based consulting firm specializing in transportation logistics, for more than ten years. He has been a director of the Company since September 2005. Mr. Welborn has served on the boards of numerous trucking companies and associations. In addition, he served on the board of a publicly traded bank for many years and for two terms as a director of the Federal Reserve Bank of Atlanta’s Birmingham Branch. He also serves on the boards of several non-profit organizations. |
Billy O. Wiggins | | 72 | | President of Checks, Inc., a Chattanooga based specialty check printing company, for more than twenty years. He has been a director of the Company since 1997. Mr. Wiggins has expertise in retailing and wholesaling and extensive experience in the matters involved in running a large company, including finance and accounting, corporate governance, employee matters, and mergers and acquisitions. |
Marsha Yessick | | 67 | | Owner of Yessick’s Design Center, a Chattanooga based interior design company, for more than thirty years and a current member of the American Society of Interior Designers. She has been a director of the Company since 1997. As the founder and operator of several businesses, Ms. Yessick has developed significant experience in managing and operating businesses of varying sizes. In addition, her background assists the Company in human resources management. |
Executive Officers
The following sets forth the names and certain information with respect to Cornerstone’s executive officers (except for Mr. Nathaniel F. Hughes whose information is included above):
Name | | Age | | Principal Occupation and Qualifications |
John H. Coxwell | | 64 | | Senior Executive Vice President of Cornerstone Community Bank since 2012. Prior to joining Cornerstone, Mr. Coxwell had a thirty-plus year career as a Certified Public Accountant (CPA) and financial institution specialist. His CPA experience includes managerial positions with Deloitte & Touche and, most recently, thirteen years as Managing Partner of Hazlett, Lewis & Bieter, PLLC. Originally from Waynesboro, MS, he is a graduate of Auburn University. His civic involvement includes board positions with the Chattanooga Symphony & Opera and READ Chattanooga (now Re:Start – the Center for Adult Education) where he also served as Board President. He is a former member of the Kiwanis Club of Chattanooga and the Chattanooga Downtown Rotary Club. |
Name | | Age | | Principal Occupation and Qualifications |
Robert B. Watson | | 58 | | President of Cornerstone Community Bank since February 2015. Mr. Watson brings 35 years’ experience in the banking industry to his position as President of Cornerstone Community Bank, where he served as Executive Vice President and Senior Loan Administrator from March 2011. Prior to joining Cornerstone in June of 2002, he worked in executive capacities with several regional and community banks, most recently as President and Chief Operating Officer of First Volunteer Bank of Tennessee. A native of Chattanooga, he holds a bachelor’s degree in Accounting and Finance from the University of Tennessee at Chattanooga (UTC). He is a graduate of the LSU School of Banking. His past civic involvement includes board positions with Chattanooga Christian School, Shepherds Arms Rescue Mission and the UTC Finance Advisory Board. |
James R. Vercoe, Jr. | | 62 | | Executive Vice President and Chief Credit Officer of Cornerstone Community Bank since December 2013. Prior to that, he served as Senior Vice President and Chief Credit Officer since 2010. Bob Vercoe joined Cornerstone in November of 2010 as a 30-year veteran of the banking industry, having served in executive positions with banks in Charlotte, NC; Nashville, TN; and Chattanooga, TN. Originally from Raleigh, NC, he holds a bachelor’s degree in U.S. History and an MBA in finance from the University of North Carolina at Chapel Hill. |
Gary W. Petty, Jr. | | 40 | | Chief Financial Officer of the Company since 2009 and Executive Vice President and Chief Operations Officer of Cornerstone Community Bank since January 2014. Prior to that, Mr. Petty served as Chief Financial Officer and Senior Vice President of the Bank from January 2007 to December 2013. He also served as interim Chief Operations Officer from February 2012 to December 2013. Prior to 2007, Mr. Petty served as Vice President/Internal Auditor since 2004. Gary Petty started with Cornerstone in January of 2000 as a credit analyst and has nearly twenty years’ experience in the banking industry. He received his undergraduate degree in Economics from the University of Georgia and a Master of Accountancy degree from the University of Tennessee at Chattanooga. |
CORPORATE GOVERNANCE AND THE BOARD OF DIRECTORS
The Company’s business is managed by its employeesbe held May 24, 2018 under the directionheadings “Proposal One Election of Directors,” “Security Ownership of Certain Beneficial Owners and oversight of theManagement,” “Corporate Governance and Board of Directors. Board members are kept informed of the Company’s business through discussions with management, materials provided to them by management and their participation in Board and Board Committee meetings.
Board Leadership Structure
The offices of Chairman of the Board and Chief Executive Officer (“CEO”) are separated, with Nathaniel F. Hughes holding the position of President and CEO and Wesley M. Welborn being Chairman of the Board. The Company does not have a formal policy with respect to the separation or combination of the offices of Chairman of the Board and CEO. Rather, the Board has the discretion to combine or separate these roles as it deems appropriate from time to time, which provides the Board with necessary flexibility to adjust to changed circumstances. In light of the transition in management in 2009 and the many challenges arising from the difficult economic and regulatory environment, the Board determined that separating the roles of Chairman and CEO would allow the CEO to devote the requisite significant time and focus on managing our business and restoring financial strength. However, under other circumstances, the Board may determine that combining these roles would better serve the Company by enabling one individual to act as a bridge between management and the Board. Historically, the Company has not designated a separate lead independent director at times when the offices of Chairman and CEO were combined.
Risk Oversight
Oversight of risk management is a central focus of the Board and its committees. The full Board regularly receives reports both from Board committees and from management with respect to the various risks facing the Company, including the Bank, and oversees planning and responding to them as appropriate. The Audit Committee currently has primary responsibility for oversight of financial risk and for oversight of the Company’s risk management processes, including those relating to litigation and regulatory compliance. Under its charter, the Audit Committee is required to discuss the Company’s risk assessment and risk management policies and to inquire about any significant risks and exposures and the steps taken to monitor and minimize such risks. The Asset/Liability Management and Strategic Planning Committee actively measures and manages interest rate risk and is responsible for approving the Company’s asset/liability management policies and for overseeing the formulation and implementation of strategies to improve balance sheet positioning and earnings. The Human Resource/Compensation Committee is chiefly responsible for compensation-related risks. Under its charter, the Human Resource/Compensation Committee must discuss and review the key business and other risks the Company faces and the relationship of those risks to certain compensation arrangements. The Bank’s Loan Committee has primary responsibility for credit risk and the committee’s duties include oversight of the Bank’s credit risk department. Each of these committees receives regular reports from management concerning areas of risk for which the committee has oversight responsibility. The Bank is in the process of developing an Enterprise Risk approach to managing the Company’s risk. The objective is to consolidate and simplify the Company’s major risk components and report them to the Board in a manageable format.
Code of Conduct
The Company has adopted a Code of Conduct, which contains provisions consistent with the SEC’s description of a code of ethics, which applies to its directors, officers and employees, including its principal executive officers, principal financial officer, principal accounting officer, controller and persons performing similar functions. The purpose of the Code of Conduct is, among other things, to provide written standards that are reasonably designed to deter wrongdoing and to: (1) promote honest and ethical conduct; (2) provide full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with the SEC and other public communications by the Company; (3) assure compliance with applicable governmental laws, rules and regulations; (4) require prompt reporting of any violations of the Code of Conduct; and (5) establish accountability for adherence to the Code of Conduct. Each director is required to read and certify annually that he or she has read, understands and will comply with the Code of Conduct. The Company’s Code of Conduct is available on the Company’s website atwww.cscbank.com in the Investor Relations area.
Audit Committee
The Audit Committee selects and engages the Company’s independent registered public accounting firm each year. In accordance with its charter, the Audit Committee, among other things, reviews the Company’s financial statements, the results of internal auditing, financial reporting procedures, reports of regulatory authorities, compliance with internal controls required by the Federal Deposit Insurance Corporation Improvement Act and regularly reports to the Board with respect to all significant matters presented at meetings of the Audit Committee. The charter of the Audit Committee is available on the Company’s website atwww.cscbank.com in the Investor Relations area. The Audit Committee is currently comprised of three non-employee directors, Messrs. Payne, Fillauer and McDonald, each of whom is “independent” as defined by the Nasdaq listing standards and the rules and regulations of the SEC. The Audit Committee does not have an “audit committee financial expert,Directors,” as defined in applicable SEC rules, because no director on the Board satisfies the criteria of an audit committee financial expert and the Company has not been able to find a suitable board member who is such an expert. The Audit Committee held four meetings for the Company during 2014, each of which was held concurrently with the Bank’s Audit Committee. Prior to the release of quarterly reports in 2014, the Audit Committee or a member of the Audit Committee also reviewed and discussed the interim financial information contained therein with the Company’s independent registered public accounting firm during fiscal 2014.
Audit Committee Report
Committee Charter
The Audit Committee and the Board have approved and adopted a charter for the Audit Committee, a copy of which is available on the Company’s website atwww.cscbank.comin the Investor Relations area. In accordance with the charter, the Audit Committee assists the Board in fulfilling its responsibility for overseeing the accounting, auditing and financial reporting processes of the Company. The responsibilities of the Audit Committee are described in greater detail in its charter.
Auditor Independence
The Audit Committee received from Mauldin & Jenkins, LLC (M&J) written disclosures and a letter regarding its independence as required by Public Company Accounting Oversight Board Rule 3526, “Communication with Audit Committees Concerning Independence,” describing all relationships between the independent registered public accounting firm and the Company that might bear on the registered public accounting firm’s independence, and discussed this information with M&J. The Audit Committee also reviewed and discussed with management and with M&J the quality and adequacy of the Company’s internal controls. The Audit Committee also reviewed with M&J and financial management of the Company the audit plans, audit scope and audit procedures. The discussions with M&J also included the matters required by the Public Accounting Oversight Board Auditing Standard No. 16. The Audit Committee has also considered, and concluded, that the provision of services by M&J described under the caption “Audit and Non-Audit Fees” are compatible with maintaining the independence of M&J.
Review of Audited Financial Statements
The Audit Committee has reviewed the audited financial statements of the Company as of and for the fiscal year ended December 31, 2014 and has discussed the audited financial statements with management and with M&J. Based on all of the foregoing reviews and discussions with management and M&J, the Audit Committee recommended to the Board“Compensation of Directors that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, to be filed with the SEC.
The foregoing report is submitted by the following members of the Audit Committee:
Doyce G. Payne, M.D., Chairman
Karl Fillauer
Frank S. McDonald
Sectionand Executive Officers,” and “Section 16(a) Beneficial Ownership Reporting Compliance
Under 16(a) of the Exchange Act, directors and executive officers of the Company and persons who own 10% or more of the Company’s Common Stock are required to report to the Securities and Exchange Commission (the “SEC”), within specified due dates, their initial beneficial ownership of the Company’s Common Stock and all subsequent changes to their beneficial ownership. Officers, directors and greater than 10% shareholders are required by SEC regulations to furnish the Company with copies of all forms they file in accordance with Section 16(a). Based solely on the Company’s review of these reports or on representations or information provided to the Company by the persons required to make such filings, the Company believes that all Section 16(a) filing requirements were complied with during the last fiscal year with the exception of the following filings: (1) John H. Coxwell filed one late report on Form 4 on March 16, 2015, reporting one transaction related to the issuance on April 1, 2014 of 15,384 shares of the Company’s Common Stock.
Compliance.” | ITEM 11. | EXECUTIVE COMPENSATION |
Introduction
ITEM 11. EXECUTIVE COMPENSATION
The
Human Resources / Compensation Committee (the “Committee”) carries outresponse to this Item is incorporated by reference to SmartFinancial's proxy statement for the
Board’s overall responsibilities with respectannual meeting of stockholders to
executive compensation, director compensation and reviewsbe held May 24, 2018 under the
performanceheadings, “Proposal One Election of the
Company’s principal executive officer (the “PEO”). The Committee also oversees administrationDirectors” and “Compensation of
the Company’s employee benefit plans, including the Company’s 401(k) planDirectors and
ESOP. The Committee operates under a written charter (seewww.cscbank.com) that is approved annually by the Board. The Committee Chairperson sets the agenda and calendar for the Committee. The Committee has the authority to hire independent consultants to advise the Committee on compensation matters. For fiscal 2014, the Committee did not hire an independent consultant to advise the Committee on compensation matters. The PEO reviews the performance of the other named executive officers and recommends to the Committee compensation packages for each of them.Total compensation of the Company’s named executive officers is determined primarily by the Company’s size in earning assets, the Company’s financial performance and the individual executive’s performance. In determining what types and levels of total compensation to offer the named executive officers, the Committee follows its written Executive Compensation Policy, including guidelines, using predetermined Company financial parameters for the distribution of the particular components of total compensation to the named executive officers.
Compensation Philosophy
The Company’s overall executive compensation philosophy is to align its compensation program with optimizing shareholder value. To that end, the program is designed to recognize superior operating performance and to attract, retain and motivate the executive talent essential to the Company’s financial success. Consistent with this philosophy, the Committee is guided by the following objectives when administering the Company’s overall compensation program:
| · | Attract and retain highly qualified executives who reflect the Company’s culture and values; |
| · | Motivate executives to provide excellent leadership and achieve the Company’s goals; |
| · | Provide substantial performance-related incentive compensation that is aligned with the Company’s strategies and directly tied to meeting specific Company objectives; |
| · | Strongly link the interests of the executives to the value derived by the Company’s shareholders from owning the Company’s Common Stock; and |
| · | Be fair, ethical, transparent and accountable in setting and disclosing executive compensation. |
In furtherance of these objectives, the following considerations underlie the Committee’s determination with respect to the following principal elements of compensation for the named executive officers:
Base Salary – Individual salary determinations should be based upon the officer’s qualifications, behaviors, cultural adherence and performance.
Annual Cash Incentives – Executives should have a portion of their total cash compensation at risk, contingent upon meeting Company objectives.
Long-Term Equity-Based Awards– Executives who are critical to the Company’s long-term success should participate in long-term incentive opportunities that link a portion of their total compensation to increasing shareholder value.
Retirement Plans and Other Benefits – Executives should participate in the Company’s benefit programs, such as health insurance, 401(k) plan, ESOP, vacation and life insurance, at a level consistent with policy, prevailing law and current regulation.
Total compensation is intended to correlate to the Company’s ability to grow earning assets, which in turn enhances the Company’s growth in shareholder value. The Committee did not use competitive salary surveys to determine or measure the total compensation of the named executive officers. A portion of each named executive officer’s total compensation consists of cash payments, including base salary and/or annual cash incentive awards. In addition, a portion of each named executive officer’s total compensation consists of equity awards designed to align the interests of the named executive officers with the interests of the Company’s stakeholders, who include shareholders, employees, directors and community interests.
Fiscal 2014 Summary Compensation Table and Narrative
Under rules established by the SEC, the Company is required to provide certain data and information regarding the compensation and benefits awarded to, earned by or paid to all persons who served as principal executive officer of the Company during 2014 and certain other executive officers, including the three other most highly compensated executive officers whose total compensation exceeded $100,000 (the “named executive officers”). The disclosure requirements include the use of tables and narrative discussion of any material factors necessary to an understanding of the information disclosed in the tables. The summary compensation table below sets forth certain elements of compensation for the named executive officers of the Company and the Bank for the periods indicated.
FISCAL 2014 SUMMARY COMPENSATION TABLE
| | | | | Salary | | | Bonus | | | Stock
Awards | | | Option
Awards | | | Non- equity
Incentive Plan
Compensation | | | Director
Fees Earned
or Paid in
Cash | | | All Other
Compens-
ation | | | Total | |
| Name and Principal Position | | Year | | ($) | | | ($)(1) | | | ($) | | | ($)(2) | | | ($) | | | ($)(3) | | | ($)(4) | | | ($) | |
| (a) | | (b) | | (c) | | | (d) | | | (e) | | | (f) | | | (g) | | | (h) | | | (i) | | | (j) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nathaniel F. Hughes | | 2014 | | | 169,200 | | | | 6,000 | | | | 0 | | | | 32,500 | | | | 0 | | | | 8,064 | | | | 0 | | | | 215,764 | |
| President & CEO | | 2013 | | | 169,200 | | | | 203 | | | | 0 | | | | 29,250 | | | | 0 | | | | 8,064 | | | | 0 | | | | 206,717 | |
| Company & Bank | | 2012 | | | 169,200 | | | | 1,000 | | | | 0 | | | | 19,500 | | | | 0 | | | | 8,064 | | | | 0 | | | | 197,764 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| John H. Coxwell | | 2014 | | | 128,799 | | | | 6,000 | | | | 26,250 | | | | 32,500 | | | | 0 | | | | 0 | | | | 0 | | | | 193,549 | |
| Senior Ex. Vice President | | 2013 | | | 60,000 | | | | 203 | | | | 35,000 | | | | 17,550 | | | | 0 | | | | 0 | | | | 0 | | | | 112,753 | |
| Bank (5) | | 2012 | | | 35,000 | | | | 500 | | | | 19,269 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 54,769 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Robert B. Watson | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ex. Vice President | | 2014 | | | 154,269 | | | | 12,500 | | | | 0 | | | | 19,500 | | | | 0 | | | | 0 | | | | 0 | | | | 186,269 | |
| Sr. Loan Officer | | 2013 | | | 140,000 | | | | 203 | | | | 0 | | | | 17,550 | | | | 0 | | | | 0 | | | | 0 | | | | 157,753 | |
| Bank | | 2012 | | | 140,000 | | | | 1,000 | | | | 0 | | | | 11,700 | | | | 0 | | | | 0 | | | | 0 | | | | 152,700 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| James R. Vercoe Jr. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ex. Vice President | | 2014 | | | 135,000 | | | | 11,000 | | | | 0 | | | | 19,500 | | | | 0 | | | | 0 | | | | 0 | | | | 165,500 | |
| Chief Credit Officer | | 2013 | | | 125,000 | | | | 217 | | | | 0 | | | | 17,550 | | | | 0 | | | | 0 | | | | 0 | | | | 142,767 | |
| Bank | | 2012 | | | 125,500 | | | | 1,000 | | | | 0 | | | | 11,700 | | | | 0 | | | | 0 | | | | 0 | | | | 137,700 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gary W. Petty Jr. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ex. Vice President | | 2014 | | | 132,500 | | | | 8,000 | | | | 0 | | | | 19,500 | | | | 0 | | | | 0 | | | | 0 | | | | 160,000 | |
| COO Bank; | | 2013 | | | 125,000 | | | | 203 | | | | 0 | | | | 17,550 | | | | 0 | | | | 0 | | | | 0 | | | | 142,753 | |
| CFO Company | | 2012 | | | 125,000 | | | | 1,000 | | | | 0 | | | | 11,700 | | | | 0 | | | | 0 | | | | 0 | | | | 137,700 | |
| (1) | Represents cash bonuses paid to the entire workforce in connection with the Christmas holiday season. |
| (2) | The amounts in this column reflect the aggregate grant date fair value of option awards computed in accordance with FASB ASC Topic 718. The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Fiscal 2012 option awards were made on March 1, 2012 with a Black-Scholes value of $0.78 per share. Fiscal 2013 option awards were made on March 1, 2013 with a Black-Scholes value of $1.17 per share. Fiscal 2014 option awards were made on March 1, 2014 with a Black-Scholes value of $1.30 per share. A more detailed discussion of the assumptions used in the valuation of option awards made in fiscal 2012, 2013 and 2014 based on performance during 2011, 2012 and 2013 may be found in Note 14 of the Notes to the Financial Statements in this report. Options acquired pursuant to option grants must generally be held at least two years before partial vesting is possible. |
| (3) | The amounts in this column reflect the aggregate amount of cash fees earned or paid to employee directors for attending meetings of the Board and the Bank, as described in greater detail under the section entitled “Director Compensation” below. |
| (4) | No contributions were made for fiscal 2012, 2013 and 2014 to the Company’s 401(k) or ESOP plans. The Bank paid $10,000 in 2014 to give the ESOP plan liquidity for individuals that had less than 1,000 shares that requested to liquidate their shares as per the plan and administrative fees. The Bank paid $4,757 in 2014 to the 401(k) plan for administrative fees. |
| (5) | John Coxwell was hired by the Bank June 1, 2012. |
Outstanding Equity Awards at 2014 Fiscal Year-End Table and Narrative
The following table sets forth information concerning outstanding equity based awards for each of the named executive officers as of December 31, 2014.Because the Company has never issued stock appreciation rights, restricted stock awards or other stock awards, the table excludes all columns relating to such awards.
OUTSTANDING EQUITY AWARDS AT 2014 FISCAL YEAR-END
| | | Option Awards (1) |
| | | | | Number of Securities Underlying
Unexercised Options (2) | | | Option
Exercise | | | Option |
| | | Grant | | Exercisable | | | Unexercisable | | | Price | | | Expiration |
| Name | | Date | | (#) | | | (#) | | | ($) | | | Date |
| | | | | | | | | | | | | | |
| Nathaniel F. Hughes(3)(4) | | 3/01/2005 | | | 18,000 | | | | | | | | 9.225 | | | 3/01/2015 |
| | | 3/01/2008 | | | 8,500 | | | | | | | | 7.990 | | | 3/01/2018 |
| | | 3/01/2009 | | | 10,000 | | | | | | | | 3.600 | | | 3/01/2019 |
| | | 3/01/2011 | | | 15,000 | | | | 10,000 | | | | 1.700 | | | 3/01/2021 |
| | | 3/01/2012 | | | 7,500 | | | | 17,500 | | | | 1.650 | | | 3/01/2022 |
| | | 3/01/2013 | | | 0 | | | | 25,000 | | | | 2.370 | | | 3/01/2023 |
| | | 3/01/2014 | | | 0 | | | | 25,000 | | | | 2.400 | | | 3/01/2024 |
| | | | | | | | | | | | | | | | | |
| John H. Coxwell (4) | | 3/01/2013 | | | 0 | | | | 15,000 | | | | 2.370 | | | 3/01/2023 |
| | | 3/01/2014 | | | 0 | | | | 25,000 | | | | 2.400 | | | 3/01/2024 |
| | | Option Awards (1) |
| | | | | Number of Securities Underlying
Unexercised Options (2) | | | Option
Exercise | | | Option |
| | | Grant | | Exercisable | | | Unexercisable | | | Price | | | Expiration |
| Name | | Date | | (#) | | | (#) | | | ($) | | | Date |
| | | | | | | | | | | | | | | | | |
| Robert B. Watson(3)(4) | | 3/01/2005 | | | 6,000 | | | | | | | | 9.225 | | | 3/01/2015 |
| | | 3/01/2008 | | | 7,000 | | | | | | | | 7.990 | | | 3/01/2018 |
| | | 3/01/2009 | | | 10,000 | | | | | | | | 3.600 | | | 3/01/2019 |
| | | 3/01/2011 | | | 9,000 | | | | 6,000 | | | | 1.700 | | | 3/01/2021 |
| | | 3/01/2012 | | | 4,500 | | | | 10,500 | | | | 1.650 | | | 3/01/2022 |
| | | 3/01/2013 | | | 0 | | | | 15,000 | | | | 2.370 | | | 3/01/2023 |
| | | 3/01/2014 | | | 0 | | | | 15,000 | | | | 2.400 | | | 3/01/2024 |
| | | | | | | | | | | | | | | | | |
| James R. Vercoe, Jr. (4) | | 3/01/2011 | | | 9,000 | | | | 6,000 | | | | 1.700 | | | 3/01/2021 |
| | | 3/01/2012 | | | 4,500 | | | | 10,000 | | | | 1.650 | | | 3/01/2022 |
| | | 3/01/2013 | | | 0 | | | | 15,000 | | | | 2.370 | | | 3/01/2023 |
| | | 3/01/2014 | | | 0 | | | | 15,000 | | | | 2.400 | | | 3/01/2024 |
| | | | | | | | | | | | | | | | | |
| Gary W. Petty, Jr.(3)(4) | | 3/01/2005 | | | 1,500 | | | | | | | | 9.225 | | | 3/01/2015 |
| | | 3/01/2008 | | | 3,000 | | | | | | | | 7.990 | | | 3/01/2018 |
| | | 3/01/2009 | | | 5,000 | | | | | | | | 3.600 | | | 3/01/2019 |
| | | 3/01/2011 | | | 9,000 | | | | 6,000 | | | | 1.700 | | | 3/01/2021 |
| | | 3/01/2012 | | | 4,500 | | | | 10,500 | | | | 1.650 | | | 3/01/2022 |
| | | 3/01/2013 | | | 0 | | | | 15,000 | | | | 2.370 | | | 3/01/2023 |
| | | 3/01/2014 | | | 0 | | | | 15,000 | | | | 2.400 | | | 3/01/2024 |
| (1) | All employee stock options awarded before 2013 were awarded under the Company’s Statutory-Nonstatutory Stock Option Plan, which was approved by the shareholders in 1996, and the Company’s 2002 Long Term Incentive Plan, which was approved by the shareholders in 2002. All unexercised stock options have been adjusted for the 2-for-1 stock splits of September 2004 and December 2006. During 2012, the Company’s 2002 Long Term Incentive Plan expired. |
| (2) | All employee stock options vest 30% on the second anniversary of the grant date, 60% on the third anniversary of the grant date and 100% on the fourth anniversary of the grant date. |
| (3) | On February 26, 2010, all named executive officers voluntarily forfeited their options for the award years 2006 and 2007, and the shares underlying these options became available for distribution in connection with future awards under the plan. |
| (4) | The shares underlying options that were issued in 2013 and 2014 were issued without a qualified plan and, therefore, these options are considered non-qualified. |
DIRECTOR COMPENSATION
Fees for Board Service
The Company’s directors do not receive fees for attendance at meetings of the Board or committees of the Board of the Company. Rather, because these meetings are held concurrently with the meetings of the Board and equivalent committees of the Board of the Bank, meeting fees are paid by the Bank solely with respect to attendance at meetings of the Board and committees of the Board of the Bank. Although employee directors are entitled to receive cash fees for attendance at Board meetings, they are not eligible for Board committee attendance fees or to participate in the Company’s annual cash incentive or long-term incentive award programs. In fiscal 2014, each director received $672 for attendance at each concurrent Board meeting (two paid absences per calendar year are allowed). Each non-employee director (also referred to herein as an “independent director”) also received $204 for attendance at each concurrent Audit Committee meeting and $179 for attendance at each other Board committee meeting (including concurrent meetings of equivalent Board and Bank committees and meetings of the Bank’s Loan Committee), except that the Chairperson of the Audit Committee and of each other Board committee of the Bank received $247 and $204, respectively, for attendance at such meetings. The Chairman of the Board also receives cash chairmanship fees (currently, $93,064 on an annualized basis) for such service of which $72,876 was allocated to the Bank. Total director fees paid by the Company for services rendered on behalf of the Company in 2014 were $199,496.
Director Annual Cash Incentive Awards
The independent directors of the Company are eligible to receive an annual cash incentive award if the Company meets certain financial performance goals set forth in its profit plan, as from time to time amended. These payments may be paid in cash or, at the election of each independent director under the 2004 Non-Employee Director Compensation Plan, in shares of Common Stock. Performance targets are established at the beginning of the fiscal year through the financial budgeting process. Therefore, the independent directors’ annual cash incentive awards are determined based on the Company’s overall financial performance. The opportunity to earn a cash incentive award payment ranges from 0% to 100% of the average independent directors’ compensation received in Board, subsidiary Board and committee fees. The independent directors’ cash incentive award pool is further limited to not be greater than the executive officers’ cash incentive award pool. Because the Company did not provide any funds for the executive officers’ cash incentive award pool in fiscal 2014, the independent directors did not receive any cash incentive awards for fiscal 2014.
Director Long-Term Equity Based Awards
The Company’s independent directors are also eligible to participate in the Company’s Statutory-Nonstatutory Stock Option Plan and the 2002 Long Term Incentive Plan, each of which was previously approved by the Board and its shareholders. The Compensation Committee establishes, in February of each fiscal year, assuming the achievement of certain financial targets for such fiscal year, the value of the Company’s incentive stock options that will be issued the following calendar year. Based on the market value of the incentive stock options issued to all Company employees, the independent directors as a group set a participate guideline at a level of 20% of the total market value of all stock options granted to both employees and independent directors. The 2014 employee grant represents 72% of the total Company grant, while the independent director grant, as a group, represents 28% of the total Company grant. The independent directors were granted 10,000 non-qualified stock options per director to reward the Directors. The Board anticipates decreasing the issuance level in 2015. The non-qualified stock options issued to independent directors for 2014 vest 50% on the first anniversary of the grant date and 100% on the second anniversary of the grant date. The Company will recognize compensation expense related to the shares subject to these awards as the shares vest.
In 2012, the Company’s independent directors chose to reinstate the reduction in director fees in previous years due to the Bank’s financial difficulty. The increase in fees was decided to be in the form of stock grants. During 2012, the independent directors were issued 2,500 shares each with the exception of Miller Welborn who was granted 15,000 shares. During 2013 there no grants issued. During 2014, the independent directors were issued 5,000 shares each with the exception of Miller Welborn who was granted 30,000 shares.
Director Compensation Table
The following table sets forth the compensation earned by the Company’s independent directors for services rendered during the fiscal year ended December 31, 2014:
DIRECTOR COMPENSATION FOR FISCAL 2014*
| | | Fees Earned
or Paid in
Cash | | | Stock
Awards | | | Option
Awards | | | Non-Equity
Incentive Plan
Compensation | | | All Other
Compensation | | | Total | |
| Name | | ($) | | | ($)(1) | | | ($)(2) | | | ($) | | | ($) | | | ($) | |
| Monique P. Berke | | | 8,644 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 8,644 | |
| B. Kenneth Driver | | | 13,917 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 38,917 | |
| Karl Fillauer | | | 10,212 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 35,212 | |
| David G. Fussell | | | 9,455 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 34,455 | |
| Frank S. McDonald | | | 15,395 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 40,395 | |
| Doyce G. Payne, M.D. | | | 14,780 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 39,780 | |
| Wesley M. Welborn | | | 93,064 | | | | 72,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 178,064 | |
| Billy O. Wiggins | | | 15,753 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 40,753 | |
| Marsha Yessick | | | 10,212 | | | | 12,000 | | | | 13,000 | | | | 0 | | | | 0 | | | | 35,212 | |
| * | Nathaniel F. Hughes is a named executive officer and Mr. Hughes was a member of the Board of Directors of the Company during all of fiscal 2014. His director compensation is set forth under “Column (h)” of the “Fiscal 2014 Summary Compensation Table” above and, as a result, has been omitted from this table. |
| (1) | Each non-employee director received 5,000 grant shares, 2,500 for 2013 and 2,500 for 2014. The shares were issued at $2.40 per share in March 2014. |
| (2) | For each non-employee director, the aggregate number of shares of Common Stock underlying option awards outstanding (whether or not exercisable) at December 31, 2014, after giving effect to the 2-for-1 stock splits in September 2004 and December 2006, was as follows: Mrs. Berke – 0 shares; Mr. Driver—29,650 shares; Mr. Fillauer—29,650 shares; Mr. McDonald—28,650 shares; Dr. Payne—29,650 shares; Mr. Welborn—28,650 shares; Mr. Wiggins—29,650 shares; and Ms. Yessick—29,650 shares. Non-qualified stock options are granted to independent directors with an exercise price equal to the market price on the grant date, and vest 50% on the first anniversary of the grant date and 100% on the second anniversary of the grant date. |
RETIREMENT AND CHANGE-IN-CONTROL BENEFITS
Stock Option Ownership; Vesting of Awards. As of December 31, 2014, Cornerstone’s named executive officers beneficially owned, in the aggregate, [389,000] stock options issued pursuant to Cornerstone’s 2002 Long Term Incentive Plan.
Under the terms of the Company’s 2002 Long Term Incentive Plan, the vesting of any outstanding stock options and other awards under the plan will be accelerated upon the occurrence of a change of control so that all awards not previously exercisable and vested are fully exercisable and vested. For purposes of this plan, a “change of control” means the happening of any of the following:
| · | When any “person” (as such term is used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), other than Cornerstone or a subsidiary or any Cornerstone employee benefit plan (including its trustee)) is or becomes the “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act) directly or indirectly of securities of Cornerstone representing 51% or more of the combined voting power of Cornerstone’s then outstanding securities; |
| · | The occurrence of a transaction requiring shareholder approval for the acquisition of Cornerstone by an entity other than Cornerstone or a subsidiary through purchase of assets, by merger or otherwise; or |
| · | The filing of an application with any regulatory authority having jurisdiction over the ownership of Cornerstone by any “person” (as defined above) to acquire 51% or more of the combined voting power of Cornerstone’s then outstanding securities. |
Also under the terms of the plan, if the employment of a participant in the plan is terminated for any reason following a change of control, any outstanding stock options or other awards under the plan granted to the participant that are not fully exercisable and vested will become fully exercisable and vested as of the date of such termination and any obligations to pay amounts to Cornerstone or any subsidiary in connection with an award will be terminated as of the date when such termination occurs.
New Employment Agreements. On December 5, 2014 Cornerstone and Cornerstone Community Bank terminated their previous change of control and severance agreements with the named executive officers, as well as certain other officers of Cornerstone and Cornerstone Community Bank, and entered into new employment agreements. Each of the new employment agreements contains the following provisions, among others:
| · | Severance on Cornerstone Termination without Cause. For termination of each named executive officer by Cornerstone without cause, Cornerstone and/or Cornerstone Community Bank, as applicable, shall be required to pay a severance benefit equal to one times each such named executive officer’s annual base salary, payable over twelve months, and reimburse such named executive officer for the reasonable cost of premium payments paid by such named executive officer to continue then-existing health insurance coverage for the lesser of (A) twelve months or (B) such time as such named executive officer obtains other employment. |
| · | Severance on Named Executive OfficerTermination with Cause. For termination for cause by a such named executive officer resulting from a (A) material reduction in duties or responsibilities, (B) a material reduction in such named executive officer’s salary, or (C) a change in the location of employment outside of a 75 mile radius from such named executive officer primary office, Cornerstone and/or Cornerstone Community Bank, as applicable, shall be required to pay a severance benefit equal to one times such named executive officer’s annual base salary, payable over twelve months, and reimburse such named executive officer for the reasonable cost of premium payments paid by such named executive officer to continue then-existing health insurance coverage for the lesser of (Y) twelve months or (Z) such time as such named executive officer obtains other employment. |
| · | Severance on Change of Control. If within twelve months following any change of control such named executive officer is terminated by Cornerstone and /or Cornerstone Community Bank (or their successor(s)), as applicable, without cause or such named executive officer terminates for cause resulting from a (A) material reduction in duties or responsibilities, (B) a material reduction in such named executive officer’s salary, or (C) a change in the location of employment outside of a 75 mile radius from such named executive officer’s primary office, such named executive officer shall receive as liquidated damages a severance payment equal to two times such named executive officer’s annual base salary in one lump sum payment. Additionally, Cornerstone shall reimburse such named executive officer for the reasonable cost of premium payments paid by such named executive officer to continue then-existing health insurance coverage for the lesser of (Y) twelve months or (Z) such time as such named executive officer obtains other employment. The definition of change of control, however, expressly excludes the transactions contemplated by the Merger Agreement. |
| · | Severance on Non-Renewal. Solely with respect to the proposed employment agreement with Nathaniel F. Hughes, which employment agreement has an initial term of one year with renewal for successive one year terms upon the mutual agreement of the parties, in the event that Cornerstone elects not to renew the employment agreement with Nathanial F. Hughes for an additional one year term, then Cornerstone shall be required to pay a severance benefit equal to one times Mr. Hughes’ annual base salary payable over twelve months and reimburse Mr. Hughes for the reasonable cost of premium payments paid by Mr. Hughes to continue then-existing health insurance coverage for the lesser of (A) twelve months or (B) such time as Mr. Hughes obtains other employment. |
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
Set forth below is information, as
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The responses to this Item will be included in SmartFinancial's proxy statement for the annual meeting of March 1, 2015, with respect to beneficial ownership by (i) each person who is known to the Companystockholders to be held May 24, 2018 under the beneficial ownerheading, “Security Ownership of 5% or more of the outstanding shares of Common Stock, (ii) each directorCertain Beneficial Owners and nominee for director of the Company, (iii) each named executive officer (as such term is defined under Item 402(m)(2) of Regulation S-K, referred to herein collectively as the “named executive officers”) for the fiscal year endedManagement.”
The following table summarizes information concerning SmartFinancial’s equity compensation plans at December 31, 2014 (referred to herein as “fiscal 2014”), and (iv) all directors and executive officers of the Company as a group. Unless otherwise indicated below, to the Company’s knowledge, all persons listed below have the sole voting and investment power with respect to their shares of Common Stock (except to the extent that authority is shared2017:
|
| | | | | | | | | | |
| Plan category | | Number of
securities to be
issued upon
exercise of
outstanding options | | Weighted
average
exercise price
of outstanding
options | | Number of
securities
remaining
available for
future issuance |
| Equity compensation plans approved by security holders: | �� | | | | | |
| 2002 Long-Term Incentive Plan | | 80,346 |
| | $ | 12.04 |
| | — |
|
| SmartFinancial 2010 Incentive Plan | | 2,000 |
| | $ | 11.67 |
| | 519,750 |
|
| 2015 Stock Incentive Plan | | 41,259 |
| | $ | 15.05 |
| | 1,958,280 |
|
| Capstone Stock Option Plan | | 130,469 |
| | $ | 11.76 |
| | — |
|
| Equity compensation plans not approved by shareholders | | 62,500 |
| | $ | 9.55 |
| | — |
|
| Total | | 316,574 |
| | $ | 11.82 |
| | 2,478,030 |
|
Equity Compensation Plans not Approved by spouses under applicable law).Name and Address of
Beneficial Owner | | Description | | Amount and
Nature of
Beneficial
Ownership of
Common Stock | | | Percent of
Outstanding
Common
Stock (1) | | | Amount and
Nature of
Beneficial
Ownership of
Series A
Convertible
Preferred
Stock | | | Percent of
Outstanding
Series A
Convertible
Preferred
Stock | |
| 5% or More Beneficial Owners: | | | | | | | | | | | | | | | | | | |
The Banc Funds Company, LLC
20 North Wacker Drive, Suite 3300
Chicago, IL 60606 | | | | | 389,406 | (2) | | | 5.88 | % | | | | | | | | |
Directors and
Named Executive Officers: | | | | | | | | | | | | | | | | | | |
| Monique P. Berke | | Director | | | - | | | | - | | | | - | | | | - | |
| John H. Coxwell | | Senior Executive Officer | | | 31,859 | (5)(6) | | | * | | | | 71 | | | | * | |
| B. Kenneth Driver | | Director | | | 160,494 | (3)(4)(5)(6) | | | 2.26 | % | | | 4,400 | (4) | | | * | |
| Karl Fillauer | | Director | | | 260,278 | (3)(4)(5)(6) | | | 3.66 | % | | | 4,000 | | | | * | |
| Nathaniel F. Hughes | | President and Chief Executive Officer and Director | | | 254,013 | (3)(4)(5)(6) | | | 3.57 | % | | | 10,000 | | | | 1.67 | % |
| Frank S. McDonald | | Director | | | 41,859 | (3)(5)(6) | | | * | | | | 1,000 | | | | * | |
| Doyce G. Payne, M.D. | | Director | | | 188,293 | (3)(4)(5)(6) | | | 2.65 | % | | | 1,200 | | | | * | |
| Gary W. Petty, Jr. | | Executive Vice President and Chief Financial Officer | | | 37,117 | (3)(6) | | | * | | | | - | | | | - | |
| James R. Vercoe, Jr. | | Executive Vice President and Chief Credit Officer, Bank | | | 31,500 | (3)(5)(6) | | | * | | | | 600 | | | | * | |
| Robert B. Watson | | President and Senior Loan Officer, Bank | | | 55,811 | (3)(4)(5)(6) | | | * | | | | 1,980 | | | | * | |
| Wesley M. Welborn | | Chairman and Director | | | 160,073 | (3)(4)(5)(6) | | | 2.25 | % | | | 4,000 | | | | * | |
| Billy O. Wiggins | | Director | | | 191,062 | (3)(4)(5)(6) | | | 2.69 | % | | | 200 | | | | * | |
| Marsha Yessick | | Director | | | 141,078 | (3)(4)(5) | | | 1.98 | % | | | 468 | | | | * | |
| | | | | | | | | | | | | | | | | | | |
| All directors and executive officers as a group (13 persons) | | | | | 1,553,437 | | | | 22.27 | % | | | 27,919 | | | | 4.65 | % |
| * | Signifies less than one percent. |
| (1) | Unless otherwise indicated, beneficial ownership consists of sole voting and investing power based on 6,627,398 shares issued and outstanding on March 1, 2015. |
| (2) | Based on a Schedule 13G/A filed jointly by Banc Fund VI L.P. ("BF VI"), an Illinois limited partnership, Banc Fund VII L.P. ("BF VII"), an Illinois Limited Partnership, and Banc Fund VIII L.P. ("BF VIII"), an Illinois limited Partnership, (collectively, the "Reporting Persons"). The general partner of BF VI is MidBanc VI L.P. ("MidBanc VI"), whose principal business is to be a general partner of BF VI. The general partner of BF VII is MidBanc VII L.P. ("MidBanc VII"), whose principal business is to be a general partner of BF VII. The general partner of BF VIII is MidBanc VIII L.P. ("MidBanc VIII"), whose principal business is to be a general partner of BF VIII. MidBanc VI, MidBanc VII, and MidBanc VIII are Illinois limited partnerships. The general partner of MidBanc VI, MidBanc VII, and MidBanc VIII is The Banc Funds Company, L.L.C., ("TBFC"), whose principal business is to be a general partner of MidBanc VI, MidBanc VII, and MidBanc VIII. TBFC is an Illinois limited liability company whose principal shareholder is Charles J. Moore. Mr. Moore has been the manager of BF VI, BF VII, and BF VIII, since their respective inceptions. As manager, Mr. Moore has voting and dispositive power over the securities of the issuer held by each of those entities. As the controlling member of TBFC, Mr. Moore will control TBFC, and therefore each of the Partnership entities directly and indirectly controlled by TBFC. |
| (3) | Includes the following numbers of shares subject to purchase pursuant to options that are exercisable or will become exercisable within 60 days of March 1, 2015: Mr. Coxwell—4,500 shares; Mr. Driver—23,650 shares; Mr. Fillauer—23,650 shares; Mr. Hughes—66,000 shares; Mr. McDonald—23,650 shares; Dr. Payne—23,650 shares; Mr. Petty—36,500 shares; Mr. Vercoe—28,500 shares; Mr. Watson—45,500 shares; Mr. Welborn—23,650 shares; Mr. Wiggins—23,650 shares; Ms. Yessick—23,650 shares; and all directors and officers as a group—304,600 shares. Such shares are deemed to be outstanding for the purposes of computing the percentage ownership of the individual holding such shares, but are not deemed outstanding for purposes of computing the percentage of any other person listed above as a beneficial owner. |
| (4) | Includes shares held by affiliated entities, shares held by spouses, children or other close relatives, and shares held jointly with spouses or as custodians or trustees, as follows: Mr. Driver—400 preferred shares; Mr. Fillauer—146,841 common shares and 2,000 preferred shares; Mr. Hughes—2,056 common shares; Dr. Payne—67,228 common shares and 1,200 preferred shares; Mr. Watson —780 preferred shares; Mr. Welborn —18,900 common shares; Mr. Wiggins—800 common shares; and Ms. Yessick—51,429 common shares and 468 preferred shares. |
| (5) | Includes the following numbers of shares subject to the conversion of Series A Convertible Preferred Stock which can be converted to Cornerstone Bancshares common stock at any time at the discretion of the owner at a 5 shares of common to 1 share of preferred conversion: Mr. Coxwell 355; Mr. Driver 22,000; Mr. Fillauer 20,000; Mr. Hughes 50,000; Mr. McDonald 5,000; Dr. Payne 6,000; Mr. Vercoe 3,000; Mr. Watson 9,900; Mr. Welborn 20,000; Mr. Wiggins 1,000; and Ms. Yessick 2,340. |
| (6) | Shares in the table do not include beneficially owned common stock in which the vesting will be accelerated upon the filing of an application with the Federal Reserve Bank for the SmartFinancial, Inc. and Cornerstone Bancshares, Inc. merger. Information shown below includes the numbers of shares subject to purchase pursuant to options that are exercisable due to prior vesting and vesting due to the stock option plan’s merger feature: Mr. Coxwell—67,359 shares; Mr. Driver—165,494 shares; Mr. Fillauer—265,278 shares; Mr. Hughes—306,513 shares; Mr. McDonald—46,859 shares; Dr. Payne—193,293 shares; Mr. Petty—68,617 shares; Mr. Vercoe—63,000 shares; Mr. Watson—87,311 shares; Mr. Welborn—165,073 shares; Mr. Wiggins—196,062 shares; Ms. Yessick—146,078 shares; and all directors and officers as a group—1,770,937 shares. |
Cornerstone Bancshares, Inc. Non-Qualified Plan Options
During 2013 and 2014, the CompanyCornerstone issued non-qualified options to employees and directors. The options were originally documented in 2013 as being issued out of the Cornerstone Bancshares, Inc. 2002 Long Term Incentive Plan but that plan expired in 2012 and thus no additional options can be issued from the plan. TheThese non-qualified options are governed by the grant document issued to the holders.
The non-qualified stock options for employees were issued at the market value of the Common Stockcommon stock on the grant date and vest 30% on the second anniversary of the grant date, 60% on the third anniversary of the grant date and 100% on the fourth anniversary of the grant date. The non-qualified stock options for directors are issued at the market value of the Common Stockcommon stock on the grant date and vest 50% on the first anniversary of the grant date and 100% on the second anniversary of the grant date. The term of all grants arewere determined by the Compensation Committee, but maycompensation committee, not to exceed ten years. As of December 31, 2014,2017, a total of 410,000128,500 non-qualified stock options had been issued to Company employees of which 410,000 remained outstanding, none had been exercised, none remained exercisable, 410,000 remained unvested and none had been forfeited. As of December 31, 2014, a total of 125,000 non-qualified stock options had been issued to Company directors, of which 125,00062,500 remained outstanding. Of the non-qualified stock options that had been issued as of December 31, 2014, none had been exercised, 22,500 remained exercisable, 102,500 remained unvestedoutstanding and none had been forfeited.
Equity Compensation Plan Information as of December 31, 2014
| Plan category | | Number of securities to
be issued upon exercise of
outstanding options | | | Weighted average
exercise price of
outstanding options | | | Number of securities
remaining available
for future issuance | |
| Equity compensation plans approved by security holders: | | | 659,085 | | | $ | 3.59 | | | | - | |
| | | | | | | | | | | | | |
| Equity compensation plans not approved by security holders: | | | 535,000 | | | $ | 2.39 | | | | | |
| | | | | | | | | | | | | |
| Total | | | 1,194,085 | | | $ | 3.05 | | | | - | |
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Board Composition and Director Independence
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The
Boardresponse to this Item is
currently comprised of nine directors. The directors of the Company are also directors of the Bank. The current Board is comprised of one employee director, Nathaniel F. Hughes, and eight non-employee directors, Messrs. Driver, Fillauer, McDonald, Payne, Welborn and Wiggins and Ms. Yessick and Ms. Berke. Although the OTC Bulletin Board does not have rules regarding director independence, the Board in its business judgment has determined that each of the non-employee directors, with the exception of Mr. Welborn, the chairman of the Board, is an “independent director,” as definedincorporated by
the listing standards of the Nasdaq Stock Market, Inc. (the “Nasdaq listing standards”). The Board has four standing committees: the Audit Committee, the Asset/Liability Management and Strategic Planning Committee, the Human Resource/Compensation Committee and the Nominating/Board Governance Committee. The Board limits membership on the Audit Committee, the Human Resource/Compensation Committee and the Nominating/Board Governance Committeereference to
independent directors as defined by the Nasdaq listing standards and the rules and regulations of the Securities and Exchange Commission (“SEC”). The standing committees advise the Board on policy origination and plan administrative strategy and assure policy compliance through management reporting from areas under their supervision. Each of these four committees has an identical counterpart which serves the board of the Bank. In addition, the Bank has a Directors Loan Committee (the “Bank’s Loan Committee”).Various Company directors, executive officers and their affiliates, including corporations and firms of which they are officers or in which they and/or their families have an ownership interest, are customers of the Company and its subsidiary. These persons, corporations and firms have had transactions in the ordinary course of business with the Company and its subsidiary, including borrowings, all of which, in the opinion of management, were on substantially the same terms including interest rates and collateral as those prevailing at the time for comparable transactions with unaffiliated persons and did not involve more than the normal risk of collectability or present other unfavorable features. The Company and its subsidiary expect to have such transactions on similar terms with directors, executive officers and their affiliates in the future. The aggregate amount of loans outstanding by the Bank to directors, executive officers and related parties as of December 31, 2014 was $3,507,155 which represented 8.6% of the Company’s consolidated shareholders’ equity on that date.
Policies and ProceduresSmartFinancial's proxy statement for the Approvalannual meeting of Related Person Transactions
The charter of the Audit Committee provides that it must approve all transactions between the Company and related parties, as defined in applicable SEC rules and regulations. In accordance with this responsibility, the Audit Committee on a timely basis reviews and, if appropriate, approves all related party transactions. At any time in which an executive officer, director or nominee for director becomes aware of any contemplated or existing transaction that, in that person’s judgment may be a related party transaction, such person is expected to notify the Chairperson of the Audit Committee of the transaction. Generally, the Chairperson of the Audit Committee reviews any reported transaction and may consult with outside legal counsel regarding whether the transaction is, in fact, a related party transaction requiring approval by the Audit Committee. If the transaction is consideredstockholders to be a related party transaction, then the Audit Committee will review the transaction and, in deciding whether to approve the transaction, will consider the factors it deems appropriateheld May 24, 2018 under the circumstances, including, but not limited to, the following:
| · | The approximate dollar amount involved in the transaction, including the amount payable by or to the related person; |
| · | The nature of the interest of the related person in the transaction; |
| · | Whether the transaction may involve a conflict of interest; |
| · | Whether the transaction involves the provision of goods or services to the Company that are available from unaffiliated third parties and, if so, whether the related party transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances; and |
| · | The purpose of the transaction and any potential benefits to the Company. |
In addition to the Audit Committee’s written responsibility, as mandated by the Audit Committee’s charter, to approve related party transactions, the Company also has other written policies and procedures for approving and monitoring related third party transactions.
Related Party Transaction
On September 25, 2014, the full Board voted to approve the purchaseheading, “Proposal One Election of its Miller Plaza branch facility located at 835 Georgia Avenue, Chattanooga, TN in the form of a condominium from Lamp Post Properties. The Company’s Chairman of the Board, Wesley M. Welborn, owns 20 percent of Lamp Post Properties and, therefore, Mr. Welborn abstained from the September 25, 2014 vote. The purchase price of the building was $1.4 million and includes floors 1 and 2 of the building along with 528.34 square footage of the basement, all naming rights and signage privileges for the building, and first right of refusal for 12 of the 19 parking spots assigned to Lamp Post Properties. The transaction closed on February 24, 2015.
Directors.” | ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Audit and Non-Audit Fees
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The
following table presents the aggregate fees billedresponse to
the Company for professional services renderedthis Item is incorporated by
Mauldin & Jenkins, LLC (M&J)reference to SmartFinancial's proxy statement for the
fiscal years ended December 31, 2013 and December 31, 2014:| Services | | 2013* | | | 2014 | |
| Audit Fees (1): | | $ | 122,400 | | | $ | 137,783 | |
| Audit Related Fees (2): | | $ | 17,000 | | | $ | 0 | |
| Tax Fees (3): | | $ | 19,400 | | | $ | 19,800 | |
| All Other Fees: | | $ | 0 | | | $ | 0 | |
| (1) | Includes fees for the audit of the consolidated financial statements and review of the interim financial information contained in the quarterly reports on the form 10-Q and other regulatory reporting. In addition, this category includes fees for services rendered associated with the review of documents filed with the SEC. |
| (2) | Includes fees for attestation and related services traditionally performed by the auditor including attestation services not required by statute or regulation and consultation concerning financial accounting and reporting standards. |
| (3) | Includes fees for tax compliance services including preparation of original and amended federal and state income tax returns, preparation of personal property tax returns and tax payment and planning advice. |
* A portionannual meeting of 2013 fees were incurred through services provided by Hazlett, Lewis & Bieter, PLLC (HLB), whose partners joined Mauldin & Jenkins, LLC on June 1, 2013. Fees billed by HLB in relationstockholders to 2013 services related to Form 10-Q filings and reviewbe held May 24, 2018 under the heading, “Proposal Three Ratification of estimated tax requirements totaled $8,200 and $600, respectively.
The charter of the Audit Committee provides that the duties and responsibilities of the Audit Committee include the pre-approval of all services that may be provided to the Company by the independent accountants whether or not related to the audit. In fiscal years 2013 and 2014, the Audit Fees, Audit Related Fees, Tax Fees and All Other Fees were pre-approved by the Audit Committee.
Independent Registered Public Accountants.”
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| (a) |
| The following documents are filed as part of this report: |
| | |
| (1) | Financial Statements |
| | | |
| | The following report and consolidated financial statements of CornerstoneSmartFinancial and Subsidiary are included in Item 8: |
| | | |
| | Report of Independent Registered Public Accounting Firm |
| | | Consolidated Balance Sheets as of December 31, 20142017 and 20132016 |
| | | Consolidated Statements of Income for the years ended December 31, 2014, 2013,2017 and 2012 2016 |
| Consolidated Statements of Comprehensive Income for the years ended December 31, 2014, 2013,2017 and 20122016 |
| | Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2014, 2013,2017 and 20122016 |
| | Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013,2017 and 20122016 |
| | Notes to Consolidated Financial Statements |
| | | |
| (2) | Financial Statement Schedules: |
| | | |
| | Schedule II: Valuation and Qualifying Accounts |
| | | |
| | All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. |
| | | |
| (3) | The following documents are filed, furnished or incorporated by reference as exhibits to this report: |
|
| | | | |
| Exhibit Index | | | |
| | | | | |
| Exhibit No. | | Description | | Location |
| | 2.1* | | | |
| | Agreement and Plan of Merger dated as of December 5, 2014 by and among SmartFinancial, Inc., SmartBank, Cornerstone Bancshares, Inc. and Cornerstone Community Bank.Bank | | Incorporated by reference to Appendix A to Form S-4 filed April 16, 2015 |
| | 3.1 | | | |
| | Loan Agreement, dated as of October 31, 2017, by and between SmartFinancial, Inc. and CapStar Bank | | Incorporated by reference to Exhibit 2.2 to Form 10-Q filed November, 14, 2017
|
| | | | |
| | Stock Pledge and Security Agreement, dated as of October 31, 2017, by and between SmartFinancial, Inc. and CapStar Bank
| | Incorporated by reference to Exhibit 2.3 to Form 10-Q filed November, 14, 2017
|
| | | | |
| | Line of Credit Note, dated as of October 31, 2017, executed by SmartFinancial, Inc. in favor of CapStar Bank
| | Incorporated by reference to Exhibit 2.4 to Form 10-Q filed November, 14, 2017
|
| | | | |
| | Agreement and Plan of Merger, dated as of December 12, 2017, by and among SmartFinancial, Inc., Tennessee Bancshares, Inc., and Southern Community Bank
| | Incorporated by reference to Exhibit 2.1 to Form 8-K filed December 13, 2017
|
| | | | |
| | Second Amended and Restated Charter of Cornerstone Bancshares,SmartFinancial, Inc. as amended.
| | Incorporated by reference to Exhibit 3.3 to Form 8-K filed September 2, 2015
|
|
| | | | |
| | 3.2 | | | |
| | Second Amended and Restated Bylaws of Cornerstone Bancshares,SmartFinancial, Inc. (1)
| | Incorporated by reference to Exhibit 3.1 to Form 8-K filed October 26, 2015
|
| | 4 | | | |
| 4.1 | | The right of securities holders are defined in the Charter and Bylaws provided in exhibits 3.1 and 3.2.3.2 | | |
| | 10.1* | | Cornerstone Bancshares, Inc. Statutory - Nonstatutory | |
| | Specimen Common Stock Option Plan. (2)Certificate | | Incorporated by reference to Exhibit 4.2 to Form 10-K filed March 30, 2016
|
| | 10.2* | | Cornerstone Bancshares, | |
| | SmartFinancial, Inc. 2002 Long-Term2015 Stock Incentive Plan. (3)Plan | | Incorporated by reference to Exhibit H to the Form S-4 filed April 16, 2015 |
| | 10.3* | | Cornerstone Bancshares, Inc. 2004 Non-Employee Director Compensation Plan. (4) | |
| 10.4* | | Cornerstone Community Bank Employee Stock Ownership Plan. (5) |
| 10.5* | | Form of Director Support Agreements2015 Stock Incentive Agreement | | Incorporated by reference to Exhibit 10.2 to From 10-K filed March 30, 2016 |
| | | | |
| | SmartFinancial, Inc. 2010 Incentive Plan and Form of Option Agreement, assumed by SmartFinancial | | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 |
| | | | |
| | SmartBank Stock Option Plan and Form of Option Agreement, assumed by SmartFinancial | | Incorporated by reference to Exhibit 10.5 to Form 8-K filed September 2, 2015 |
| | | | |
| | Employment Agreement, dated as of February 1, 2015, by and among each current directorWilliam Y. Carroll, Jr., SmartFinancial, Inc. and SmartBank | | Incorporated by reference to Exhibit 10.2 to Form 8-K filed September 2, 2015 |
| | | | |
| | Employment Agreement, dated as of Smart FinancialFebruary 1, 2015, by and Cornerstoneamong William Y. Carroll, Sr., SmartFinancial, Inc. and SmartBank | | Incorporated by reference to Exhibit 10.3 to Form 8-K filed September 2, 2015 |
| | | | |
| | Employment Agreement, dated as of April 15, 2015, by and among C. Bryan Johnson, SmartFinancial, Inc. and SmartBank | | Incorporated by reference to Exhibit 10.4 to Form 8-K filed September 2, 2015 |
| | | | |
| | First Amendment to Employment Agreement by and between Gary W. Petty, Jr., SmartFinancial, Inc. and Cornerstone Community Bank.Bank dated December 8, 2015
| | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 9, 2015
|
| | 10.6* | | | |
| | Form of Subscription Agreement for 2015 Equity Financing
| | Incorporated by reference to Exhibit 10.1 to Form 8-K filed August 20, 2015
|
| | | | |
| | Form of Registration Rights Agreement for 2015 Equity Financing
| | Incorporated by reference to Exhibit 10.2 to Form 8-K filed August 20, 2015
|
| | | | |
| | Employment Agreement with Nathaniel F. Hughes.Hughes, dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc. and Nathaniel F. Hughes
| | Incorporated by reference to Exhibit 10.2 to Form 8-K filed December 10, 2014
|
| | 10.7* | | | |
| | Employment Agreement with Gary W. Petty, Jr. dated as of December 5, 2014, by and between Cornerstone Bancshares, Inc., Cornerstone Community Bank, and Gary W. Petty, Jr.
| | Incorporated by reference to Exhibit 10.3 to Form 8-K filed December 10, 2014
|
|
| | | | |
| | 10.8* | | Employment Agreement with Robert B. Watson. | |
| | Cornerstone Bancshares, Inc. 2002 Long-Term Incentive Plan
| | Incorporated by reference to Exhibit 99.1 to Form S-8 filed on March 5, 2004
|
| | 10.9* | | Employment | |
| | Form of Incentive Agreement with James R. Vercoe, Jr.under 2002 Long-Term Incentive Plan
| | Incorporated by reference to Exhibit 10.22 to Form 10-K filed March 30, 2016
|
| | 14 | | Code | |
| | Form of Ethics. (6)Stock Appreciation Rights Agreement
| | Incorporated by reference to Exhibit 10.1 to Form 8-K filed August 8, 2017
|
| | 21 | | Subsidiary | |
| | Form of the registrant.Restricted Stock Award Agreement
| | Incorporated by reference to Exhibit 10.2 to Form 8-K filed August 8, 2017
|
| | 23 | | | |
| | Employment Agreement, dated as of May 22, 2017, by and between SmartBank and Robert Kuhn
| | Incorporated by reference to Exhibit 10.1 to Form 10-Q filed November 7, 2017
|
| | | | |
| | Capstone Bancshares, Inc. 2008 Long-Term Equity Incentive Plan
| | Incorporated by reference to Exhibit 10.2 to Form 10-Q filed November 7, 2017
|
| | | | |
| | Form of Capstone Bancshares, Inc. Stock Option Agreement
| | Incorporated by reference to Exhibit 10.3 to Form 10-Q filed November 7, 2017
|
| | | | |
| | Salary Continuation Agreement, dated August 11, 2010, by and between Capstone Bank and Robert W. Kuhn
| | Incorporated by reference to Exhibit 10.4 to Form 10-Q filed November 7, 2017
|
| | | | |
| | Employment Agreement, dated as of February 1, 2015, by and among Rhett Jordan, SmartFinancial, Inc. and SmartBank
| | Filed herewith
|
| | | | |
| | Employment Agreement, dated as of February 1, 2015, by and among Greg L. Davis and SmartBank
| | Filed herewith |
| | | | |
| | SmartFinancial, Inc. List of Subsidiaries | | Filed herewith |
| | | | |
| | Consent of Mauldin and& Jenkins, LLC.LLC | | Filed herewith |
| | | | | |
| | Certification of principal executive officer.officer | | Filed herewith |
| | | | | |
| | Certification of principal financial officer.officer | | Filed herewith |
| | 32 | | | |
| | Section 906 certifications of chief executive officer and chief financial officer.officer | | Filed herewith |
| | | | | |
| 101.INS | | XBRL Instance Document | | Filed herewith |
| | | | | |
| 101.SCH | | XBRL Taxonomy Extension Schema Document | | Filed herewith |
| | | | | |
|
| | | | |
| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document | | Filed herewith |
| | | | | |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document | | Filed herewith |
| | | | | |
| 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document | | Filed herewith |
| | | | | |
| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
| * | This item is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 15(b) of this report. |
| (1) | Incorporated by reference to Exhibit 3.2 of the registrant’s Form 10-KSB filed on March 24, 2004. |
| (2) | Incorporated by reference to Exhibit 10.1 of the registrant’s Registration Statement on Form S-1 filed on February 4, 2000, as amended (File No. 333-96185). |
| (3) | Incorporated by reference to Exhibit 99.1 of the registrant’s Registration Statement on Form S-8 filed March 5, 2004 (File No. 333-113314). |
| (4) | Incorporated by reference to Exhibit 99.3 of the registrant’s Registration Statement on Form S-8 filed March 5, 2004 (File No. 333-113314). |
| (5) | Incorporated by reference to Exhibit 10.1 of the registrant’s Form 8-K filed on July 19, 2005. |
| (6) | Incorporated by reference to Exhibit 14 of the registrant’s Form 10-KSB filed on March 24, 2004. |
SIGNATURES
In accordance with
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
| | | |
| | | CORNERSTONE BANCSHARES,SMARTFINANCIAL, INC. | |
| | | |
Date:March 30, 201516, 2018 | By: | /s/ Nathaniel F. HughesWilliam Y. Carroll, Jr. | |
| | | Nathaniel F. HughesWilliam Y. Carroll, Jr. | |
| | | President and Chief Executive Officer and Director | |
| | | (principal executive officer) | |
|
| | | |
| | By: | /s/ Gary W. Petty, Jr.C. Bryan Johnson | |
| | | Gary W. Petty, Jr.C. Bryan Johnson | |
| | | Executive Vice President and Chief Financial Officer | |
| | | (principal financial officer and accounting officer) |
In accordance with
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities
indicatedand on
March 30, 2015.the dates indicated.
|
| | | | |
| Signature | | Title | | Date |
| | | | |
/s/ W. Miller Welborn | | Chairman of the Board of Directors |
W. Miller Welborn | | |
| | |
/s/ Nathaniel F. HughesWilliam Y. Carroll, Jr. | | President |
Nathaniel F. Hughes and Chief Executive Officer and Director | | (principal executive officer) and DirectorMarch 16, 2018 |
| William Y. Carroll, Jr. | | | | |
/s/ B. Kenneth Driver(Principal Executive Officer) | | Director |
B. Kenneth Driver | | |
| | | | | |
/s/ Karl FillauerC. Bryan Johnson | | DirectorExecutive Vice President and Chief Financial Officer | | March 16, 2018 |
Karl FillauerC. Bryan Johnson | | | | |
| (Principal Financial Officer and Principal Accounting Officer) | | | | |
| | | | |
| /s/ Victor L. Barrett | | Director | | March 16, 2018 |
| Victor L. Barrett | | | | |
| | | | |
| /s/ Monique P. Berke | | Director | | March 16, 2018 |
| Monique P. Berke | | | | |
| | | | |
| /s/ William Y. Carroll, Sr. | | Director | | March 16, 2018 |
| William Y. Carroll, Sr. | | | | |
| | | | |
| /s/ Frank S. McDonald | | Director | | March 16, 2018 |
Frank S. McDonald
| | | | |
| | | | | |
/s/ Doyce G. PayneTed C. Miller | | Director | | March 16, 2018 |
Doyce G. PayneTed C. Miller | | | | |
| | | | | |
/s/ Billy O. WigginsDavid A. Ogle | | Director | | March 16, 2018 |
Billy O. WigginsDavid A. Ogle | | | | |
| | | | | |
/s/ Marsha YessickDoyce Payne | | Director | | March 16, 2018 |
Marsha YessickDoyce Payne | | | | |
| | | | | |
/s/ Monique BerkeMiller Welborn | | Director | | March 16, 2018 |
Monique BerkeMiller Welborn | | | | |
| | | | | |
/s/ Gary W. Petty, Jr.Keith E. Whaley | | Executive Vice President and Chief Financial Officer |
Gary W. Petty, Jr.Director | | (principal financial officer and accounting officer)March 16, 2018 |
INDEX OF EXHIBITS
Exhibit No.Keith E. Whaley | | Description | | |
| | | | | |
2.1*/s/ Geoffrey A. Wolpert | | Agreement and Plan of Merger dated as of December 5, 2014 by and among SmartFinancial, Inc., SmartBank, Cornerstone Bancshares, Inc. and Cornerstone Community Bank. |
3.1Director | | Amended and Restated Charter of Cornerstone Bancshares, Inc., as amended.March 16, 2018 |
3.2Geoffrey A. Wolpert | | Amended and Restated Bylaws of Cornerstone Bancshares, Inc. (1) |
4 | | The right of securities holders are defined in the Charter and Bylaws provided in exhibits 3.1 and 3.2. |
10.1* | | Cornerstone Bancshares, Inc. Statutory - Nonstatutory Stock Option Plan. (2) |
10.2* | | Cornerstone Bancshares, Inc. 2002 Long-Term Incentive Plan. (3) |
10.3*/s/ Steven B. Tucker | | Cornerstone Bancshares, Inc. 2004 Non-Employee Director Compensation Plan. (4) |
10.4* | | Cornerstone Community Bank Employee Stock Ownership Plan. (5)March 16, 2018 |
10.5*Steven B. Tucker | | Form of Director Support Agreements by and among each current director of Smart Financial and Cornerstone and Cornerstone Community Bank. |
10.6* | | Employment Agreement with Nathaniel F. Hughes. |
10.7* | | Employment Agreement with Gary W. Petty, Jr. |
10.8* | | Employment Agreement with Robert B. Watson. |
10.9*/s/ J. Beau Wicks | | Employment Agreement with James R. Vercoe, Jr. |
14Director | | Code of Ethics. (6)March 16, 2018 |
21J. Beau Wicks | | Subsidiary of the registrant. |
23 | | Consent of Mauldin and Jenkins, LLC. |
31.1 | | Certification of principal executive officer. |
31.2 | | Certification of principal financial officer. |
32 | | Section 906 certifications of chief executive officer and chief financial officer. |
101.INS | | XBRL Instance Document |
101.SCH | | XBRL Taxonomy Extension Schema Document |
101.CAL | | XBRL Taxonomy Calculation Linkbase Document |
101.DEF | | XBRL Taxonomy Definition Linkbase Document |
101.LAB | | XBRL Taxonomy Label Linkbase Document |
101.PRE | | XBRL Taxonomy Presentation Linkbase Document |
| * | This item is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 15(b) of this report. |
| (1) | Incorporated by reference to Exhibit 3.2 of the registrant’s Form 10-KSB filed on March 24, 2004. |
| (2) | Incorporated by reference to Exhibit 10.1 of the registrant’s Registration Statement on Form S-1 filed on February 4, 2000, as amended (File No. 333-96185). |
| (3) | Incorporated by reference to Exhibit 99.1 of the registrant’s Registration Statement on Form S-8 filed March 5, 2004(File No. 333-113314). |
| (4) | Incorporated by reference to Exhibit 99.3 of the registrant’s Registration Statement on Form S-8 filed March 5, 2004(File No. 333-113314). |
| (5) | Incorporated by reference to Exhibit 10.1 of the registrant’s Form 8-K filed on July 19, 2005. |
| (6) | Incorporated by reference to Exhibit 14 of the registrant’s Form 10-KSB filed on March 24, 2004. |