10QSB 1 e10qsb.txt CORNERSTONE BANCSHARES INC 1 U.S. Securities and Exchange Commission Washington, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2000 [ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to ________________ Commission file number 0-30497 CORNERSTONE BANCSHARES, INC. (Exact name of small business issuer as specified in its charter) TENNESSEE 62-1173944 (State of other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 6401 SUITE B LEE CORNERS CHATTANOOGA, TENNESSEE 37421 (Address of principal executive offices) (423) 385-3000 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 1,166,129 SHARES OF COMMON STOCK AS OF JUNE 30, 2000. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] 2 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CORNERSTONE BANCSHARES PRESENTATION OF FINANCIAL INFORMATION The 2000 financial information in this report has not been audited. The information included herein should be read in conjunction with the notes to consolidated financial statements included in the 1999 Annual Report to Shareholders which was furnished to each shareholder of the Company in March 2000. The consolidated financial statements presented herein conform to generally accepted accounting principles and to general industry practices. Consolidation The accompanying consolidated financial statements include the accounts of Cornerstone Bancshares Inc. ("Company") and its sole subsidiary Cornerstone Community Bank ("Bank"). Substantially all intercompany transactions, profits and balances have been eliminated. Accounting Policies During interim periods, Cornerstone Bancshares follows the accounting policies set forth in its Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission. Since December 1999, there have been no changes in any accounting principles or practices, or in the method of applying any such principles or practices. Interim Financial Data (Unaudited) In the opinion of the Company management, the accompanying interim financial statements contain all material adjustments, consisting only of normal recurring adjustments necessary to present fairly the financial condition, the results of operations, and cash flows for the interim period. Results for interim periods are not necessarily indicative of the results to be expected for a full year. Earnings Per Common Share Basic earnings per share ("EPS") is computed by dividing income available to common shareholders (numerator) by the number of common shares outstanding (denominator). Diluted EPS is computed by dividing income available to common shareholders (numerator) by the adjusted number of shares outstanding (denominator). The adjusted number of shares outstanding reflects the potential dilution occurring if securities or other contracts to issue common stock were exercised or converted into common stock resulting in the issuance of common stock that share in the earnings of the entity. Forward-Looking Statements Certain written and oral statements made by or with the approval of an authorized executive officer of the Company may constitute "forward-looking statements" as defined under the Private Securities Litigation Reform Act of 1995. Words or phrases such as "should result, are expected to, we anticipate, we estimate, we project" or similar expressions are intended to identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual 3 results to differ materially from the Company's historical experience and its present expectations or projections. These risks and uncertainties include, but are not limited to, unanticipated economic changes, interest rate movements and the impact of competition. Caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date of making such statements. 4 PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS
Unaudited Unaudited June 30, December 31, June 30, ASSETS 2000 1999 1999 ------------- ------------- ------------- Cash and due from banks $ 9,857,546 $ 7,721,701 $ 6,654,167 Federal funds sold -- -- 5,355,000 Investment securities available for sale 17,008,300 13,339,306 11,955,433 Investment securities held to maturity 4,938,914 5,723,320 6,989,300 Loans, less allowance for loan loss 81,247,022 71,323,878 65,220,182 Premises and equipment, net 2,247,022 2,231,179 1,921,513 Accrued interest receivable 717,828 656,159 534,078 Excess cost over fair value of assets acquired 2,665,275 2,722,651 2,778,539 Other assets 2,040,660 2,084,033 1,853,347 ------------- ------------- ------------- Total assets $ 120,722,567 $ 105,802,227 $ 103,261,559 ============= ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non interest bearing $ 13,593,950 $ 12,411,939 $ 12,259,447 NOW accounts 21,932,543 12,626,200 14,985,198 Savings deposits and money market accounts 11,132,449 10,254,825 9,616,620 Time deposits of $100,000 or more 16,973,270 16,129,350 15,138,652 Time deposits of less than $100,000 42,241,131 39,923,313 39,404,797 ------------- ------------- ------------- Total deposits 105,873,344 91,345,627 91,404,714 Other Borrowings 2,506,094 2,179,363 282,191 Accrued interest payable 190,035 189,870 183,682 Other liabilities 211,509 193,108 351,544 Note Payable -- -- 1,250,000 ------------- ------------- ------------- Total Liabilities 108,780,982 93,907,968 93,472,131 ------------- ------------- ------------- Redeemable common stock -- 237,504 237,504 Stockholders' Equity Common stock 1,166,129 1,166,629 1,011,561 Additional paid-in capital 11,322,276 11,128,234 9,284,418 Undivided profits (deficit) (357,700) (454,818) (664,092) Accumulated other comprehensive income (189,120) (183,290) (79,963) ------------- ------------- ------------- Total Stockholders' Equity 11,941,585 11,894,259 9,789,428 ------------- ------------- ------------- Total liabilities and stockholders equity $ 120,722,567 $ 105,802,227 $ 103,261,559 ============= ============= =============
5 CONSOLIDATED STATEMENTS OF INCOME
Unaudited Unaudited Three months ended Six months ended June 30, June 30, -------------------------- ------------------------ 2000 1999 2000 1999 ----------- ----------- ---------- ----------- INTEREST INCOME Interest and fees on loans $ 1,978,042 $ 1,485,614 $3,822,591 $ 3,062,752 Interest on investment securities 359,024 252,250 688,169 528,186 Interest on federal funds sold 17,364 86,568 19,882 125,101 Interest on other earning aseets 10 -- 263 -- ----------- ----------- ---------- ----------- Total interest income 2,354,441 1,824,432 4,530,905 3,716,039 ----------- ----------- ---------- ----------- INTEREST EXPENSE Interest bearing demand accounts 75,010 56,023 137,597 116,804 Money market accounts 68,693 47,037 128,791 99,107 Savings accounts 28,981 27,257 58,930 53,886 Time deposits of less than $100,000 595,892 521,915 1,144,747 1,077,686 Time deposits of $100,000 or more 235,379 218,842 440,681 456,909 Federal funds purchased 7,673 -- 29,259 732 Securities sold under agreements to repurchase 36,557 2,040 57,648 3,718 Other borrowings -- 28,255 -- 52,474 ----------- ----------- ---------- ----------- Total interest expense 1,048,185 901,369 1,997,653 1,861,316 ----------- ----------- ---------- ----------- Net interest income 1,306,255 923,063 2,533,253 1,854,723 Provision for loan losses 256,000 605,000 414,500 655,000 ----------- ----------- ---------- ----------- Net interest income after the provision for loan losses 1,050,255 318,063 2,118,752 1,199,723 ----------- ----------- ---------- ----------- NONINTEREST INCOME Service charges on deposit accounts 94,087 82,375 187,104 173,553 Net securities gains (losses) -- -- -- -- Other income 43,600 76,191 110,174 113,222 ----------- ----------- ---------- ----------- Total noninterest income 137,687 158,566 297,278 286,775 ----------- ----------- ---------- ----------- NONINTEREST EXPENSE Salaries and employee benefits 570,077 556,833 1,129,714 1,037,178 Occupancy and equipment expense 138,768 134,338 264,237 262,521 Other operating expense 464,799 518,048 882,584 900,803 ----------- ----------- ---------- ----------- Total noninterest expense 1,173,644 1,209,219 2,276,535 2,200,502 ----------- ----------- ---------- ----------- Income before provision for income taxes 14,298 (732,590) 139,496 (714,004) Provision for income taxes 18,154 (113,475) 42,378 (91,607) ----------- ----------- ---------- ----------- NET INCOME $ (3,856) $ (619,115) $ 97,118 $ (622,397) =========== =========== ========== =========== Basic net income per common share (0.00) (0.61) 0.08 (0.62) Diluted net income per common share (0.00) (0.59) 0.08 (0.60) Dividends declared per common share -- -- -- --
6 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30
Unaudited Unaudited 2000 1999 ------------ ------------ Cash flows from operating activities: Net income 97,118 (622,397) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Provision for possible loan losses 414,500 655,000 Net Charge-offs (330,255) (1,024,757) Provision for depreciation and amortization 174,097 176,334 Accrued interest receivable (61,669) 104,363 Accrued interest payable 165 (86,952) Changes in other assets and liabilities: 61,774 (734,809) ------------ ------------ Net cash provided by (used in) operating activities 355,729 (1,533,218) ------------ ------------ Cash flows from investing activities: Purchase of investment securities: AFS (4,053,044) (6,865,216) Purchase of investment securities: HTM -- -- Proceeds from security transactions: AFS 368,362 4,418,020 Net increase in loans (10,007,388) 7,642,124 Purchase of bank premises and equipment (132,563) (81,272) ------------ ------------ Net cash provided by (used in) investing activities (13,030,871) 6,904,034 ------------ ------------ Cash flows from financing activities: Net increase in deposits 14,527,717 (6,606,894) Net increase in repurchase agreements 326,731 282,191 Net increase of notes payable -- -- Issuance of common stock (43,462) 269,088 ------------ ------------ Net cash provided by (used in) financing activities 14,810,986 (6,055,615) ------------ ------------ Net increase (decrease) in cash and cash equivalents 2,135,845 (684,800) Cash and cash equivalents beginning of period 7,721,701 12,693,967 ------------ ------------ Cash and cash equivalents end of period $ 9,857,546 $ 12,009,167 ============ ============
7 Cornerstone Bancshares, Inc and Subsidiary Changes in Stockholders' Equity June 30, 2000
Accumulated Additional Retained Other Total Comprehensive Common Paid-in Earnings Comprehensive Stockholders' Income Stock Capital (Deficit) Income Equity -------- ----------- ------------ ---------- ---------- ------------ BALANCE, December 31, 1999 $ 1,166,629 $ 11,128,234 $ (454,818) $ (183,290) $ 11,656,755 Redemption of Common Stock (15,344) (222,660) (238,004) Issuance of Common Stock 14,844 179,198 194,042 Decrease in Redeemable Common Stock 237,504 237,504 Comprehensive Income: Net Income $ 97,118 97,118 97,118 Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities available for sale, net of reclassification adjustment (5,830) (5,830) (5,830) -------- ----------- ------------ ---------- ---------- ------------ Total comprehensive income $ 91,288 ======== BALANCE, June 30, 2000 (Unaudited) $ 1,166,129 $ 11,322,276 $ (357,700) $ (189,120) $ 11,941,585 =========== ============ ========== ========== ============
8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. OVERVIEW The Company ended the first six months of 2000 with total assets of $121 million, a 14.1% increase from December 31, 1999, and a 17.0% increase from June 30, 1999. The Company reported a net loss for the second quarter ending June 30, 2000 of $(3,855) or $(0.004) basic earnings per share, compared to net loss $(619,115) or $(0.61) basic earnings per share, for the same period in 1999. The increase in earnings represents a 99.4% increase from the second quarter 1999 compared to the second quarter of 2000. The Company reported net income for the first six months ending June 30, 2000 of $97,118, or $0.08 basic earnings per share, compared to $(622,397), or $(0.62) basic earnings per share, for the same period in 1999. The increase in earnings represents a 115.6% increase from the first six months in 1999 compared to the same period in 2000. The increase in net income from first six months 1999 to first six months 2000 is due primarily to the improvement in the Bank's net interest margin. The Bank has seen an increase in the net interest margin to 5.13% in first six months of 2000 from 4.08% in the first six months of 1999. This represents an increase of 105 basis points. Several factors have contributed to the improvement in net interest margin. First, the loan portfolio quality has improved. The non-performing assets and 90 days past due loan category decreased from $1,362,582 at year end 1999 to $792,582 as of June 30, 2000. The 30-day or greater past due ratio dropped from 1.20% as of the end of 1999 to .70% as of the end of June 30, 2000. These two facts allowed the Bank to recover some previously charged off interest, which increased the interest and fees earned on loans. The growth in average earning-assets out paced the growth in average non-earning assets. Average earning assets increased 13.5% from June 30, 1999 to June 30, 2000 (on a QTQ basis) while average non-earning assets increased 11.4% over the same time period. We also have an improved asset and liability mix. The Bank's average loan to asset ratio improved from 65.9% as of June 30, 1999 to 69.9% as of June 30, 2000 (on a QTQ basis) on the asset side of the balance sheet. On the liability side, average transaction and saving accounts increased 28.3% while average certificates of deposits increased only 4.3% to fund the asset growth (on a QTQ basis). Going forward the Bank expects the net interest margin to be in line with its peer group and will focus on improving the Bank's efficiency ratio and asset and liability mix to create further earnings increases to net income of the Company. The Company expects net income to materially increase over the next several quarters as the loan portfolio quality continues to improve and the Bank efficiency ratios become more comparable with other peer banks. The strategic plan of the Company is to provide a competitive footprint (convenient branches) to the Chattanooga MSA (Metropolitan Statistical Area) which would allow Cornerstone Bancshares to compete with the three major regional banks located in the area. The Bank will focus its efforts in the suburb branch network and not on a central hub bank located in downtown Chattanooga. The customer base will consist of small businesses and individual consumers. The most recent action the Bank has taken to implement the strategic plan is the acquisition of a new branch location. The Bank has entered into an agreement with AmSouth Bank to purchase its closed Gunbarrel Road Branch building (located 50 yards in front of our present Gunbarrel supermarket branch). The move is consistent with the strategic plan and will facilitate the Bank's movement away from grocery store branches to full service branches that can provide the full service expected of a community bank. 9 Cornerstone Community Bank is operating under a Memorandum of Understanding (Memorandum) with the Tennessee Department of Financial Institutions and the Federal Deposit Insurance Corporation. Among other things, the Memorandum provides the following: - The Board of Directors must develop a written management plan that addresses Cornerstone Community Bank's plans for size, structure, growth, earnings, services, information systems, personnel, accounting, financial reporting and operating matters; - Cornerstone Community Bank must maintain a Tier I leverage capital ratio of equal to or greater than 8%; - Cornerstone Community Bank may not pay dividends without the prior approval of the FDIC; and - Cornerstone Community Bank must report its progress on the actions required by the Memorandum to the FDIC on specific dates. At the June 2000, examination the FDIC reported that Cornerstone Community Bank was materially in compliance with the provisions of the Memorandum. However, because of the increased regulatory scrutiny required by the Memorandum, the activities of Cornerstone Community Bank and Cornerstone are more restricted, and these restrictions may affect the flexibility of Cornerstone in conducting its business operations. FINANCIAL CONDITION Earning Assets. Average earning assets for three months ending June 30, 2000 increased $13.4 million or 13.3% above the three months ending June 30, 1999. The average balance increase was due to strong loan demand and a steady growth in core deposits during the period. Management expects average earning assets to steadily increase during the rest of 2000 and anticipates similar growth in 2001. Loan Portfolio. Average loans for the first six months of 2000 were $77.8 million, an increase of $8.7 million or 12.7% from the first six months in 1999, while actual balances increased to $82.3 million, an increase of 24.1% above $66.3 million in loans at the end of June 1999. Management is anticipating increased loan growth for the remainder of the year in average balances, with a smaller increase in actual balances. This is due primarily to the Bank's loan to asset ratio reaching industry norm. As a result, loan growth will be restricted to the percentage of asset growth going forward. The amount of such growth, if any, will depend upon general economic conditions. Investment Portfolio. Investment securities portfolio increased by 15.8% or $3.0 million from June 30, 1999 to June 30, 2000. The growth was a timing issue as the Bank remained liquid (holding $5.4 million in Fed Funds) as management made its transition and allowed expensive deposits to terminate. The Bank maintains an investment strategy of making prudent investment decisions with active management of the portfolio to optimize, within the constraints of established policies, an adequate return and value. Investment objectives include Gap Management, Liquidity, Pledging, Return, and Local Community Support in that order of priority. Cornerstone maintains two classifications of investment securities: "Held to Maturity" (HTM) and "Available for Sale" (AFS). The "Available for Sale" securities are carried at fair market value, whereas the "Held to Maturity" securities are carried at book value. As of June 30, 2000, unrealized losses in the "Available for Sale" and "Held to Maturity" amounted to $352,353 or a 1.6% decrease in value. 10 Deposits. Bank's average deposits increased $9.1 million or 11.6% from June 30, 1999 to June 30, 2000, while actual deposit balances increased $14.5 million or 15.8%. The actual deposit growth has been broad based with the exception of certificates of deposit over $100,000, which decreased 3.6% during the same time period. Management will continue to focus its efforts on attracting core deposits and expects average deposit growth in the 10% level for the next several quarters. Transaction accounts will be continuously solicited from new customers and existing customers. Attracting transaction accounts is the Bank's highest liability management priority and will provide the Bank with an increased net interest margin. Capital Resources. Stockholders' average equity increased $1.7 million or 16.9% to $11.9 million for the three months ending June 30, 2000, compared with $10.2 million during the same three months ending June 30, 1999. Actual equity increased $2.2 million or 22.0% from June 30, 1999 to June 30, 2000. This increase was primarily due to a capital program to encourage warrant holders to exercise their warrants with net proceeds of approximately $2 million. The balance represents current year earnings sustained from operations and unrealized losses in the bond portfolio. The Company has approved a stock offering of 150,000 shares of common stock at $13 per share ($1.9 million). The Company plans to initiate the offering during the third quarter of 2000. 11 CONSOLIDATED AVERAGE BALANCE SHEET INTEREST INCOME / EXPENSE AND YIELD / RATES Taxable equivalent basis (in thousands)
Three months ended June 30, ---------------------------------------------------------------- 2000 1999 ------------------------------- ----------------------------- Assets Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate -------- ------- -------- -------- ----- ------- Earning Assets: Loans, net of unearned income 79,974 1,978 9.95% 66,610 1,486 8.95% Investment securities 22,699 376 6.67% 23,840 339 5.70% Other earning assets -- -- -------- ------ -------- ----- Total earning assets 102,673 2,354 9.22% 90,450 1,824 8.09% Allowance for loan losses (1,021) (874) Cash and other assets 12,761 11,454 -------- -------- TOTAL ASSETS 114,413 101,030 ======== ======== Liabilities and Stockholders' Equity Interest bearing liabilities: Interest bearing demand deposits 17,272 75 1.75% 13,646 56 1.65% Savings deposits 11,453 98 3.43% 9,378 74 3.18% Time deposits 42,827 596 5.60% 39,507 522 5.30% Time deposits of $100,000 or more 15,731 235 6.02% 15,657 219 5.61% Federal funds and securities sold under Agreement to repurchase 3,353 44 5.31% 222 2 3.69% Other borrowings -- -- 0.00% 1,250 28 9.07% -------- ------ -------- ----- Total interest bearing liabilities 90,635 1,048 4.65% 79,660 901 4.54% ------ ----- Net interest spread 1,306 923 ===== ===== Noninterest bearing demand deposits 11,191 10,478 Accrued expenses and other liabilities 668 692 Stockholders' equity 11,919 10,201 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 114,413 101,030 ======== ======== Net interest margin on earning aseets 5.12% 4.09% ==== ==== Net interest spread on earning assets 4.57% 3.55% ==== ==== Taxable equivalent adjustment: Loans -- -- Investment Securities -- -- ------ ----- Total adjustment -- -- ====== =====
12 RESULTS OF OPERATIONS - QUARTER ENDED JUNE 30, 2000 COMPARED TO QUARTER ENDED JUNE 30, 1999 Net Interest Income. Net interest income is the principal component of a financial institution's income stream and represents the spread between interest and fee income generated from earning assets and the interest expense paid on deposits. The following discussion is on a fully taxable equivalent basis. Net interest income after loan loss provision for the three month period ending June 30 2000 increased $732,192 or 230.2% above net interest income after loan loss provision as of the same period 1999. The increase in net interest income as of June 30, 2000 is primarily due to an increase in the Bank's net interest margin on earning assets, which rose from 4.09% to 5.12% in three months ending June 30, 2000 as compared to the three months ended June 30, 1999. A larger loan loss provision offset would result in even larger growth. The increased margin was a result of management's efforts to change the deposit mix from certificate of deposit base to a transaction account deposit base and the collection of interest from non-accrual loans written-off in the previous year. The increase in prime rate loans helped the Bank maintain its margin in an increasing interest rate environment. The strategic direction has produced material improvements in the net interest margin and should continue to increase the Bank's earnings in the future. The larger loan loss provision represents a continued purging of substandard loans and should continue throughout the year 2000. Interest income increased $530,009 or 29.1% as of June 30, 2000 compared to June 30, 1999. Interest income produced by the loan portfolio increased $492,428 or 33.2% from June 30, 1999 to June 30, 2000 due to the increase in average loans outstanding for the period and the collection of interest from non-accrual loans and loan fees for loan origination. Management estimates the average balances will increase, but will restrain origination of these loans to insure quality standards and documentation are maintained. Interest income on investment securities and federal funds increased $37,570 or 11.1% from June 30, 1999 to June 30, 2000, due primarily to reduced prepayments of mortgage backed securities that were purchased at a premium and a fully invested cash position. Total interest expense increased $146,816 or 16.3% from June 30, 1999 to June 30, 2000. The interest expense increase from the second quarter of 1999 to the second quarter of 2000 is primarily due to increased market rates caused by the Federal Reserve's 125 basis point rate increases of Fed Funds over the last 12 months. Offsetting this increase in rates is the Bank's active management of the deposit mix and the solicitation of lower costing transaction accounts at the branch locations. The trend in net interest income is commonly evaluated in terms of average rates using the net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield on average earning assets and the average rate paid for all funds used to support those earning assets. The net interest margin at June 30, 2000 was 5.12%. The yield on earning assets increased 113 basis points to 9.22% at June 30, 2000 from 8.09% at June 30, 1999. The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing sources of funds. The interest rate spread 13 eliminates the impact of noninterest bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in the asset and liability mix during late 1999 and recaptured interest during the current period, the interest rate spread was 4.57% on June 30, 2000, compared to 3.55% on June 30, 1999, an increase of 102 basis points. Allowance for Loan Losses. The allowance for possible loan losses represents management's assessment of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for possible loan losses and the appropriate provisions required to maintain a level considered adequate to absorb anticipated loan losses. Management believes that the $1,086,054 for June 30, 2000 in the allowance for loan loss account reflects the full known extent of credit exposure. The provision for the second quarter ending June 30, 2000 was $256,000, well above the budgeted amount for that time period. The Bank does not anticipate similar provisions for the remainder of 2000. In the future and as the loan portfolio grows and unanticipated loan losses occur, the Bank may have loan loss provisions slightly above peer to cover the above average loan growth the Bank will realize. No assurances can be given, however, that adverse economic circumstances will not result in increased losses in the loan portfolio, and require greater provisions for possible loan losses in the future. Non-performing Assets. Non-performing assets include non-performing loans and foreclosed real estate held for sale. Non-performing loans include loans classified as non-accrual or renegotiated. Cornerstone's policy is to place a loan on non-accrual status when it is contractually past due 90 days or more as to payment of principal or interest. At the time a loan is placed on non-accrual status, interest previously accrued but not collected may be reversed and charged against current earnings. As of June 30, 2000 Cornerstone had $128,041 in non-accrual loans and $792,858 in non-performing assets. Non-interest Income. Non-interest income consists of revenues generated from a broad range of financial services and activities including fee-based services and profits and commissions earned through credit life insurance sales and other activities. In addition, gains or losses realized from the sale of loans are included in non-interest income. Total non-interest income decreased by $20,879 or 13.3% from June 30, 1999 to June 30, 2000. Due primarily to slow down of home mortgage origination caused by a sharp increase in interest rates. Non-interest Expense. Non-interest expense for the three months ending June 30, of 2000, decreased by $35,575 or 2.95% as compared to the three months ending June 30, 1999. Salaries and employee benefits increased by $13,244 or 2.4% in June 30, 2000 over June 30, 1999. Occupancy expense as of June 30, 2000 increased by $4,430 or 3.3% over the same period in 1999. All other non-interest expenses at June 30, 2000 decreased $53,249 or 10.3% over the non-interest expenses as of June 30, 1999. 14 CONSOLIDATED AVERAGE BALANCE SHEET INTEREST INCOME / EXPENSE AND YIELD / RATES Taxable equivalent basis (in thousands)
Six months ended June 30, ---------------------------------------------------------------- 2000 1999 ------------------------------- ----------------------------- Assets Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate -------- ------- -------- -------- ----- ------- Earning Assets: Loans, net of unearned income 77,838 3,823 9.88% 69,097 3,063 8.94% Investment securities 21,551 708 6.61% 22,683 653 5.81% Other earning assets -- -- -------- ------ -------- ----- Total earning assets 99,389 4,531 9.17% 91,780 3,716 8.16% Allowance for loan losses (1,003) (1,116) Cash and other assets 12,857 12,129 -------- -------- TOTAL ASSETS 111,243 102,793 ======== ======== Liabilities and Stockholders' Equity Interest bearing liabilities: Interest bearing demand deposits 16,169 138 1.71% 13,402 117 1.76% Savings deposits 11,073 188 3.41% 9,641 153 3.20% Time deposits 41,337 1,145 5.57% 40,568 1,078 5.36% Time deposits of $100,000 or more 15,486 441 5.72% 16,073 457 5.73% Federal funds and securities sold under Agreement to repurchase 3,294 87 5.31% 182 4 4.93% Other borrowings -- -- 1,255 52 8.43% -------- ------ -------- ----- Total interest bearing liabilities 87,359 1,998 4.60% 81,121 1,861 4.63% ------ ----- Net interest spread 2,533 1,855 ====== ===== Noninterest bearing demand deposits 11,358 10,604 Accrued expenses and other liabilities 610 779 Stockholders' equity 11,916 10,290 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 111,243 102,793 ======== ======== Net interest margin on earning assets 5.13% 4.08% ==== ==== Net interest spread on earning assets 4.57% 3.54% ==== ==== Taxable equivalent adjustment: Loans -- -- Investment Securities -- -- ------ ----- Total adjustment -- -- ====== =====
15 RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999 Net Interest Income. Net interest income is the principal component of a financial institution's income stream and represents the spread between interest and fee income generated from earning assets and the interest expense paid on deposits. The following discussion is on a fully taxable equivalent basis. Net interest income after loan loss provision for the first six months of 2000 increased $919,030 or 76.6% above net interest income after loan loss provision as of first six months of 1999. The increase in net interest income as of June 30, 2000 is primarily due to an increase in the Bank's net interest margin on earning assets, which rose from 4.08% to 5.13% in first six months of 2000 as compared to the first six months of 1999. The increased margin was a result of management's efforts to change the deposit mix from certificate of deposit based to a transaction account deposit base, the collection of interest from non-accrual loans written off in the previous year, and a smaller loan loss provision. The strategic direction has produced improvements in the net interest margin and should continue to assist the Bank's earnings in the future. The current year provision represents a continued purging of substandard loans and should continue throughout the year 2000. Interest income increased $814,866 or 21.9% as of June 30, 2000 compared to June 30, 1999. Interest income produced by the loan portfolio increased $759,839 or 24.8% from June 30, 1999 to June 30, 2000 due to the increase in average loans outstanding for the period and the collection of interest from non-accrual loans and loan fees for loan origination. Management estimates the average balances will increase, but will restrain origination of these loans to insure quality standards and documentation are maintained. Interest income on investment securities and federal funds increased $54,764 or 8.4% from June 30, 1999 to June 30, 2000, due primarily to reduced prepayments of mortgage backed securities that were purchased at a premium and a fully invested cash position. Total interest expense increased $136,337 or 7.3% from June 30, 1999 to June 30, 2000. The interest expense increase from the first six months of 1999 to the first six months of 2000 is primarily due to increased market rates caused by the Federal Reserve's five 25 basis point rate increases of Fed Funds over the last 12 months. The trend in net interest income is commonly evaluated in terms of average rates using the net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield on average earning assets and the average rate paid for all funds used to support those earning assets. The net interest margin at June 30, 2000 was 5.13%. The yield on earning assets increased 101 basis points to 9.17% at June 30, 2000 from 8.16% at June 30, 1999. The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing sources of funds. The interest rate spread eliminates the impact of non-interest bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in the asset and liability mix during late 1999 and recaptured interest during the current period, the interest rate spread was 4.57% on June 30, compared to 3.53% on June 30, 1999, an increase of 104 basis points. 16 Allowance for Loan Losses. The allowance for possible loan losses represents management's assessment of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for possible loan losses and the appropriate provisions required to maintain a level considered adequate to absorb anticipated loan losses. Management believes that the $414,500 provision for loan loss as of June 30, 2000 adequately provides funds to the Bank's loan loss allowance to cover the full known extent of credit exposure. The Bank anticipates a smaller provision for the rest of 2000 that will cover the Bank's credit risk as the loan portfolio grows and unanticipated loan losses occur. No assurances can be given, however, that adverse economic circumstances will not result in increased losses in the loan portfolio, and require greater provisions for possible loan losses in the future. Non-performing Assets. Non-performing assets include non-performing loans and foreclosed real estate held for sale. Non-performing loans include loans classified as non-accrual or renegotiated. Cornerstone's policy is to place a loan on non-accrual status when it is contractually past due 90 days or more as to payment of principal or interest. At the time a loan is placed on non-accrual status, interest previously accrued but not collected may be reversed and charged against current earnings. As of June 30, 2000 Cornerstone had $128,041 in non-accrual loans and $792,858 in non-performing assets. Non-interest Income. Non-interest income consists of revenues generated from a broad range of financial services and activities including fee-based services and profits and commissions earned through credit life insurance sales and other activities. In addition, gains or losses realized from the sale of loans are included in non-interest income. Total non-interest income increased by $10,503 or 3.7% from June 30, 1999 to June 30, 2000. Non-interest Expense. Non-interest expense for the first six months of 2000 increased by $76,032 or 3.53% as compared to the first six months in 1999. Salaries and employee benefits increased by $92,536 or 8.9% in June 30, 2000 over June 30, 1999. Occupancy expense as of June 30, 2000 increased by $1,716 or 0.7% over the same period in 1999. All other non-interest expenses at June 30, 2000 decreased $18,219 or 2.0% over the non-interest expenses as of June 30, 1999. 17 ALLOWANCE FOR LOAN LOSSES
2000 1999 -------------------------- ------------------------------------------ Quarter Ending June 30 March 31 December 31, September 30 June 30 --------- --------- ------- --------- --------- Balance at beginning of period 1,028,838 1,001,809 985,234 1,030,243 1,208,311 Loans charged-off (259,543) (170,891) (123,631) (225,363) (858,844) Loans recovered 60,758 39,420 45,206 75,354 75,777 ----------------------------------------------------------------------------------------------------------------- Net Charge-offs (recoveries) (198,784) (131,471) (78,425) (150,009) (783,068) Provision for loan losses charged to expense 256,000 158,500 95,000 105,000 605,000 ----------------------------------------------------------------------------------------------------------------- Balance at end of period 1,086,054 1,028,838 1,001,809 985,234 1,030,243 ================================================================================================================= Allowance for loan losses as a percentage of average loans outstanding for the period 1.358% 1.358% 1.390% 1.438% 1.547% Allowance for loan losses as a percentage of nonperforming assets and loans 90 days past due outstanding for the period 136.980% 83.251% 73.523% 78.287% 76.738% Annualized QTD net charge-offs as a percentage of average loans outstanding for the period -0.994% -0.694% -0.435% -0.876% -4.702% Annualized YTD net charge-offs as a percentage of average loans outstanding for the period -1.106% -0.694% -1.797% -2.273% -2.966 YTD Average Outstanding Loans 77,837,484 75,760,000 69,731,000 68,922,000 69,097,000 QTD Average Outstanding Loans 79,974,088 75,760,000 72,065,598 68,513,772 66,610,187 Nonperforming assets and loans 90 days past due 792,858 1,235,826 1,362,582 1,258,493 1,342,538
18 PART II - OTHER INFORMATION Item 1. Legal Proceedings There are various claims and lawsuits in which the Bank is periodically involved incidental to the Bank's business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits. Item 2. Changes in Securities None Item 3. Defaults on Senior Securities N/A Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and reports on Form 8-K (a) Exhibits: Financial Data Schedule (For SEC Use Only) (b) There have been no Current Reports on Form 8-K during the quarter ended June 30, 2000. 19 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 14, 2000 /s/Gregory B. Jones, President & CEO Date: August 14, 2000 /s/Nathaniel F. Hughes, EVP & CFO