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PART I FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30
Cornerstone Bancshares, Inc and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PRESENTATION OF FINANCIAL INFORMATION
The 2004 financial information in this report has not been audited. The information included herein should be read in conjunction with the notes to the consolidated financial statements included in the 2003 Annual Report to
Shareholders which was furnished to each shareholder of Cornerstone Bancshares, Inc. (Cornerstone) in March of 2004. 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 and its subsidiary Cornerstone Community Bank (the Bank).
Substantially all intercompany transactions, profits and balances have been eliminated.
Accounting Policies
During interim periods, Cornerstone follows the accounting policies set forth in its 10-KSB for the year ended December 31, 2003, as filed with the Securities and Exchange Commission. Since December 31, 2003, 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 Cornerstones 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.
Stock Based
The company has two stock-based compensation plans. The company applies the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for
those plans. No stock-based employee compensation is reflected in net income as all options granted under these plans have an exercise price equal to or above the market value of the underlying common stock on the date of the grant. The following
table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation," to stock-based compensation.
Off-Balance Sheet Arrangements
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include standby letters of credit and various
commitments to extend credit. At June 30, 2004, commitments under standby letters of credit and undisbursed loan commitments aggregated $40,674,990. The Banks credit exposure for these financial instruments is represented by their contractual
amounts. The Bank does not anticipate any material losses as a result of the commitments under standby letters of credit and undisbursed loan commitments.
Certain written and oral statements made by or with the approval of an authorized executive officer of Cornerstone 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 results to differ materially from Cornerstones historical experience and its present expectations or projections. These risks and uncertainties include, but are
not limited to, unanticipated economic changes, interest rate fluctuations 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 they
are made.
Item 2. Management's Discussion and Analysis or Plan of Operation.
Cornerstone Bancshares, Inc. (Cornerstone) is a bank holding company and the parent of Cornerstone Community Bank, a Tennessee banking corporation (the Bank) that operates in
and around Hamilton County, Tennessee. The Banks 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 compensation and benefits, office expenses, and other overhead expenses.
The following discussion and analysis sets forth the major factors that affect Cornerstones results of operations and financial condition reflected in the unaudited financial statements for the
three-month and six-month periods ended June 30, 2004 and 2003. This discussion and analysis should be read in conjunction with the Companys Consolidated Financial Statements contained herein and notes attached thereto. As of June 30,
2004 Cornerstone had total consolidated assets of $230.6 million, total loans
of $183.7 million, total deposits of $179.1 million and stockholders equity
of $17.8 million. Our net income was $623,000 and $1,146,000 for the three and
six months ended June 30, 2004.
Cornerstone ended the first six months of 2004 with total assets of $231 million, a 14.7% increase from December 31, 2003 and a 26.7% increase from June 30, 2003. Cornerstone reported net income for
the six months ending June 30, 2004 of $1,145,912, or $0.92 basic earnings per share, compared to $902,222, or $0.73 basic earnings per share, for the same period in 2003. The increase in earnings during the first six months of 2004 represents a 27%
increase compared to the first six months of 2003. The increase in net income for the first six
months of 2004 was due primarily to the Bank increasing its net-interest income by $1 million, or 26.9% compared to the same period in 2003. The Bank accomplished this by increasing its total average earning assets by $39.5 million, or 24.2% compared to the same period in
2003, while maintaining an above average net interest margin of 5.02% . During the same time period, peer banks net interest margin averaged 4.36% . The Bank was also able to increase deposits and as use alternative sources of funding to
improve the Banks interest rate exposure while decreasing the overall cost of funds. Interest expense increased by $8,000 for the first six months of 2004 compared to the same period in 2003. This small increase was due to the Bank increasing
deposits by 30% mostly in transaction based accounts compared to the period ending on June 30, 2003, and was assisted by continued repricing of its certificates of deposit. The Banks transaction accounts grew 17.4% during the first six months
of 2004 while certificates of deposit increased 7.5% for the same period. The Bank also took advantage of attractive non-traditional funding sources during the second quarter of 2004. Cornerstone increased its Federal Home Loan Bank borrowings by
$10 million and selected longer-term maturities to reduce the Banks general interest rate risk. In addition, the Bank actively used its federal funds lines of credit as an inexpensive source of funds. The Bank anticipates rapid deposit growth
in both transaction deposits and certificates of deposit during the third and fourth quarters of 2004, which would be used to reduce its federal funds lines of credit balances.
Non-interest income increased 17.7% for the first six months of 2004 compared to the same period in 2003. This increase was broad based, but had a large contribution from a new line of business of
leasing assets to customers and saw continued growth of e-commerce as a revenue generator to the Banks income statement.
On the qualitative side, the Bank maintained its asset quality, which is quantified by the Banks below peer bank average of past due loans to net loans ratio of 0.24% and a below peer bank
average non-performing asset ratio of 0.025% . This was accomplished during a time period when regional banks struggled to maintain net interest margin and suffered from a general deterioration of loan quality. For the first six months of 2004, the
Banks net interest margin was 5.02%, compared to 4.87% for the same time period in 2003. The Banks management expects the Banks net interest margin to decrease slightly to a more historic level of 4.9% over the remainder of
2004.
During the second quarter of 2004 Cornerstone continued to work on improving its manpower and capital capacity as an increasing number of businesses and other banking customers that were unable to
retain relationships with, or were poorly treated by, regional banking institutions became customers of the Bank. The Chattanooga banking community continued to suffer from manpower adjustments which left many quality businesses and other banking
customers without previously existing banking relationships. As a result, many businesses and other banking customers changed banks. Cornerstone and other stable community banks have readily accepted these banking relationship transfers and
Cornerstone expects the trend to continue.
The Bank has continued to expand its asset based lending program and has developed into a Tennessee leader in SBA lending dollar volume as several SBA loan generation associations refer loans to the
Bank due its depth of knowledge with respect to specialty loans and willingness to consider these loans. The banks position on SBA loans is to strictly underwrite each loan to bank credit guidelines. In addition, when SBA loans are saleable to
the secondary market, the Bank will generally sell the SBA loans to increase fee income and enhance the net income of the Bank. The Bank has
opened a new branch on Old Lee Highway, Ooltewah, Tennessee, to existing customers
and expects to have a Grand Opening in the middle of August 2004. The opening gives Cornerstone five full service branches in Hamilton County and gives customers in the Cleveland, Tennessee area a branch slightly south of Clevelands city limits. The Bank intends to continue to open new branch
locations as opportunities present themselves.
The Bank, pursuant to its strategic plan, intends to continue to focus on providing a competitive footprint (convenient branches) to the Chattanooga Metropolitan Statistical Area allowing it to
compete with the three major regional banks located in the area. The Bank also intends to focus its efforts in the suburb branch network and not on a central hub bank located in downtown Chattanooga. It is also intended that special emphasis will be
placed on providing services specifically targeted to small businesses and individual consumers.
Earning Assets. Average earning assets for the six months ending June 30, 2004, increased by $36.9 million, or 23.2% compared to the six months ending June 30, 2003,
while actual earning assets increased $48.0 million or 28.5% during the same period. The average and actual balance increases were due to strong loan demand in the first half of 2004 and a strong growth in transaction account deposits during the
current reporting period. Management expects average earning assets to grow at a similar pace during the remainder of 2004.
Loan Portfolio. The Bank's average loans for the first six months of 2004 were $169.1 million, an increase of $37.3 million, or 28.3% compared to the first six months
of 2003, while actual balances increased to $183.7 million, an increase of 28.1% above the $143.4 million in loans as of June 30, 2003. Management anticipates similar loan growth for the remainder of the year in both average and actual
balances.
Investment Portfolio. The Bank's average investment securities portfolio and Federal Funds Sold decreased by 1.2% or $0.4 million for the six months ending June 30,
2004 compared to the six months ending June 30, 2003, while actual balances increased $6.1 million or 24.4% . The difference in growth is due to the purchasing of securities late in the second quarter after the market correction materially increased
security rates. Prior to that correction, management believed the interest rate risk versus the yield reward was not sufficient to warrant purchases of securities unless they were tied to a variable rate index. After the correction, the Bank began
to purchase securities with longer durations and higher yields. Management currently is carefully purchasing securities that provide acceptable return versus the interest rate risk. Management expects the average and actual balance of securities to
increase over the remainder of 2004. The Bank expects to maintain 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, in order of priority, gap management, liquidity, pledging, return, and local community support. The Bank 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 "Held to Maturity" securities are carried at book value. As of June 30, 2004, net unrealized losses in the "Available for Sale" portfolio amounted to
$110,778, a 0.4% decrease in value. Deposits.
The Bank's average deposits increased by $28.2
million or 21.1% for the six-month period ending June 30, 2004 compared to the
same period ending June 30, 2003, while actual deposit balances increased by
$41.6 million or 30.2% . The actual deposit growth was broad based with non-interest
bearing transaction accounts increasing by 48.1% during the same time period. Management
intends to continue to focus its efforts on attracting core deposits and expects
certificates of deposit to increase over the remainder of 2004 as loan growth
continues. The Bank intends to maintain as one of its highest priorities the
continued solicitation of transaction accounts from new and existing customers,
which should provide the Bank with an increased net interest margin. Liquidity and Capital Resources.
As of the end of the second quarter of 2004 the Bank had $27 million of Federal Home Loan Bank of Cincinnati (FHLB) borrowings and the ability to borrow another $10 million. The borrowings
are designed with a maturity of 10 years with call and put options after a stated conversion date. During the second quarter of 2004, the Bank borrowed $5 million with a three-year conversion date and an interest rate of 3.46% bringing the total
Bank borrowings to $27 million. Management believes that FHLB borrowings provide an inexpensive method to reduce interest rate risks by obtaining longer term liabilities to match the typically longer term assets the Bank has on its balance sheet
that are usually below the cost of certificates of deposit. Cornerstone, under its $5.0 million guidance line with Fifth Third Bank, borrowed $2.1 million to inject capital into the Bank. The injection was needed to maintain an 8.0% capital leverage
ratio, which the regulators consider appropriate, given the size of our Bank. The loan is priced at 30-day LIBOR index plus 150 basis points, which as of June 30 was 3.1% .
Average stockholders' equity increased by $1.8 million or 11.7% to $17.5 million for the six months ending June 30, 2004 compared with $15.7 million during the
six months ending June 30, 2003. Actual equity increased by $1.7 million or 10.6% from June 30, 2003 to June 30, 2004. This increase was primarily due to retained earnings.
Due to its rapid asset growth, the Bank has been forced to address issues of liquidity and capital resources. The Bank is currently earning a return on equity of approximately 15% while growing assets
at a rate of approximately 30%, which leaves a shortfall of approximately 15%. Having no desire to reduce or slow-down the Banks current growth, Cornerstones board of directors and management have decided to raise additional capital to
allow the Bank to continue to grow its market share and above average earnings growth. Cornerstone is currently contemplating raising additional capital through an offering of its common stock.
CONSOLIDATED AVERAGE BALANCE SHEET
Results of Operations Six months ended June 30, 2004 compared to six months ended June 30, 2003
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 before loan loss provision for the first six months of 2004 increased $1,030,239 or 26.9% above net interest income before loan loss provision for the first six months of 2003. The
incrase in net interest income as of June 30, 2004 was primarily due to the growth in interest income and fees associated with loan growth, which grew $1.1 million or 22.0%, while interest expense remained constant. The loan income growth was mainly
in the commercial and commercial real estate areas and was supplemented by SBA fees and loan participation fees. Deposits and interest expense remained constant for the first six months of 2004 even with a 21% growth of average interest bearing
liabilities due to the cost of funds decreasing from 2.39% for the first six months of 2003 to 1.98% for the first six months of 2004. The yield from earning assets decreased from 6.92% to 6.69% over the same time period. Two additional factors
assisted net interest income growth. First, the Banks asset mix shifted as the percentage of average loans to average total assets increased to 80.9% for the first six months of 2004 from 77.6% for the first six months of 2003, providing the
majority of the Banks asset growth in higher yielding assets. Second, SBA loan production that is not reflected in the average loan balances was sold to the secondary market for fee income. The increase in net interest margin exceeded the
Banks projections by approximately 24 basis points and can be directly attributed to the above-mentioned factors. Management foresees the net interest margin decreasing from these levels for the remainder of 2004 and having a slight
compression as rates adjust during the second half of 2004.
Interest income increased $1,038,206 or 19.1% for the period ended June 30, 2004 compared to the same period ended June 30, 2003. Interest income produced by the loan portfolio increased $1,083,499 or
22.0% for the six month period ended June 30, 2004 compared to six month period ended June 30, 2003, due to the increase in average loans outstanding and origination fees associated with loan growth for the period. The increase of loan interest
income was partially offset by the general repricing of the loan portfolio in a low interest rate environment. Management estimates the average and actual balances will continue to increase throughout the remainder of 2004. Interest income on
investment securities, Federal Funds and other investments decreased $45,293 or 8.6% for the six month period ending June 30, 2004 compared to the six month period ended June 30, 2003, due primarily to a decrease in general market rates and lower
average outstanding balances for a prolonged period of time.
Total interest expense increased $7,967 or 0.5% from June 30, 2003 to June 30, 2004. The interest expense increase from the first six months of 2003 to the first six months of 2004 is primarily due to
a growth in interest bearing liabilities of 21.4%, but was offset by a decrease in the rates of all deposits or other borrowings. 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 for the
first six months of 2004 was 5.02% . The yield on earning assets decreased 23
basis points to 6.69% for the period ended June 30, 2004, compared to 6.92%
for the period ended June 30, 2003.
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 the Federal Reserve decreased interest rates during the first six months of 2003, certificates of deposits and transaction
accounts were able to reprice at a much lower level and assisted the interest rate spread increase to 4.71% for the six month period ending June 30, 2004 compared to 4.53% for the same period ending June 30, 2003, an increase of 18 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 $2.3 million allowance for loan losses as of June 30, 2004 reflects the full known extent of credit exposure. Cornerstone made a $410,000 provision during the first
half of 2004 and anticipates similar provisions in the future 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. The Bank's policy is to place a loan on non-accrual status when payment of principal or interest is contractually 90 or more days past due. 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, 2004, the Bank had $45,116 in non-accruing loans and no other 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, commissions earned through credit life insurance sales and other activities. In addition, gains or losses realized from the sale
of residential mortgage loans are included in non-interest income. Total non-interest income increased by $101,447 or 17.7% from the first half of 2003 compared with the first half of 2004. During the first six months of 2004 the Bank purchased
customers assets for the purpose of leasing them to back to these existing customers. The product line should produce accelerated depreciation for the Bank while de-leveraging the customers balance sheet. The expected internal rates of
return on these types of leases range from 15% to 25%. The leases are scheduled over three years and the customer will be given the option to buy back the assets at the end of the lease at fair market value or renew the existing lease. Management
believes the line of business will provide above average returns with similar risk to a loan. Non-interest Expense.
Non-interest expense for the first six months
of 2004 increased by $471,349 or 16.9% compared to the first six months in 2003.
Expenses for salaries and employee benefits increased by $367,122 or 23.6% for
the six months ending June 30, 2004 over the same period ending June 30, 2003.
Occupancy and equipment expense as of June 30, 2004 increased by $98,381 or
29.3% over the same period in 2003. All other non-interest expenses for the
six-month period ended June 30, 2004 increased $5,847 or 0.7% over the non-interest
expenses for the same period ended June 30, 2003. The increase in all other
non-interest expense is due primarily to the growth of the Bank and its needs
to properly manage the growth. The Bank added one talented lender and has had
to add two back office personnel to handle the increased volume of activity
from the new transaction accounts open over the last year. The growth in occupancy
expense can be attributed to the expenses associated with opening the Banks
new Ooltewah branch in June of 2004. In addition the bank data processing cost
has grown concurrently with the Banks deposit growth. CONSOLIDATED AVERAGE BALANCE SHEET
Results of Operations Three months ended June 30, 2004 compared to three months ended June 30, 2003
Net Interest Income. Net interest income before loan loss provision for the second quarter of
2004 increased $587,643 or 29.4% above net interest income before loan loss provision for the second quarter of 2003. The increase in net interest income was primarily due to an increase in interest income from earning asset growth while deposit
cost remained flat. Partially offsetting the growth was a decrease in asset yields but several SBA fees and loan participation fees generated during the second quarter of 2004 partially offset the decrease in yields. The interest yield from earning
assets decreased from 6.89% to 6.74% while interest cost from the Banks liabilities decreased from 2.30% to 1.92% over the same time period. Two additional factors assisted net interest income growth. First, the Banks deposit mix
shifted as the percentage of average transaction accounts to average total deposits grew from 48.8% for the second quarter of 2003 to 51.8% for the second quarter of 2004, providing the majority of the Banks deposit growth in less expensive
deposits. Second, the Banks percentage of average loans to average assets increased to 80.7% for the second quarter of 2004 compared with 78.0% during the second quarter of 2003. The increase in net interest margin was above the Banks
projections and can be directly attributed to the above-mentioned change in the Banks deposit mix and the recent addition of commercial finance department fee income and SBA fees. Management foresees the margin decreasing to more historic
levels for the remainder of 2004.
Total interest income increased $600,284 or 21.4% for the period ended June 30, 2004 compared to the same period ended June 30, 2003. Interest income produced by the loan portfolio increased $623,920
or 24.7% for the three month period ended June 30, 2004 compared to the three month period ended June 30, 2003, due to the increase in average loans outstanding and origination fees associated with loan growth for the period. The increase in the
volume of loan interest income was partially offset by the general repricing of the loan portfolio in a low interest rate environment. Management estimates the average balances will continue to increase. Interest income on investment securities,
Federal Funds and other investments decreased $23,636 or 8.6% for the three-month period ending June 30, 2004 compared to the three-month period ended June 30, 2003. This was due primarily to a low interest rate environment in the Treasury and
Federal Funds markets and a position taken by the Bank to move to variable rate securities to reduce the interest rate risk associated if rates were to increase in the near future.
Total interest expense increased $12,641 or 1.5% from June 30, 2003 to June 30, 2004. The interest expense increase from the second quarter of 2003 to the second quarter of 2004 is primarily due to an
increase of $30.2 million in average interest bearing liabilities, but was mostly offset by decreases in the rates of certificates of deposit and the change in the deposit mix mentioned above.
The net interest margin for the second quarter of 2004 was 5.12% compared to 4.90% for the second quarter of 2003. The yield on earning assets decreased 15 basis points to 6.74% for the period ended
June 30, 2004, compared to 6.89% for the period ended June 30, 2003.
As the Federal Reserve decreased interest rates during the second quarter of 2003, deposits in general were able to reprice at a lower level and assisted the interest rate spread increase to 4.82% for
the three month period ending June 30, 2004 compared to 4.59% for the same period ending June 30, 2003, an increase of 23 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 $2.3 million allowance for loan losses
as of June 30, 2004 reflects the full known extent of credit exposure. Cornerstone
made a $250,000 provision during the second quarter of 2004 and anticipates
similar provisions in the future 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. ALLOWANCE
FOR LOAN LOSSES
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, commissions earned through service charges of deposit accounts 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 $39,346 or 13.6% for the second quarter of 2004 compared with the second quarter of 2003. The increase of non-interest income during the
second quarter of 2004 was broad based, but was highlighted by the new revenue generated by leases originated during the first half of 2004.
Non-interest Expense. Non-interest expense for the second quarter of 2004 increased by $220,833 or 15.5% compared to the same three months in 2003. Expenses for
salaries and employee benefits increased by $200,455 or 24.7% for the three months ending June 30, 2004 over the same period ending June 30, 2003. Occupancy and equipment expense as of June 30, 2004 increased by $28,305 or 16.4% over the same period
in 2003. All other non-interest expenses for the three-month period ended June 30, 2004 decreased $7,926 or 1.8% below the non-interest expenses for the same period ended June 30, 2003. The increase in non-interest expense is due primarily to the
cost to support the Banks 30% growth of assets and liabilities while protecting existing employees from competitors and the opening of the Banks fifth branch.
Item 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures
Cornerstones Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Cornerstones disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)) as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date). Based on such evaluation, such officers have concluded that,
as of the Evaluation Date, Cornerstones disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to Cornerstone (including its consolidated subsidiaries) required to be included in
Cornerstones periodic filings under the Exchange Act.
Since the Evaluation Date, there have not been any significant changes in Cornerstones internal controls or in other factors that could significantly affect such controls.
(State of Jurisdiction
of Incorporation or
Organization)
(I.R.S. Employer
Identification
Number)
Chattanooga, Tennessee 37423
(423) 385-3000
(Address, and Telephone Number of Principal Executive Offices
and Principal Place of Business)
Item 1. Financial Statements
CONSOLIDATED BALANCE
SHEET
Unaudited
Unaudited
June 30,
June 30,
2004
2003
2003
Cash and due from
banks
5,527,775
7,071,075
6,600,841
Due from banks
time deposits
Federal funds sold
1,615,000
3,060,000
Investment securities
available for sale
29,581,173
24,825,961
23,506,072
Investment securities
held to maturity
548,405
640,651
812,394
Federal Home Loan
Bank stock
837,600
582,300
576,800
Loans, less allowance
for loan loss
181,411,545
155,278,321
141,579,121
Premises and equipment,
net
5,812,386
4,292,566
3,903,529
Accrued interest
receivable
973,038
938,763
814,074
Excess cost over
fair value of assets acquired
2,541,476
2,541,476
2,541,476
Other assets
1,755,859
1,765,604
1,625,990
Total
Assets
230,604,257
200,996,717
181,960,297
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits
Noninterest-bearing
$
29,185,040
22,326,841
19,704,610
NOW accounts
31,694,528
28,513,598
23,331,500
Savings deposits
and money market accounts
31,375,663
27,712,339
25,188,406
Time deposits of
$100,000 or more
24,556,498
22,264,211
18,873,926
Time deposits of
less than $100,000
62,333,982
58,535,286
50,464,275
Total deposits
179,145,711
159,352,275
137,562,716
Federal funds purchased
and securites sold under
agreement to repurchase
3,561,501
6,084,078
9,902,394
Federal Home Loan
Bank Advance and note payable
29,150,000
17,400,000
17,000,000
Accrued interest
payable
70,194
102,163
92,184
Other liabilities
873,645
1,154,700
1,278,363
Total
Liabilities
212,801,051
184,093,216
165,835,657
Stockholders' Equity
Common stock
1,243,617
1,243,167
1,243,167
Additional paid-in
capital
12,193,318
12,183,868
12,183,868
Retained Earnings
4,441,796
3,295,884
2,440,563
Accumulated other
comprehensive income
(75,525)
180,582
257,042
Total Stockholders'
Equity
17,803,206
16,903,501
16,124,640
Total liabilities
and stockholders equity
230,604,257
200,996,717
181,960,297
CONSOLIDATED STATEMENTS OF INCOME
Three months ended
June 30,
Six months ended
June 30,
2004
2003
INTEREST INCOME
Interest and fees on loans
$
3,153,715
$
2,529,795
$
5,998,503
$
4,915,004
Interest on investment securities
248,835
267,548
479,944
503,648
Interest on federal funds
sold
1,168
1,649
2,739
15,134
Interest on other earning
assets
589
5,031
1,016
10,210
Total interest income
3,404,307
2,804,023
6,482,203
5,443,997
INTEREST EXPENSE
Interest bearing demand accounts
27,646
19,821
51,234
38,694
Money market accounts
93,958
82,095
176,911
150,332
Savings accounts
9,275
12,771
18,308
29,202
Time deposits of less than
$100,000
343,422
374,359
717,262
791,694
Time deposits of $100,000
or more
127,989
156,406
266,292
317,145
Federal funds purchased
12,468
11,836
16,754
16,235
Securities sold under agreements
to repurchase
7,288
6,629
10,803
10,670
Other borrowings
195,933
141,421
367,872
263,495
Total interest expense
817,978
805,337
1,625,435
1,617,468
Net interest income
2,586,329
1,998,686
4,856,768
3,826,529
Provision for loan losses
250,000
50,000
410,000
155,000
Net interest income after
the provision for loan losses
2,336,329
1,948,686
4,446,768
3,671,529
NONINTEREST INCOME
Service charges on deposit
accounts
177,886
164,135
343,289
309,639
Net securities gains (losses)
Other income
150,628
125,033
332,840
265,040
Total noninterest income
328,514
289,168
676,129
574,679
NONINTEREST EXPENSE
Salaries and employee benefits
1,012,390
811,936
1,923,099
1,555,977
Occupancy and equipment expense
200,805
172,500
433,931
335,550
Other operating expense
432,783
440,709
893,156
887,309
Total noninterest expense
1,645,977
1,425,145
3,250,185
2,778,836
Income before provision for
income taxes
1,018,866
812,709
1,872,712
1,467,372
Provision for income taxes
396,300
312,500
726,800
565,150
NET INCOME
$
622,566
$
500,209
$
1,145,912
$
902,222
Basic net income per common
share
0.50
0.40
0.92
0.73
Diluted net income per common
share
0.46
0.38
0.84
0.69
Dividends declared per common
share
2004
2003
Cash flows from
operating activities:
Net income
1,145,912
$
902,222
Adjustments to
reconcile net income
to net cash provided
by operating actvities:
Provision for loan
losses
410,000
$
155,000
Net Charge-offs
(432,535)
81,582
Depreciation and
amortization
244,319
145,812
Accrued interest
receivable
(34,275)
(134,476)
Accrued interest
payable
(31,969)
(29,086)
Changes in other
assets and liabilities
(2,021,310)
505,025
Net cash provided
by operating activities
(719,858)
1,626,079
Cash flows from
investing activities:
Purchase of investment
securities: AFS
(15,947,752)
(10,527,143)
Purchase of investment
securities: HTM
Proceeds from
security transactions: AFS
10,988,446
7,814,990
Proceeds from
security transactions: HTM
96,070
211,129
Purchase of due
from banks time deposits
Net increase
in loans
(26,434,114)
(18,719,125)
Purchase of bank
premises and equipment
(1,741,952)
(108,816)
Net cash used
in investing activities
(33,039,302)
(21,328,965)
Cash flows from
financing activities:
Net increase in
deposits
19,793,436
7,116,392
Net increase in
securities sold under agreements to repurchase
(2,522,577)
6,399,255
Net increase of
FHLB advances and other borrowings
13,500,000
7,400,000
Issuance of common
stock
Net cash provided
by financing activities
30,770,859
20,915,647
Net decrease in
cash and cash equivalents
(2,988,300)
1,212,761
Cash and cash equivalents
beginning of period
10,131,075
5,388,080
Cash and cash equivalents
end of period
7,142,775
6,600,841
Consolidated Statement of Changes in Stockholders' Equity
June 30, 2004
Accumulated
Additional
Retained
Other
Total
Comprehensive
Common
Paid-in
Earnings
Comprehensive
Stockholders'
Income
Stock
Capital
(Deficit)
Income
Equity
BALANCE, December
31, 2003
1,243,167
12,183,868
3,295,884
180,582
16,903,501
Redemption
of Common Stock
Issuance
of Common Stock
450
9,450
9,900
Comprehensive
Income:
Net
Income
1,145,912
1,145,912
1,145,912
Other
comprehensive income, net of tax:
Unrealized
holding gains (losses) on
securities
available for sale, net of
reclassification
adjustment
(256,107)
(256,107)
(256,107)
Total
comprehensive income
889,805
BALANCE, June 30,
2004
1,243,617
12,193,318
4,441,796
(75,525)
17,803,206
CORNERSTONE BANCSHARES, INC.
Compensation
Jun-04
Dec-03
Jun-03
Dec-02
Net Income, as reported
$1,145,911
$1,881,859
$902,222
$1,061,423
Deduct: Total Stock-based
employee
compensation expense determined
under
fair value method for all
awards, net of
the related tax effects
($24,734)
($36,962)
($18,481)
($21,348)
Pro Forma Net Income
$1,121,177
$1,844,897
$883,741
$1,040,075
Earnings Per Share:
Basic-as reported
$0.92
$1.52
$0.73
$0.86
Basic-pro forma
$0.90
$1.49
$0.71
$0.84
Diluted-as reported
$0.84
$1.41
$0.69
$0.83
Diluted-pro forma
$0.82
$1.39
$0.67
$0.81
Stock Amounts
Common Stock Issued
1,243,617
1,239,578
1,239,578
1,233,167
Forward-Looking Statements
Introduction
Overview
Results of Operations
Financial Condition
INTEREST INCOME / EXPENSE AND YIELD / RATES
Taxable equivalent basis
(in thousands)
Six months ended
June 30,
2004
2003
Assets
Average
Income /
Yield /
Average
Income /
Yield /
Balance
Expense
Rate
Balance
Expense
Rate
Loans, net of unearned income
169,079
5,999
7.15%
131,848
4,915
7.52%
Investment securities
26,032
480
3.84%
24,544
514
4.32%
Other earning assets
584
4
1.30%
2,427
15
1.26%
Total earning assets
195,694
6,482
6.69%
158,819
5,444
6.92%
Allowance for loan losses
(2,143)
(1,690)
Cash and other assets
15,251
12,738
TOTAL ASSETS
208,802
169,867
Liabilities and Stockholders'
Equity
Interest bearing liabilities:
Interest bearing demand deposits
26,353
51
0.39%
21,642
39
0.36%
Savings deposits
7,211
18
0.51%
6,813
29
0.86%
MMDA's
23,526
177
1.52%
18,110
150
1.67%
Time deposits
57,536
717
2.51%
51,359
792
3.11%
Time deposits of $100,000
or more
22,478
266
2.39%
19,091
317
3.35%
Federal funds and securities
sold under
agreements to repurchase
5,223
33
1.28%
4,452
27
1.22%
Other borrowings
22,782
362
3.21%
14,823
263
3.58%
Total interest bearing liabilities
165,111
1,625
1.99%
136,290
1,617
2.39%
Net interest spread
4,857
3,827
Noninterest bearing demand
deposits
24,846
16,790
Accrued expenses and other
liabilities
1,275
1,125
Stockholders' equity
17,570
15,662
TOTAL LIABILITIES
AND
STOCKHOLDERS' EQUITY
208,802
169,867
Net interest margin on earning
assets
5.02%
4.87%
Net interest spread on earning
assets
4.70%
4.53%
INTEREST INCOME / EXPENSE AND YIELD / RATES
Taxable equivalent basis
(in thousands)
Three months ended
June 30,
2004
2003
Assets
Average
Income /
Yield /
Average
Income /
Yield /
Balance
Expense
Rate
Balance
Expense
Rate
Loans, net of unearned income
175,397
3,154
7.21%
136,473
2,530
7.44%
Investment securities
27,312
249
3.79%
27,110
273
4.12%
Other earning assets
511
2
1.29%
103
2
6.39%
Total earning assets
203,220
3,404
6.74%
163,687
2,804
6.89%
Allowance for loan losses
(2,212)
Cash and other assets
16,417
12,948
TOTAL ASSETS
217,425
174,879
Liabilities and Stockholders'
Equity
Interest bearing liabilities:
Interest bearing demand deposits
26,351
28
0.42%
22,534
20
0.35%
Savings deposits
7,317
9
0.51%
6,889
13
0.74%
MMDA's
24,827
94
1.52%
19,474
82
1.69%
Time deposits
57,737
343
2.39%
50,264
374
2.99%
Time deposits of $100,000
or more
22,688
128
2.26%
19,081
156
3.29%
Federal funds and securities
sold under
agreements to repurchase
6,998
23
1.29%
6,078
18
1.22%
Other borrowings
24,900
193
3.11%
16,341
141
3.47%
Total interest bearing liabilities
170,820
818
1.92%
140,660
805
2.30%
2,586
1,999
Noninterest bearing demand
deposits
27,821
17,091
Accrued expenses and other
liabilities
1,116
1,196
Stockholders' equity
17,668
15,932
TOTAL LIABILITIES
AND
STOCKHOLDERS' EQUITY
217,425
174,879
Net interest margin on earning
assets
5.12%
4.90%
Net interest spread on earning
assets
4.82%
4.59%
2004
2003
Quarter Ending
June 30
March 31
December 31
September 30
June 30
Balance at beginning of period
2,113,930
2,011,329
2,090,751
1,827,734
1,691,538
Loans charged-off
(68,763)
(202,060)
(220,401)
(3,802)
(43,095)
Loans recovered
17,050
144,662
5,978
11,819
129,291
Net charge-offs (recoveries)
51,712
57,399
214,423
(8,018)
(86,196)
Provision for loan losses
charged
to expense
250,000
160,000
135,000
255,000
50,000
Balance at end of period
2,312,218
2,113,930
2,011,329
2,090,751
1,827,734
Allowance for loan losses
as a
percentage of average loans
outstanding for the period
1.318%
1.299%
1.311%
1.439%
1.339%
Allowance for loan losses
as a
percentage of nonperforming
assets
and loans 90 days past due
outstanding for the period
5125.050%
4802.094%
696.646%
482.654%
761.543%
Annualized QTD net charge-offs
as
a percentage of average loans
outstanding for the period
0.118%
0.141%
0.559%
-0.022%
-0.253%
Annualized YTD net charge-offs
as
a percentage of average loans
outstanding for the period
0.129%
0.141%
0.088%
-0.087%
-0.124%
YTD Average Outstanding Loans
169,078,607
162,760,681
141,586,000
137,585,459
131,848,342
QTD Average Outstanding Loans
175,396,703
162,760,681
153,454,946
148,873,000
136,473,429
Nonperforming assets and
loans 90 days past due
45,116
44,021
288,716
433,178
240,004
Changes in Internal Controls
OTHER INFORMATION
Item 1. Legal Proceedings
There are various claims and lawsuits in which the Bank is periodically involved incidental to the Banks business. In the opinion of Management, no material loss is expected from any of such pending claims or lawsuits.
Item 4. Submission of Matters to a Vote of Security Holders
Cornerstones annual shareholder meeting was held on April 22, 2004. At the meeting, the individuals whose names appear below were elected to Cornerstones board of directors. In addition, the shareholders approved an amendment to Cornerstones charter and the ratification of the appointment of Hazlett, Lewis & Bieter, PLL as its independent auditors for the fiscal year ending December 31, 2004. The shareholders votes were cast as follows with 70.6% of total shares voting:
For | Against | Abstain | |||||
Election of Directors | |||||||
B. Kenneth Driver | 99.8% | 0.0% | 0.2% | ||||
Karl Fillauer | 99.8% | 0.0% | 0.2% | ||||
Nathaniel F. Hughes | 99.6% | 0.0% | 0.4% | ||||
Gregory B. Jones | 99.6% | 0.0% | 0.4% | ||||
James H. Large | 99.6% | 0.0% | 0.4% | ||||
Jerry D. Lee | 99.7% | 0.0% | 0.3% | ||||
Lawrence D. Levine | 96.7% | 0.0% | 3.3% | ||||
Russell W. Lloyd | 96.8% | 0.0% | 3.2% | ||||
Earl A. Marler, Jr. | 99.8% | 0.0% | 0.2% | ||||
Doyce G. Payne, M.D. | 99.7% | 0.0% | 0.3% | ||||
Turner Smith | 99.8% | 0.0% | 0.2% | ||||
Bill O. Wiggins | 99.6% | 0.0% | 0.4% | ||||
Marsha Yessick | 91.1% | 0.0% | 8.9% | ||||
Amendment to Charter | 97.7% | 1.9% | 0.4% | ||||
Ratification of Appointment of | |||||||
Hazlett, Lewis & Bieter, PLLC | 99.4% | 0.3% | 0.3% |
Item 5. Other Information
The Company has announced a two-for-one stock split with a record date of August 16, 2004 and payment date of September 15, 2004.
Item 6. Exhibits and Reports on Form 8-K
(a) | Exhibits | |||||
Exhibit Number | Description | |||||
3
|
First Amendment to Amended and Restated Charter of Cornerstone Bancshares, Inc. (1) | |||||
31 |
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002. | |||||
32 |
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002. | |||||
|
||||||
(1) Incorporated by reference from Exhibit 3 of the registrants Form 10-QSB filed on May 14, 2004. | ||||||
(b) | Reports on Form 8-K | |||||
(1) Form 8-K filed on April 16, 2004, disclosing press release related to first quarter earnings. | ||||||
(2)
Form 8-K filed on July 23, 2004, disclosing press release
related to second quarter earnings and announcement of stock-split.
|
||||||
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.
Cornerstone Bancshares, Inc. | ||||
Date: | August 14, 2004 | /s/ Gregory B. Jones | ||
|
||||
Gregory B. Jones, | ||||
Chairman and Chief Executive Officer | ||||
Date: | August 14, 2004 | /s/ Nathaniel F. Hughes | ||
|
||||
Nathaniel F. Hughes | ||||
President and Chief Financial Officer |
EXHIBIT INDEX | ||||||
Exhibit Number | Description | |||||
3
|
First Amendment to Amended and Restated Charter of Cornerstone Bancshares, Inc. (1) | |||||
31 |
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002. | |||||
32 |
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002. | |||||
|
||||||
(1) Incorporated by reference from Exhibit 3 of the registrants Form 10-QSB filed on May 14, 2004. |
EXHIBIT 31 |
CERTIFICATION
I, Gregory B. Jones, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Cornerstone Bancshares, Inc (the Registrant);
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in the light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as, and for, the periods presented in this quarterly report
4. The Registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) for the Registrant and have:
(a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the Registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusion about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the
Registrants auditors and the audit committee of Registrants board of directors (or persons performing the equivalent functions);
(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrants ability to record, process, summarize and report financial data and have identified for the Registrants auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrants internal controls; and
6. The Registrants other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: | August 14, 2004 | ||
/s/ Gregory B. Jones | |||
Gregory B. Jones, | |||
Chairman and Chief Executive Officer |
CERTIFICATION
I, Nathaniel F. Hughes, President and Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Cornerstone Bancshares, Inc;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in the light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as, and for, the periods presented in this quarterly report
4. The Registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) for the Registrant and have:
(a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the Registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusion about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the
Registrants auditors and the audit committee of Registrants board of directors (or persons performing the equivalent functions);
(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrants ability to record, process, summarize and report financial data and have identified for the Registrants auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrants internal controls; and
6. The Registrants other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: | August 14, 2004 | ||
/s/ Nathaniel F. Hughes | |||
Nathaniel F. Hughes | |||
President and Chief Financial Officer |
Exhibit 32 |
CERTIFICATIONS PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)
In connection with the Quarterly Report of Cornerstone Bancshares, Inc., a Tennessee corporation (the Company), on Form 10-QSB for the quarter ended June 30, 2004, as filed with the Securities and Exchange Commission (the Report), Gregory B. Jones, Chief Executive Officer of the Company and Chairman of the Companys Board of Directors, and Nathaniel F. Hughes, President and Chief Financial Officer of the Company, respectively, do each hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), that to his knowledge:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
/s/ Gregory B. Jones
Gregory B. Jones Chief Executive Officer
August 14, 2004
/s/ Nathaniel F. Hughes
Nathaniel F. Hughes Chief Financial Officer
August 14, 2004
[A signed original of this written statement required by Section 906 has been provided to Cornerstone Bancshares Inc. and will be retained by Cornerstone Bancshares, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.]