10QSB

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 June30, 2005

o TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________________ to _________________________ 

Commission file number 000-30497

CORNERSTONE BANCSHARES, INC.

(Exact name of small business issuer as specified in its charter)

Tennessee (State of Jurisdiction of Incorporation or Organization)		62-1173944 (I.R.S. Employer Identification Number)
	5319 Highway 153 Chattanooga, Tennessee 37423 (423) 385-3000 (Address, and Telephone Number of Principal Executive Offices and Principal Place of Business)

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 o

APPLICABLE ONLY TO CORPORATE ISSUERS

The aggregate market value of the Registrant’s outstanding Common Stock held by non-affiliates of the Registrant on June 30, 2005 was approximately $44,102,016. There were 3,051,334 shares of Common Stock outstanding as of June 30, 2005.

Transitional Small Business Disclosure Format (check one) :

Yes oNo x

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

	Unaudited					Unaudited
	June 30,		December 31,			June 30,
ASSETS	2005		2004			2004
Cash and due from banks	$	19,191,605	$	6,900,054		$	5,527,775
Federal funds sold		-		-			1,615,000
Cash and cash equivalents		19,191,605		6,900,054			7,142,775
Securities available for sale		28,955,665		26,470,691			29,581,173
Securities held to maturity		347,523		390,599			548,405
Federal Home Loan Bank stock, at cost		947,600		854,200			837,600
Loans, net of allowance for loan losses of  $ 3,054,841 at June 30, 2005, $2,665,464 at  December 31, 2004 and $2,312,218 at June 30, 2004
Bank premises and equipment, net		5,978,552		5,967,735			5,812,386
Accrued interest receivable		1,309,010		1,184,478			973,038
Goodwill		2,541,476		2,541,476			2,541,476
Other assets		2,319,793		1,749,539			1,755,859
Total Assets	$	298,082,925	$	248,614,634		$	230,604,257
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits	$	30,348,607	$	34,024,241		$	29,185,040
Interest-bearing demand deposits		39,552,512		32,855,396			31,694,528
Savings deposits and money market accounts		59,949,138		31,211,457			31,375,663
Time deposits of $100,000 or more		30,078,939		30,089,057			24,556,498
Time deposits of less than $100,000		70,030,958		59,652,751			62,333,982
Total deposits		229,960,154		187,832,902			179,145,711
Federal funds purchased and securites sold under agreements to repurchase		5,994,419		7,409,162			3,561,501
Federal Home Loan Bank advances and note payable		32,000,000		27,000,000			29,150,000
Accrued interest payable		109,210		91,595			70,194
Other liabilities		1,632,206		1,473,655			873,645
Total Liabilities		269,695,989		223,807,314			212,801,051
Stockholders' Equity
Common stock - $l.00 par value; 10,000,000 authorized at June 30, 2005 and December 31, 2004 and 2,000,000 shares authorized at June 30, 2004; shares issued and  outstanding - 3,051,334 at June 30, 2005, 2,868,823 at  December 31, 2004, and 1,243,617 at June 30, 2004		3,051,334		2,868,823			1,243,617
Commom stock subscribed; 119,961 shares at December 31, 2004
Additional paid-in capital		19,415,074		19,160,936			12,193,318
Retained earnings		5,848,883		4,340,981			4,441,796
Accumulated other comprehensive income		71,645		116,034			(75,525	)
		28,386,936		26,606,735			17,803,206
Stock subscription receivable		-		(1,799,415	)		-
Total Stockholders' Equity		28,386,936		24,807,320			17,803,206
Total liabilities and stockholders' equity	$	298,082,925	$	248,614,634		$	230,604,257

CONSOLIDATED STATEMENTS OF INCOME

	Unaudited				Unaudited
	Three months ended				Six months ended
	June 30,				June 30,
	2005		2004		2005		2004
INTEREST INCOME
Loans, including fees	$	4,495,493	$	3,153,715	$	8,529,172	$	5,998,503
Investment securities		314,891		248,835		580,024		479,944
Federal funds sold		31,257		1,168		52,907		2,739
Other earning assets		2,358		588		4,389		1,016
Total interest income		4,843,999		3,404,306		9,166,492		6,482,202
INTEREST EXPENSE
Interest bearing demand accounts		81,310		27,646		146,847		51,233
Money market accounts		260,230		93,958		429,286		176,911
Savings accounts		19,342		9,275		32,274		18,308
Time deposits of less than $100,000		539,218		343,421		950,833		717,262
Time deposits of more than $100,000		233,598		127,989		438,118		266,292
Federal funds purchased		7,545		12,468		20,510		16,754
Securities sold under agreements to repurchase		13,834		7,287		27,843		10,803
Other borrowings		272,256		195,933		516,938		367,872
Total interest expense		1,427,333		817,977		2,562,649		1,625,435
Net interest income before provision for loan losses		3,416,666		2,586,329		6,603,843		4,856,767
Provision for loan losses		340,000		250,000		550,000		410,000
Net interest income after the provision for loan losses		3,076,666		2,336,329		6,053,843		4,446,767
NONINTEREST INCOME
Service charges		162,843		177,886		317,290		343,289
Other income		107,535		150,628		254,805		332,842
Total noninterest income		270,378		328,514		572,095		676,131
NONINTEREST EXPENSE
Salaries and employee benefits		1,074,939		1,012,390		2,167,235		1,923,099
Occupancy and equipment expense		209,827		200,805		426,385		433,931
Other operating expense		571,958		432,783		1,167,808		893,156
Total noninterest expense		1,856,724		1,645,978		3,761,428		3,250,186
Income before provision for income taxes		1,490,320		1,018,865		2,864,510		1,872,712
Provision for income taxes		578,500		396,300		1,112,500		726,800
NET INCOME	$	911,820	$	622,565	$	1,752,010	$	1,145,912
EARNINGS PER COMMON SHARE
Basic net income per common share	$	0.30	$	0.25	$	0.59	$	0.46
Diluted net income per common share	$	0.28	$	0.23	$	0.53	$	0.42
DIVIDENDS DECLARED PER COMMON SHARE	$	0.08	$	-	$	-	$	-

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30

	Unaudited			Unaudited
	2005			2004
Cash flows from operating activities:
Net income	$	1,752,010		$	1,145,912
Adjustments to reconcile net income
to net cash provided by (used in) operating actvities:
Provision for loan losses		550,000			410,000
Depreciation and amortization		234,850			244,319
Changes in other operating assets and liabilities:
Accrued interest receivable		(124,532	)		(34,275	)
Accrued interest payable		17,615			(31,969	)
Other assets and liabilities		(571,940	)		(2,021,309	)
Net cash provided (used in) by operating activities		1,858,003			(287,322	)
Cash flows from investing activities:
Purchase of investment securities: AFS		(9,722,538	)		(15,947,752	)
Proceeds from security transactions: AFS		7,312,123			10,988,446
Proceeds from security transactions: HTM		42,798			96,070
Purchase of FHLB Stock		(93,400	)		-
Loan originations and principal collections, net		(34,325,216	)		(26,866,649	)
Purchase of bank premises and equipment		(326,462	)		(1,741,952	)
Net cash used in investing activities		(37,112,695	)		(33,471,837	)
Cash flows from financing activities:
Net increase in deposits		42,127,252			19,793,436
Net increase in securities sold under agreements to repurchase		(1,414,743	)		(2,522,577	)
Proceeds from Federal Home Loan Bank advances and other borrowings		5,000,000			13,500,000
Dividends paid on common stock		(282,369	)		-
Issuance of common stock		2,116,103			-
Net cash provided by financing activities		47,546,243			30,770,859
Net increase (decrease) in cash and cash equivalents		12,291,551			(2,988,300	)
Cash and cash equivalents beginning of period		6,900,054			10,131,075
Cash and cash equivalents end of period	$	19,191,605		$	7,142,775
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest	$	2,545,034		$	1,657,404
Cash paid during the period for taxes	$	943,500			1,127,822

Cornerstone Bancshares, Inc. and Subsidiary

Consolidated Statement of Changes in Stockholders' Equity - Unaudited

June 30, 2005

						Common			Additional					Other			Stock			Total
	Comprehensive			Common		Stock			Paid-in		Retained			Comprehensive			Subscriptions			Stockholders'
	Income			Stock		Subscribed			Capital		Earnings			Income			Receivable			Equity
BALANCE, December 31, 2004				$	2,868,823	$	119,961		$	19,160,936	$	4,340,981		$	116,034		$	(1,799,415	)	$	24,807,320
Issuance of common stock					62,550		-			254,138		-			-			-			316,688
Dividend - $0.08 per share					-		-			-		(244,108	)		-			-			(244,108	)
Stock subscriptions redeemed					119,961		(119,961	)		-		-			-			1,799,415			1,799,415
Comprehensive income:
Net income	$	1,752,010			-		-			-		1,752,010			-			-			1,752,010
Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities available for sale, net of reclassification adjustment		(44,389	)		-		-			-		-			(44,389	)		-			(44,389	)
Total comprehensive income	$	1,707,621
BALANCE, June 30, 2005				$	3,051,334	$	-		$	19,415,074	$	5,848,883		$	71,645		$	-		$	28,386,936

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CORNERSTONE BANCSHARES, INC.

PRESENTATION OF FINANCIAL INFORMATION

The 2005 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 2004 Annual Report to Shareholders which was furnished to each shareholder of Cornerstone Bancshares, Inc. (“Cornerstone”) in March of 2005. 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, 2004, as filed with the Securities and Exchange Commission. Since December 31, 2004, 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 Cornerstone’s 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 weighted average number of common shares outstanding during the period (denominator). Diluted EPS is computed by dividing income available to common shareholders (numerator) by the adjusted weighted average number of shares outstanding (denominator). The adjusted weighted average 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 Compensation

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.

	Jun-05			Jun-04			Dec-04			Dec-03
Net Income, as reported	$	1,752,010		$	1,145,912		$	2,571,083		$	1,881,859
Deduct: Total Stock-based employee compensation expense determined under fair value method for all awards, net of the related tax effects		($54,048	)		($24,734	)		($49,469	)		($36,962	)
Pro Forma Net Income (2)	$	1,697,962		$	1,121,178		$	2,521,614		$	1,844,897
Earnings Per Share:
Basic-as reported	$	0.59		$	0.46		$	1.03		$	0.76
Basic-pro forma	$	0.57		$	0.45		$	1.01		$	0.74
Diluted-as reported	$	0.53		$	0.42		$	0.92		$	0.71
Diluted-pro forma	$	0.52		$	0.41		$	0.90		$	0.69
Stock Amounts
Average Common Stock Issued as of: (1)		2,988,038			2,487,234			2,490,340			2,479,156
Effect of dilutive stock options:		288,061			233,800			308,873			184,762

1.   The number of average common shares issue as of June 2004 and December 2003 reflect the retroactive adjustment caused by a two-for-one-stock split in the form of a 100% stock dividend which occurred September 15, 2004.

2.   Three month periods ended June 30, 2005 and June 30, 2004 data is not presented within the table in that it does not differ significantly from the six month periods data.

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, 2005, commitments under standby letters of credit and undisbursed loan commitments aggregated $54,030,202. The Bank’s 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.

Forward-Looking Statements

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 Cornerstone’s 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.

Introduction

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 Bank’s business consists primarily of attracting deposits from the general public and, with these and other funds, originating real estate loans, consumer loans, business loans, and residential and commercial construction loans. The principal sources of income for the Bank are interest and fees collected on loans, fees collected on deposit accounts, and interest and dividends collected on other investments.  The principal expenses of the Bank are interest paid on deposits, employee compensation and benefits, office expenses, and other overhead expenses. 

The following discussion and analysis sets forth the major factors that affect Cornerstone’s results of operations and financial condition reflected in the unaudited financial statements for the three-month and six-month periods ended June 30, 2005 and 2004. This discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements contained herein and notes attached thereto.

Overview

As of June 30, 2005 Cornerstone had total consolidated assets of $298.1 million, total loans of $236.4 million, total deposits of $229.9 million and stockholders equity of $28.4 million. Our net income was $911,820 and $1,752,010 for the three and six months ended June 30, 2005, respectively.

Results of Operations

Cornerstone ended the first six months of 2005 with total assets of $298.1 million, a 19.9% increase from December 31, 2004 and a 29.3% increase from June 30, 2004. Cornerstone reported net income for the six months ending June 30, 2005 of $1,752,010, or $0.59 basic earnings per share, compared to $1,145,912, or $0.46 basic earnings per share, for the same period in 2004. The increase in earnings during the first six months of 2005 represents a 52.9% increase compared to the first six months of 2004. The total number of outstanding shares as of the end of the second quarter ended June 30, 2005 was 3,051,334 compared to a stock split adjusted 2,487,234 in the second quarter ended June 30, 2004.

The increase in net income for the first six months of 2005 was due primarily to the 16.8% growth of loans and 22.4% growth of deposits since the 2004 year end and the increase in the Bank’s net interest margin to 5.30%. The balance sheet growth and enlarged net interest margin enabled the Bank to increase its net interest income by $1.7 million or 36% compared to the same period in 2004. The Bank’s relationship managers accomplished this by collecting fees on newly originated loans and by selling loan participations to other banks outside of Cornerstone’s market area and retaining a servicing fee and the customer’s deposits. In addition, the Bank’s asset sensitivity contributed 20-30 basis points of the net interest margin increase and should be considered temporary since the interest expense will catch up once the Federal Reserve stops increasing interest rates. The Bank’s success is considered to be directly related to the quality of its relationship managers and the Bank will continue to seek additional talented lenders to increase the Bank’s market share of business banking in the Chattanooga MSA.

The Bank was also able to increase deposits by 42.1 million over the first six months of 2005. The Bank’s non-interest bearing checking accounts increased $1.2 million and interest bearing checking accounts increased $8 million or 24.79% while savings accounts and money market accounts increased 91.1% or $28.6 million when compared to the same time period in 2004. The Bank has a material deposit that represents a large portion of the growth of deposits in the money market category. The deposit is from an out of state depositor that uses the Bank for ACH services and has ranged from $7 to $30 million and should not be considered a core deposit. The increases, including the above mentioned large deposit, are due to the Bank’s continued focus on attracting transaction accounts that allowed the Bank to maintain its above peer average net interest margin. The Bank selected longer-term maturities to reduce the Bank’s general interest rate risk, and utilized its federal funds lines of credit as an inexpensive source of funds. The Bank anticipates slower deposit growth in transaction deposits during the second half of 2005.

Non-interest income decreased 15.4% for the first six months of 2005 compared to the same period in 2004. This decrease was due to increased non-interest bearing checking balances which reduced the Bank’s analysis charges on business checking accounts. In addition, gains from the sale of mortgage loans on the secondary market continue to slow as the refinance market for one to four family residences slowed substantially. However the Bank saw continued gains in non-interest revenue from electronic payments.

On the qualitative side, the Bank maintained its asset quality, which is quantified by the Bank’s below peer bank average of past due loans to net loans ratio of 0.32% and a below peer bank average non-performing asset ratio of 0.52%. 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 2005, the Bank’s net interest margin was 5.30%, compared to 5.03% for the same time period in 2004. The Bank’s management expects the Bank’s net interest margin to decrease slightly to a more historic level of 4.9% over the remainder of 2005.

During the second quarter of 2005 the Federal Reserve continued its steady move to a neutral stance with monetary policy. The United State’s GDP settled into a 3% growth level and the financial markets began to price into the interest rate curve the expectation that the rise in interest rates would eliminate all chances of inflation. Management believes the economy will remain robust (remain above a 3% GDP growth) and inflation will become an issue in 2006 due to the enormous budget deficit and equally large trade deficit. As a result, management believes interest rate adjustments will continue for at least a short period of time. The Bank believes the Federal Reserve will continue to increase rates repetitively until the Federal Funds rate is in the 4% range. Due to this position, the Bank has a positive “GAP” which means the Bank’s assets will reprice quicker than its liabilities as interest rates increase or decrease and is in an appropriate position if rates were to increase as most economists have predicted.

During the second quarter of 2005 Cornerstone continued to work on expanding its manpower and capital capacity to maintain quality customer service as the Bank continued to grow at an above average pace. Cornerstone is determined to continue to find quality commercial relationship managers as they become available in our market and build the appropriate support staff to enable them.

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 Bank’s 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, 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.

Financial Condition

Earning Assets. Average earning assets for the six months ending June 30, 2005, increased by $56.4 million, or 28.8% compared to the six months ending June 30, 2004, while actual earning assets increased $52.7 million or 24.65% during the same period. The average and actual balance increases were due to strong loan demand in the first half of 2005 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 2005.

Loan Portfolio. The Bank's average loans for the first six months of 2005 were $219.6 million, an increase of $50.4 million, or 29.8% compared to the first six months of 2004, while actual balances increased to $236.5 million, an increase of 30.4% above the $181.4 million in loans as of June 30, 2004. 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 increased by 9.2% or $2.4 million for the six months ending June 30, 2005 compared to the six months ending June 30, 2004, while actual balances decreased $716 thousand or 2.31%. Management believes the appropriate current level of investment securities for the Bank is $30.0 million and will carefully purchase securities that provide acceptable return versus the interest rate risk. Management anticipates the average and actual balance of securities to increase over the remainder of 2005. 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, 2005, net unrealized gains in the "Available for Sale" portfolio amounted to $108,553, a 0.36% increase in value.

Deposits.The Bank's average deposits increased by $49.4 million or 26% for the six-month period ending June 30, 2005 compared to the same period ending June 30, 2004, while actual deposit balances increased by $50.8 million or 28.36%. The actual deposit growth was broad based with non-interest bearing transaction accounts increasing by 12.18% 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 2005 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 2005 the Bank had $32 million of Federal Home Loan Bank of Cincinnati (“FHLB”) borrowings. The borrowings are designed with a maturity of 10 years with call and put options after a stated conversion date. 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.

Average stockholders' equity increased by $9.2 million or 53.1% to $26.7 million for the six months ending June 30, 2005 compared with $17.5 million during the six months ending June 30, 2004. Actual equity increased by $10.6 million or 59.5% from June 30, 2004 to June 30, 2005. This increase was primarily due to a stock offering during the last quarter of 2004 wherein 500,000 additional shares of stock were sold at $15 per share, raising stockholder’s equity by $7.5 million. The remainder of the increase was due to the increase of retained earnings.

CONSOLIDATED AVERAGE BALANCE SHEET

INTEREST INCOME / EXPENSE AND YIELD / RATES

Taxable equivalent basis

(in thousands)

	Six months ended
	June 30,
	2005								2004
Assets	Average			Income /		Yield /			Average			Income /		Yield /
	Balance			Expense		Rate			Balance			Expense		Rate
Loans, net of unearned income	$	219,567		$	8,529		7.83	%	$	169,126		$	5,999		7.15	%
Investment securities		28,450			580		4.22	%		26,043			480		3.81	%
Other earning assets		4,097			57		2.82	%		579			4		1.31	%
Total earning assets		252,114			9,166		7.34	%		195,748			6,482		6.69	%
Allowance for loan losses		(2,816	)							(2,143	)
Cash and other assets		18,804								15,378
TOTAL ASSETS		268,102								208,983
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand deposits	$	33,099		$	147		0.89	%	$	26,351		$	51		0.39	%
Savings deposits		7,783			32		0.84	%		7,212			18		0.51	%
MMDA's		34,592			429		2.50	%		23,532			177		1.52	%
Time deposits		65,518			951		2.93	%		57,540			717		2.51	%
Time deposits of $100,000 or more		29,232			438		3.02	%		22,479			266		2.39	%
Federal funds and securities sold under agreements to repurchase		6,044			52		1.73	%		5,234			33		1.28	%
Other borrowings		30,370			513		3.41	%		23,049			362		3.17	%
Total interest bearing liabilities		206,638			2,563		2.50	%		165,397			1,625		1.98	%
Net interest spread				$	6,604							$	4,857
Noninterest bearing demand deposits		33,082								24,876
Accrued expenses and other liabilities		1,614								1,223
Stockholders' equity		26,768								17,487
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		268,102								208,983
Net interest margin on earning assets							5.29	%							5.02	%
Net interest spread on earning assets							4.84	%							4.71	%

Results of Operations - Six months ended June 30, 2005 compared to six months ended June 30, 2004

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 2005 increased $1.7 million. or 36% above net interest income before loan loss provision for the first six months of 2004. The increase in net interest income as of June 30, 2005 was primarily due to the growth in earning assets while deposit cost increased at a slower rate. Average earning assets grew to $252.1 million compared to $195.7 in June 2004. Interest income from earning assets increased from 6.69% to 7.34% during the second quarter while the cost of deposits grew from 1.98% to 2.5%over the same period. The increase in net interest margin was above the Bank’s projections and can be directly attributed to the above-mentioned change in the Bank’s 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 2005.

Interest income increased $2,684,288 or 41.4% for the period ended June 30, 2005 compared to the same period ended June 30, 2004. Interest income produced by the loan portfolio increased $2,530,669 or 42.2% for the six month period ended June 30, 2005 compared to six month period ended June 30, 2004, 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 lower interest rate environment. Management estimates the average and actual balances will continue to increase throughout the remainder of 2005. Interest income on investment securities, Federal Funds and other investments increased $153,621 or 31.7% for the six month period ending June 30, 2005 compared to the six month period ended June 30, 2004. This was largely due to money market deposit growth providing opportunity for Federal Funds investments.

Total interest expense increased $937,214 or 57.7% from June 30, 2004 to June 30, 2005.The interest expense increase from the second quarter of 2004 to the second quarter of 2005 is primarily due to an increase of $41.2 million in average interest bearing liabilities.

The net interest margin for the second quarter of 2005 was 5.3% compared to 5.03% for the same period of 2004. The yield on earning assets increased 65 basis points to 7.34% for the period ended June 30, 2005, compared to 6.69% for the period ended June 30, 2004.

The measure the Bank and many other financial institutions use to measure this interest rate sensitivity is a GAP report. The report determines the amount of difference between repricing assets and liabilities over a period of time. The period most commonly used by financial institutions is the one year cumulative GAP. Currently the Bank’s balance sheet structure is considered asset sensitive, which means the assets will reprice faster than liabilities. The Bank’s one year cumulative GAP is 26.6% and considered beneficial if rates are moving up. Management anticipates that the Federal Reserve will continue to increase short term interest rates for the rest of 2005 which should benefit the Bank’s earning for the short term until liabilities have time to reprice and the Bank’s net interest margin returns to a more normal level. Management plans to actively manage the balance sheet and during the fourth quarter reduce the asset sensitivity of the Bank to a more neutral position that would not negatively impact earnings if short term interest rates were to go down.

Allowance for Loan Losses.The allowance for 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 loan losses and the appropriate provisions required to maintain a level considered adequate to absorb anticipated loan losses. Management believes that the $3.1 million allowance for loan losses as of June 30, 2005 reflects the full known extent of credit exposure. The Bank made a $550,000 provision during the first half of 2005 compared to $410,000 during the same period 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, 2005, the Bank had $857,069 in non-accruing loans and $380,722 in repossessed and foreclosed properties of which the majority is one relationship with three 1-4 family residences as collateral, compared to $45,116 in non-accruing loans and none in repossessed and foreclosed properties as of June 30, 2004.

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 fromthe sale of residential mortgage loans are included in non-interest income. Total non-interest income decreased by $104,034 or 15.4% from the first half of 2004 compared with the first half of 2005.

Non-interest Expense. Non-interest expense for the first six months of 2005 increased by $511,242 or 15.73% compared to the first six months in 2004. Expenses for salaries and employee benefits increased for the six months ending June 30, 2005 increased by $244,136 or 12.7% over the same period ending from June 30, 2004. Occupancy and equipment expense as of June 30, 2005 increased by $7,546 or 1.74% over the same period in 2004. All other non-interest expenses for the six-month period ended June 30, 2005 increased $274,652 or 30.7% over the non-interest expenses for the same period ended June 30, 2004. The increase in non-interest expenses is broad based and used to support the rapid growth of the Bank’s assets and liabilities in a safe and sound manner.

CONSOLIDATED AVERAGE BALANCE SHEET

INTEREST INCOME / EXPENSE AND YIELD / RATES

Taxable equivalent basis

(in thousands)

	Three months ended
	June 30,
	2005								2004
Assets	Average			Income /		Yield /			Average			Income /		Yield /
	Balance			Expense		Rate			Balance			Expense		Rate
Loans, net of unearned income	$	228,367		$	4,495		7.90	%	$	175,397		$	3,154		7.21	%
Investment securities		30,418			315		4.29	%		27,312			249		3.79	%
Other earning assets		4,527			34		2.98	%		511			2		1.38	%
Total earning assets		263,312			4,844		7.39	%		203,220			3,404		6.74	%
Allowance for loan losses		(2,933	)							(2,212	)
Cash and other assets		19,206								16,417
TOTAL ASSETS		279,585								217,425
Liabilities and Stockholders' Equity
Interest bearing liabilities:
Interest bearing demand deposits	$	33,510		$	81		0.97	%	$	26,351		$	28		0.42	%
Savings deposits		7,817			19		0.99	%		7,317			9		0.51	%
MMDA's		40,651			260		2.57	%		24,827			94		1.52	%
Time deposits under $100,000		69,359			539		3.12	%		57,737			343		2.39	%
Time deposits of $100,000 or more		29,229			234		3.21	%		22,688			128		2.26	%
Federal funds and securities sold under agreements to repurchase		4,805			25		2.07	%		6,998			22		1.29	%
Other borrowings		32,000			269		3.37	%		24,900			193		3.11	%
Total interest bearing liabilities		217,370			1,427		2.63	%		170,820			818		1.92	%
				$	3,417							$	2,586
Noninterest bearing demand deposits		32,720								27,821
Accrued expenses and other liabilities		1,727								1,116
Stockholders' equity		27,768								17,668
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		279,585								217,425
Net interest margin on earning assets							5.22	%							5.10	%
Net interest spread on earning assets							4.76	%							4.82	%

Results of Operations - Three months ended June 30, 2005 compared to three months ended June 30, 2004

Net Interest Income.Net interest income before loan loss provision for the second quarter of 2005 increased $830,337 or 32.1% above net interest income before loan loss provision for the second quarter of 2004. The increase in net interest income was primarily due to an increase in income from earning asset growth during the three month period; loan growth representing $19.6 million or 8.91% from March 31, 2005. The interest yield from earning assets increased 65 basis point from 6.74% to 7.39%, while interest cost from the Bank’s liabilities increased 71 basis points from 1.92% to 2.63% over the same time period. The Bank’s deposit mix shifted as the percentage of average transaction accounts to average total deposits increased slightly to 13.4% from 13.3%, with average money market accounts increasing from $24 million during the three months ended June 30, 2004 to $40.1 million for the three months ended June 30, 2005.

The Bank’s percentage of average loans to average assets remained relatively constant for the three months ended June 30, 2005 compared to the same period ending June 30, 2004. The increase in net interest margin was above the Bank’s projections and can be directly attributed to the above-mentioned change in the Bank’s deposit mix and the continuation of commercial finance department fee income and SBA fees. Management foresees the margin decreasing to more historic levels for the remainder of 2005.

Total interest income increased $1.4 million or 42.3% during the second quarter of 2005 compared to the second quarter 2004. Interest income produced by the loan portfolio increased $1.3 million or 42.52% for the three month period ended June 30, 2005 compared to the three month period ended June 30, 2004, due to the increase in average loans outstanding and origination fees associated with loan growth for the period. Management estimates the average balances will continue to increase.

Interest income on investment securities, Federal Funds and other investments increased $98,000 or 39.04% for the three-month period ending June 30, 2005 compared to the three-month period ended June 30, 2004, largely due to an increase in Federal Funds. 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 $609,000 or 74.5% during the three months ending June 30, 2005 from the same period ending June 30, 2004.The interest expense increase from the second quarter of 2004 to the second quarter of 2005 was primarily due to an increase of $46.5 million or 27.2% in average interest bearing liabilities.

The net interest margin for the three months ended June 30, 2005 was 5.22% compared to 5.10% for the three months ended June 30, 2004. The yield on earning assets increased 72 basis points to 7.39% for the period ended June 30, 2005, compared to 6.74% for the period ended June 30, 2004.

Allowance for Loan Losses.The allowance for 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 loan losses and the appropriate provisions required to maintain a level considered adequate to absorb anticipated loan losses. Management believes that the $3.1 million allowance for loan losses as of June 30, 2005 reflects the full known extent of credit exposure. The Bank made a $340,000 provision during the second quarter of 2005 compared to $250,000 during the same period 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

	2005						2004
Quarter Ending	June 30			March 31			December 31			September 30			June 30
Balance at beginning of period		2,845,765			2,665,464			2,460,541			2,312,218			2,113,930
Loans charged-off		(135,055	)		(44,994	)		(60,810	)		(33,024	)		(68,763	)
Loans recovered		4,131			15,295			10,733			6,347			17,050
Net charge-offs (recoveries)		130,924			29,699			50,077			26,677			51,712
Provision for loan losses charged to expense		340,000			210,000			255,000			175,000			250,000
Balance at end of period		3,054,841			2,845,765			2,665,464			2,460,541			2,312,218
Allowance for loan losses as a  percentage of average loans outstanding for the period		1.314	%		1.351	%		1.356	%		1.294	%		1.318	%
Allowance for loan losses as a percentage of nonperforming assets and loans 90 days past due outstanding for the period		246.798	%		1056.833	%		1285.527	%		3571.540	%		5125.050	%
Annualized QTD net charge-offs as a percentage of average loans outstanding for the period		0.226	%		0.056	%		0.102	%		0.056	%		0.118	%
Annualized YTD net charge-offs as a percentage of average loans outstanding for the period		0.148	%		0.056	%		0.103	%		0.103	%		0.129	%
YTD Average Outstanding Loans		219,566,305			210,666,687			181,278,891			175,190,146			169,078,607
QTD Average Outstanding Loans		232,409,647			210,666,687			196,542,130			190,151,000			175,396,703
Nonperforming assets and loans 90 days past due		1,237,791			269,273			207,344			68,893			45,116

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 fromthe sale of loans are included in non-interest income. Total non-interest income decreased by $58,136 or 17.7% for the second quarter of 2005 compared with the second quarter of 2004. The decrease of non-interest income during the second quarter of 2005 was largely due to the reduced activity in secondary mortgage lending.

Non-interest Expense. Non-interest expense for the second quarter of 2005 increased by $210,745 or 12.8% compared to the same three months in 2004. Expenses for salaries and employee benefits increased by $62,549 or 6.18% for the three months ending June 30, 2005 over the same period ending June 30, 2004. Occupancy and equipment expense as of June 30, 2005 increased by $9,022 or 4.49% over the same period in 2004. All other non-interest expenses for the three-month period ended June 30, 2005 increased $139,174 or 32.16% below the non-interest expenses for the same period ended June 30, 2004. The increase in non-interest expense is due primarily to the cost to support the Bank’s growth of assets and liabilities while protecting existing employees from competitors.

Item 3.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Cornerstone’s Chief Executive Officer and Treasurer have evaluated the effectiveness of Cornerstone’s 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, Cornerstone’s 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 Cornerstone’s periodic filings under the Exchange Act.

Changes in Internal Controls

Since the Evaluation Date, there have not been any significant changes in Cornerstone’s internal controls or in other factors that could significantly affect such controls.

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 4.Submission of Matters to a Vote of Security Holders

Cornerstone’s annual shareholder meeting was held on April 21, 2005. At the meeting, the individuals whose names appear below were elected to Cornerstone’s board of directors. In addition, the shareholders ratified the appointment of Hazlett, Lewis & Bieter, PLL as its independent auditors for the fiscal year ending December 31, 2005. The shareholders’ votes were cast as follows with 78.8% of total shares voting:

	For	Against	Abstain
Election of Directors
B. Kenneth Driver	99.7%	0.0%	0.3%
Karl Fillauer	99.5%	0.0%	0.5%
Nathaniel F. Hughes	100.0%	0.0%	0.0%
Gregory B. Jones	100.0%	0.0%	0.0%
James H. Large	99.7%	0.0%	0.3%
Jerry D. Lee	100.0%	0.0%	0.0%
Lawrence D. Levine	99.5%	0.0%	0.5%
Russell W. Lloyd	99.7%	0.0%	0.0%
Earl A. Marler, Jr.	97.5%	0.0%	2.5%
Doyce G. Payne, M.D.	97.7%	0.0%	2.3%
Turner Smith	97.1%	0.0%	2.9%
Bill O. Wiggins	99.7%	0.0%	0.3%
Marsha Yessick	96.6%	0.0%	3.4%
Ratification of Appointment of Hazlett, Lewis & Bieter, PLLC	99.9%	0.0%	0.1%

Item 5.Other Information

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)
10.1	Employee Stock Ownership Plan between Cornerstone Community Bank and Nathaniel F. Hughes dated July 1, 2005. (2)
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 registrant’s Form 10-QSB filed on May 14, 2004.

(2)Incorporated by reference from Exhibit 10.1 of the registrant’s Form 8-K dated July 18, 2005.

(b)   Reports on Form 8-K

(1)   Form 8-K dated April 15, 2005, disclosing press release related to fiscal quarter ended March 31, 2005

(2)   Form 8-K dated April 25, 2005 disclosing the resignation of Russell Lloyd as a director.

(3)   Form 8-K dated May 19, 2005 disclosing press release related to the authorization of a $.08 cash dividend.

(4)   Form 8-K dated July 18, 2005 (i) disclosing a press release related to the fiscal quarter ended June 30, 2005 and (ii) an announcement of Employee Stock Ownership Plan by and between Cornerstone Community Bank, a wholly owned subsidiary of Cornerstone Bancshares, Inc. and Nathaniel F. Hughes.

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 15, 2005	/s/ Gregory B. Jones
	Gregory B. Jones,
	Chairman and Chief Executive Officer

Date:August 15, 2005	/s/ Nathaniel F. Hughes
	Nathaniel F. Hughes
	President and Treasurer

EXHIBIT INDEX

Exhibit Number	Description
3	First Amendment to Amended and Restated Charter of Cornerstone Bancshares, Inc. (1)
10.1	Employee Stock Ownership Plan between Cornerstone Community Bank and Nathaniel F. Hughes dated July 1, 2005. (2)
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 registrant’s Form 10-QSB filed on May 14, 2004.

(2)Incorporated by reference from Exhibit 10.1 of the registrant’s Form 8-K dated July 18, 2005.

EX-31.1

EXHIBIT 31.1

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 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 Registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the Registrant and have:

(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervisions, 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)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the Registrant’s disclosure controls and procedures; and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

5.The Registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions);

(a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control of internal controls over financial reporting.

Date:August 15, 2005	/s/ Gregory B. Jones
	Gregory B. Jones,
	Chairman and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Nathaniel F. Hughes, President and Treasurer, 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 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 Registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the Registrant and have:

(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

5.The Registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent functions);

(a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control of internal controls over financial reporting.

Date:August 15, 2005	/s/ Nathaniel F. Hughes
	Nathaniel F. Hughes
	President and Treasurer

EX-32

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, 2005, as filed with the Securities and Exchange Commission (the “Report”), Gregory B. Jones, Chief Executive Officer of the Company and Chairman of the Company’s Board of Directors, and Nathaniel F. Hughes, President and Treasurer of the Company, respectively, do each hereby certify, pursuant to § 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 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

Chairman and Chief Executive Officer

August 15, 2005

/s/ Nathaniel F. Hughes

Nathaniel F. Hughes

President and Treasurer

August 15, 2005

[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.]