-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IE3NY6LXtF9hPuriETT3CVyHdcwfoRgmnr/iAP3zenEZKvkf0g3TQvNrd6jhg9MK KARW9qUAgDzIFq6z7h024A== 0000948520-08-000167.txt : 20081112 0000948520-08-000167.hdr.sgml : 20081111 20081112172338 ACCESSION NUMBER: 0000948520-08-000167 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20080930 FILED AS OF DATE: 20081112 DATE AS OF CHANGE: 20081112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CORNERSTONE BANCORP/SC CENTRAL INDEX KEY: 0001087455 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 571077978 STATE OF INCORPORATION: SC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-51950 FILM NUMBER: 081181883 BUSINESS ADDRESS: STREET 1: PO BOX 428 CITY: EASLEY STATE: SC ZIP: 29641 BUSINESS PHONE: 8643061444 10-Q 1 cstn10q3-08.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended September 30, 2008 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Transition Period From _______________ To _________________. Commission File Number 000-51950 CORNERSTONE BANCORP - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) South Carolina 57-1077978 -------------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 1670 East Main Street, Easley, South Carolina 29640 (Address of principal executive offices) (864) 306-1444 (Registrant's telephone number, including Area Code) Not Applicable (Former name, former address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company . See definition of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X] (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: Common Stock - No Par Value, 1,991,565 shares outstanding on November 1, 2008 PART I FINANCIAL INFORMATION Item 1. Financial Statements CORNERSTONE BANCORP AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
September 30, December 31, 2008 2007 ---- ---- Assets (Unaudited) Cash and due from banks ....................................................................... $ 6,345,743 $ 4,266,777 Federal funds sold ............................................................................ 545,000 967,000 ------------- ------------- Cash and cash equivalents .............................................................. 6,890,743 5,233,777 Investment securities Available-for-sale ......................................................................... 19,713,894 18,054,409 Other investments .......................................................................... 1,027,250 816,500 Loans, net .................................................................................... 116,368,373 107,350,202 Property and equipment, net ................................................................... 5,611,376 5,808,568 Cash surrender value of life insurance policies ............................................... 1,750,744 1,697,429 Other real estate owned ....................................................................... 650,720 69,000 Other assets .................................................................................. 1,759,938 1,468,187 ------------- ------------- Total assets .................................................................... $ 153,773,038 $ 140,498,072 ============= ============= Liabilities And Shareholders' Equity Liabilities Deposits Noninterest bearing ...................................................................... $ 11,297,833 $ 13,645,852 Interest bearing ......................................................................... 105,096,701 97,288,616 ------------- ------------- Total deposits ........................................................................... 116,394,534 110,934,468 Customer repurchase agreements ............................................................. 4,650,324 5,802,935 Borrowings from Federal Home Loan Bank of Atlanta .......................................... 8,431,713 3,544,838 Broker repurchase agreements ............................................................... 5,000,000 - Other liabilities .......................................................................... 368,225 635,001 ------------- ------------- Total liabilities ........................................................................ 134,844,796 120,917,242 Commitments and contingencies Shareholders' equity Preferred stock, 10,000 shares authorized, no shares issued ................................ - - Common stock, no par value, 20,000,000 shares authorized, 1,991,565 and 1,983,169 shares issued at September 30, 2008 and December 31, 2007, respectively ................ 18,308,878 18,185,328 Retained earnings .......................................................................... 638,212 1,177,450 Accumulated other comprehensive income (loss) .............................................. (18,848) 218,052 ------------- ------------- Total shareholders' equity ............................................................... 18,928,242 19,580,830 ------------- ------------- Total liabilities and shareholders' equity ............................................... $ 153,773,038 $ 140,498,072 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. 2 CORNERSTONE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
For the three months ended For the nine months ended September 30, September 30, -------------- ------------- 2008 2007 2008 2007 ---- ---- ---- ---- Interest and Dividend Income Interest and fees on loans ............................. $ 1,957,863 $ 2,232,096 $ 5,997,307 $ 6,596,912 Investment securities .................................. 293,738 258,234 910,380 696,994 Federal funds sold and interest bearing balances ............................................... 20,420 73,630 82,414 192,518 ----------- ----------- ----------- ----------- Total interest income .............................. 2,272,021 2,563,960 6,990,101 7,486,424 ----------- ----------- ----------- ----------- Interest Expense Deposits ............................................... 748,011 1,021,001 2,498,885 2,866,884 Borrowings ............................................. 145,296 84,793 426,557 254,306 ----------- ----------- ----------- ----------- Total interest expense .............................. 893,307 1,105,794 2,925,442 3,121,190 ----------- ----------- ----------- ----------- Net Interest Income ...................................... 1,378,714 1,458,166 4,064,659 4,365,234 Provision for Loan Losses ................................ 220,000 23,610 460,000 136,636 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses ......................................... 1,158,714 1,434,556 3,604,659 4,228,598 ----------- ----------- ----------- ----------- Noninterest Income Service charges on deposit accounts .................... 152,043 143,586 439,587 392,463 Mortgage loan origination fees ......................... 53,408 95,576 226,038 376,831 Other than temporary impairment loss on investment securities available for sale .......................................... (918,264) - (918,264) - Other .................................................. 29,500 23,612 88,693 72,893 ----------- ----------- ----------- ----------- Total noninterest income (loss) ..................... (683,313) 262,774 (163,946) 842,187 ----------- ----------- ----------- ----------- Noninterest Expense Salaries and employee benefits ......................... 579,378 613,251 1,847,901 1,830,604 Premises and equipment ................................. 152,863 126,133 452,702 407,613 Data processing ........................................ 57,944 63,374 172,382 175,145 Professional and regulatory fees ....................... 97,626 82,830 245,437 249,041 Supplies ............................................... 19,637 32,100 60,856 78,082 Advertising ............................................ 16,625 19,947 52,255 56,489 Other .................................................. 163,312 148,508 463,967 388,809 ----------- ----------- ----------- ----------- Total noninterest expense ........................... 1,087,385 1,086,143 3,295,500 3,185,783 ----------- ----------- ----------- ----------- Net income (loss) before taxes ...................... (611,984) 611,187 145,213 1,885,002 Provision (benefit) for income taxes ..................... (206,510) 203,722 47,591 630,263 ----------- ----------- ----------- ----------- Net income (loss) ................................... $ (405,474) $ 407,465 $ 97,622 $ 1,254,739 =========== =========== =========== =========== Earnings (Loss) Per Share Basic .................................................. $ (.20) $ .21 $ .05 $ .64 Diluted ................................................ $ (.20) $ .20 $ .05 $ .62 Weighted Average Shares Outstanding Basic .................................................. 1,991,565 1,965,354 1,989,328 1,963,592 Diluted ................................................ 1,991,565 2,023,779 2,021,275 2,020,187
The accompanying notes are an integral part of these consolidated financial statements. 3 CORNERSTONE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME For the nine months ended September 30, 2008 and 2007 (Unaudited)
Accumulated Common stock other Total ------------ Retained comprehensive shareholders' Shares Amount earnings income (loss) equity ------ ------ -------- ------------- ------ Balance, December 31, 2006 ..................... 1,777,313 $ 15,972,666 $ 1,499,803 $ 66,258 $ 17,538,727 Net income ..................................... - - 1,254,739 1,254,739 Other comprehensive income, net of income taxes Unrealized loss on investment securities, net ............................. - - (12,495) (12,495) ------------ Comprehensive income ........................... - - 1,242,244 Stock based compensation ....................... - 30,268 30,268 Options exercised .............................. 9,491 92,044 92,044 Stock dividend (10%), net of cash in lieu of fractional shares ................... 178,550 1,932,875 (1,935,106) - (2,231) ------------ ------------ ------------ ------------ ------------ Balance, September 30, 2007 .................... 1,965,354 $ 18,027,853 $ 819,436 $ 53,763 $ 18,901,052 ============ ============ ============ ============ ============ Balance, December 31, 2007 ..................... 1,983,169 $ 18,185,328 $ 1,177,450 $ 218,052 $ 19,580,830 Net income ..................................... - - 97,622 - 97,622 Other comprehensive income, net of income taxes Unrealized loss on investment securities, net ............................. - - - (236,900) (236,900) ------------ Comprehensive income (loss) .................... (139,278) Cumulative effect of accounting change ......... - - (39,389) - (39,389) Stock based compensation ....................... - 41,717 - - 41,717 Options exercised .............................. 8,396 81,833 - - 81,833 Dividend paid .................................. - - (597,471) - (597,471) ------------ ------------ ------------ ------------ ------------ Balance, September 30, 2008 .................... 1,991,565 $ 18,308,878 $ 638,212 $ (18,848) $ 18,928,242 ============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 4 CORNERSTONE BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the nine months ended September 30, ------------- 2008 2007 ---- ---- Operating Activities Net income ................................................................................ $ 97,622 $ 1,254,739 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization .......................................................... 220,770 202,281 Provision for loan losses .............................................................. 460,000 136,636 Non-cash option expense ................................................................ 41,717 30,268 Other than temporary impairment loss of AFS securities .................................... 918,264 - Gain on sale of property and equipment .................................................... (481) - Gain on sale of property acquired in foreclosure .......................................... (3,828) - Changes in operating assets and liabilities Change in interest receivable .......................................................... 137,434 (84,494) Change in other assets ................................................................. (482,500) (109,188) Change in other liabilities ............................................................ (184,126) (68,631) ------------ ------------ Net cash provided by operating activities ........................................... 1,204,872 1,361,611 ------------ ------------ Investing Activities Proceeds from maturities and principal repayments of available for sale securities ........ 4,140,996 3,216,913 Purchase of FHLB and Federal Reserve stock ................................................ (210,750) (2,900) Purchase of investment securities available for sale ...................................... (7,085,514) (3,998,800) Purchase of property and equipment ........................................................ (22,763) (1,667,868) Proceeds from sale of property acquired in foreclosure .................................... 343,852 - Proceeds from sale of property and equipment .............................................. 7,495 - Net increase in loans to customers ........................................................ (10,399,915) (8,144,648) ------------ ------------ Net cash used for investing activities .............................................. (13,226,599) (10,597,303) ------------ ------------ Financing Activities Net increase in demand, savings and time deposits ......................................... 5,460,066 9,350,958 Net increase (decrease) in customer repurchase agreements ................................. (1,152,611) 657,757 Repayment of FHLB advances ................................................................ (3,413,125) (113,125) Borrowings from FHLB ...................................................................... 8,300,000 - Increase in broker repurchase agreements .................................................. 5,000,000 - Dividends paid ............................................................................ (597,470) - Cash paid in lieu of fractional shares for stock dividend ................................. - (2,231) Proceeds from exercise of stock options ................................................... 81,833 92,044 ------------ ------------ Net cash provided by financing activities ........................................... 13,678,693 9,985,403 ------------ ------------ Net increase in cash and cash equivalents ........................................... 1,656,966 749,711 Cash and Cash Equivalents, Beginning of Period ................................................. 5,233,777 5,911,623 ------------ ------------ Cash and Cash Equivalents, End of Period ....................................................... $ 6,890,743 $ 6,661,334 ============ ============ Supplemental Information Cash paid for interest ..................................................................... $ 2,937,257 $ 3,069,085 Cash paid for income taxes ................................................................. $ 438,048 $ 727,075
The accompanying notes are an integral part of these consolidated financial statements. 5 CORNERSTONE BANCORP AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Summary of Significant Accounting Principles A summary of significant accounting policies is included in the Cornerstone Bancorp (the "Company") 2007 Annual Report to Shareholders, which also contains the Company's audited financial statements for 2007 and is also included in the Form 10-KSB for the year ended December 31, 2007. Principles of Consolidation The consolidated financial statements include the accounts of Cornerstone Bancorp, the parent company, and Cornerstone National Bank (the "Bank"), its wholly owned subsidiary, and Crescent Financial Services, Inc., a wholly owned subsidiary of the Bank. All significant intercompany items have been eliminated in the consolidated statements. Certain amounts have been reclassified to conform to current year presentation. Management Opinion The accompanying financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. Accordingly they do not contain all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The statements in this report are unaudited. In the opinion of management, all the adjustments necessary to present a fair statement of the results for the interim period have been made. Such adjustments are of a normal and recurring nature. The results of operations for any interim period are not necessarily indicative of the results to be expected for an entire year. These interim financial statements should be read in conjunction with the annual financial statements and notes thereto contained in the 2007 Annual Report on Form 10-KSB. Earnings per Share Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share" requires that the Company present basic and diluted net income (loss) per common share. The assumed conversion of stock options creates the difference between basic and diluted net income per share. Income per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for each period presented. The weighted average number of common shares outstanding for basic net income (loss) per common share for the three month period ended September 30, 2008 was 1,991,565 shares. The weighted average number of common shares outstanding for diluted net income (loss) per share for the quarter ended September 30, 2008 was also 1,991,565 shares. The weighted average number of common shares outstanding for basic net income per common share for the nine month period ended September 30, 2008 was 1,989,328 shares. The weighted average number of common shares outstanding for diluted net income per share for the nine months ended September 30, 2008 was 2,021,275 shares. There were 52,414 outstanding options that were anti-dilutive as of September 30, 2008. Stock Based Compensation As described in Notes 1 and 16 to the financial statements in the Company's Annual Report on Form 10-KSB for the year ended December 31, 2007, the Company has a stock-based employee and director compensation plan, which was approved by shareholders in 2003 (the "2003 Plan"). The Company accounts for stock-based compensation under the provisions of SFAS No. 123(R). On January 2, 2008 and January 2, 2007 the Board of Directors awarded options to purchase 19,200 and 18,000 shares, respectively, to executive officers and directors under the 2003 Plan. The options vest over five years and expire ten years from the date of grant. The exercise price for the 2008 grant was $12.50 per share. In accordance with the terms of the 2003 Plan, the 2007 grant has been adjusted as a result of the 10% stock dividend declared in April 2007. Refer to the notes to the financial statements in the Company's Annual Report on Form 10-KSB for the year ended December 31, 2007 for further information. The fair value of an option is estimated on the date of grant using the Black-Scholes option pricing model. The risk free interest rate used in the calculation was 3.91% for the 2008 grant and 4.68% for the 2007 grant (equal to the U.S. Treasury 10 year constant maturity on the date of grant) and the assumed dividend rate was zero in each case. The expected option life in each case was 10 years. Volatility was estimated at 27.5% for the 2008 options and 11.7% for the 2007 options based on a review of stock trades known to management or quoted on the over-the-counter bulletin board during the preceding period. Management is aware of only limited trades, which may not represent market value 6 as the stock is not traded on an exchange, though it is quoted on the Over-the-Counter Bulletin Board. For the three months ended September 30, 2008, the Company expensed $4,913 related to options granted in 2008, net of forfeitures, $5,174 related to options granted in 2007, and $3,956, related to the options granted in 2006. The expense is included in salaries and employee benefits in the accompanying consolidated statements of income. Prior to adopting the provisions of SFAS No. 123(R) the Company accounted for stock option awards under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. These awards are fully vested, and no compensation expense has been recognized related to these option awards. Options were granted under the 2003 Plan in 2004 and 2005, and have been adjusted to reflect the stock dividends declared since the grant date. As of September 30, 2008, there are 36,884 of these options outstanding under the 2003 Plan, exercisable at a weighted average exercise price of $9.13 per share. The Company awarded options to its Organizers in 1999 (the "Organizers' Options"). Each of the organizing directors was awarded options to purchase 4,000 shares of the Company's common stock at $10.00 per share. The options expire 10 years from the date of grant. Since 1999, 12,000 of the original options have been exercised (20,614 after stock dividends) and 4,000 have been forfeited. As of September 30, 2008, after the effect of stock dividends and exercises, there are 42,514 Organizers' Options outstanding. Each option is exercisable at a price of $5.64. These options vested in 2002 and were accounted for under the provisions of APB No. 25. Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of interest and noninterest income and expenses during the reporting period. Actual results could differ from those estimates. The primary significant estimate in the accompanying consolidated financial statements is the allowance for loan losses. A discussion of the significant factors involved in estimating the allowance for loan losses is included in this Form 10-Q in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the section titled "Results of Operations" and in the Company's 2007 Form 10-KSB. The provision for income taxes is also considered a significant estimate. Concentrations of credit risk The Bank makes loans to individuals and small businesses located primarily in upstate South Carolina for various personal and commercial purposes. The Bank has a diversified loan portfolio and borrowers' ability to repay loans is not dependent upon any specific economic sector. The Bank monitors the portfolio for concentrations of credit on a quarterly basis using North American Industry Codes ("NAIC"). The Bank has loans in two NAIC categories that each represents more than 10% of the portfolio. The NAIC concentrations are 36.8% in Residential Building Construction and 14.1% in Real Estate and Rental and Leasing. The portfolio also has loans representing 20 other NAIC categories. The Bank does not make long term (more than 15 years) mortgage loans to be held in its portfolio, does not offer loans with negative amortization features or long-term interest only features, or loans with loan to collateral value ratios in excess of 100%. The Bank does offer loan products with features that can increase credit risk during periods of declining economic conditions such as adjustable rate loans, short-term interest-only loans, and loans with amortization periods that differ from the maturity date (i.e., balloon payment loans). However, the Bank evaluates each customer's creditworthiness based on the customer's individual circumstances, and current and expected economic conditions, and underwrites and monitors each loan for associated risks. Loans made with exceptions to internal loan guidelines and those with loan-to-value ratios in excess of regulatory loan-to-value guidelines are monitored and reported to the Board of Directors on a monthly basis. The regulatory loan-to-value guidelines permit exceptions to the guidelines up to a maximum of 30% of total capital for commercial loans and exceptions for all types of real estate loans up to a maximum of 100% of total capital. As of September 30, 2008, the Bank has $80,282 of loans which exceed the regulatory loan to value guidelines. This amount is within the maximum allowable exceptions to the guidelines. 7 Recently issued accounting standards The following is a summary of recent authoritative pronouncements that may affect accounting, reporting, and disclosure of financial information by the Company: Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements." SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds. Level 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities, and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts. SFAS 157 did not have a significant impact on the Company's financial position, results of operations, or cash flows. SFAS 157 is presently under review by the FASB as a result of the impact it has had on banks during the current financial crisis. In September, 2006, The FASB ratified the consensuses reached by the FASB's Emerging Issues Task Force ("EITF") relating to EITF 06-4 "Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements." EITF 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods. Employers should recognize a liability for future benefits in accordance with SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," or Accounting Principles Board ("APB") Opinion No. 12, "Omnibus Opinion--1967." EITF 06-4 was effective January 1, 2008. The Company recorded a liability of $39,389 in the accompanying consolidated financial statements for the cumulative effect of the change. In September 2006, the FASB ratified the consensus reached on EITF 06-5, "Accounting for Purchases of Life Insurance--Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance" ("EITF 06-5"). EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 was effective for 8 the Company on January 1, 2008. There was no material effect on the Company's financial position, results of operations or cash flows. CAUTIONARY NOTICE WITH RESPECT TO FORWARD LOOKING STATEMENTS Statements included in this report which are not historical in nature are intended to be, and are hereby identified as "forward looking statements" for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. Words such as "estimate", "project", "intend", "expect", "believe", "anticipate", "plan", "may", "will", "should", "could", "would", "assume", "indicate", "contemplate", "seek", "target", "outlook", "potential", and similar expressions identify forward-looking statements. The Company cautions readers that forward looking statements including without limitation, those relating to the Company's new offices, future business prospects, revenues, working capital, adequacy of the allowance for loan losses, liquidity, capital needs, interest costs, and income, are subject to certain risks and uncertainties that could cause actual results to differ from those indicated in the forward looking statements, due to several important factors identified in this report, among others, and other risks and factors identified from time to time in the Company's other reports filed with the Securities and Exchange Commission. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs, and assumptions made by management. Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, and objectives concerning the Company's future financial and operating performance. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict, particularly in light of the fact that the Company is a relatively new company with limited operating history. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The risks and uncertainties include, but are not limited to: o the Company's growth and ability to maintain growth; o governmental monetary and fiscal policies, o legislative and regulatory changes; o the effect of interest rate changes on our level, cost and composition of deposits, loan demand and the value of our loan collateral, securities and interest sensitive assets and liabilities; o the indirect effects on demand for the Company's mortgage loan products arising from effects on the overall market of the subprime mortgage loan situation; o the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, as well as competitors that offer banking products and services by mail, telephone, computer, and/or the Internet; o credit risks; o failure of our customers to repay loans; o failure of assumptions underlying the establishment of the allowance for loan losses, including the value of collateral securing loans; o perceptions by depositors about the safety of their deposits; o higher than anticipated levels of defaults on loans; o ability to weather the current economic downturn; o loss of consumer or investor confidence; o the risks of opening new offices, including, without limitation, the related costs and time of building customer relationships and integrating operations, and the risk of failure to achieve expected gains, revenue growth and/or expense savings; o changes in accounting policies, rules, and practices; o cost and difficulty of implementing changes in technology or products; and o loss of consumer confidence and economic disruptions resulting from terrorist activities. 9 All forward-looking statements are expressly qualified in their entirety by this cautionary notice. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. Website References References to the Bank's website included in, or incorporated by reference into, this report are for information purposes only, and are not intended to incorporate the website by reference into this report. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation General Cornerstone Bancorp, (the "Company") is a bank holding company and has no operations other than those carried on by its wholly owned subsidiary, Cornerstone National Bank (the "Bank"). The Bank commenced business in 1999, and conducts a general banking business from three offices in the Easley area of Pickens County, in the Berea area of Greenville County, and in the Powdersville area of Anderson County, South Carolina. In 2004, the Bank established a wholly owned subsidiary, Crescent Financial Services, Inc. ("Crescent"), which is an insurance agency that has not yet engaged in any significant operations. Effect of Economic Trends The current outlook for the national economy in the United States is negative. During the quarter ended September 30, 2008, the United States Treasury Department ("Treasury") has taken several unprecedented actions which have affected the banking industry and the Company. On September 7, 2008 Treasury and the Federal Housing Finance Agency took steps to place the Federal National Mortgage Association ("FNMA") and the Federal National Mortgage Corporation ("FHLMC") in conservatorship. Many depository institutions in the United States, including the Bank, owned investments in these government-sponsored entities at that time. In addition, investments in various financial instruments owned by other large financial companies have lost substantial value, and Treasury, along with the Federal Reserve Bank and other regulatory agencies recommended that Congress take action to restore capital and confidence to the US financial system. Central Banks in countries worldwide have also taken action to restore confidence, capital, and liquidity to financial markets. Currently depository institutions in the United States are determining the effect of the actions taken by Treasury and Congress and assessing whether or not to participate in the various programs that have been made available. Management expects that unfavorable economic conditions will persist through the remainder of 2008 and into 2009. We will continue to monitor both the local and national economic conditions in an effort to minimize any negative impact on the Company. Since September 15, 2007, the Federal Reserve has decreased its target short-term interest rates significantly. These decreases have been in response to turmoil in the overall economy, the market for mortgages, and the housing industry in the United States. As a result of the decreases in interest rates by the Federal Reserve, interest rates applicable to many of the Bank's loans, which are tied to the prime rate, have also decreased quickly in a short period of time. However, due to competitive pressures for funds, interest rates on the Bank's interest bearing liabilities have not decreased as quickly, tightening the Bank's net interest margin. In addition, the turmoil in the national mortgage market has impacted our ability to broker mortgage loans for our customers. Many third party lenders have changed their programs frequently, discontinued programs, and tightened credit standards. The result has been a decrease in income earned from mortgage brokerage fees in the first nine months of 2008 as compared with the first nine months of 2007. Both of these trends have negatively impacted the Company's profitability in 2008. Additionally, problems in the economy have adversely affected the ability of some borrowers to repay their loans. Although the Company's market area has not experienced the negative effects of the slowing economy and real estate markets and the decline in real estate values to as great a degree as many other parts of the country, these factors have had some effect on the local markets, as evidenced by the increases in our potential problem loans, charge-offs, and nonaccrual loans. Results of Operations Results of Operations for the Three Months Ended September 30, 2008 and 2007 Summary The Company lost $405,474 during the third quarter of 2008 or $.20 per basic and diluted share compared to income of $407,465 during the third quarter of 2007 or $.21 per basic and $.20 per diluted share. The loss in 2008 was a result of a 10 $606,054, net of tax, Other Than Temporary Impairment loss on FNMA preferred stock owned by the Company at the time of FNMA's conservatorship. The Company recorded a loss for impairment because preferred stock dividends were suspended in conjunction with the conservatorship of FNMA, causing a significant decrease in the value of the Bank's preferred stock holding. There is significant uncertainty regarding the ultimate value of the preferred stock and whether or not dividends will be resumed at some future date. Additional reasons for the decline in earnings include a decrease in the net interest margin, an increase in the provision for loan losses, and a decrease in mortgage loan origination fees. The decrease in the net interest margin is due to changes in market interest rates as described above. The decrease in mortgage loan origination fees is also related to trends in the national market for mortgage loan products. The increase in the provision for loan losses is a result of an increase in potential problem loans as a result of the current economic environment. Net Interest Income Net interest income is the primary driver of net income for the Company. Net interest income is equal to the difference between interest income earned on the Company's interest earning assets and the interest paid on its interest bearing liabilities. Throughout 2008, we have experienced pressure on our interest rate margin as a result of market conditions. The Bank's balance sheet is sensitive to changes in market interest rates because approximately 57% of the Bank's loans are tied to the Prime Rate, which responds immediately to changes in market interest rates. Although many of the Bank's interest-bearing liabilities are also short-term in nature, even when those rates can be changed, liquidity needs of other institutions may put pressure on the Bank to keep deposit account interest rates high in order to retain deposits. As a result of changes in market interest rates by the Federal Open Market Committee of the Federal Reserve from September 2007 through September of 2008, earning rates on over half of the Bank's loan portfolio adjusted downward. While the average balance of loans outstanding grew 11.4% million in the third quarter of 2008 as compared to 2007, decreases in rates earned on the portfolio had a greater impact on interest income than the increases in volume. Average rates earned decreased 160 basis points in the third quarter of 2008 in comparison to 2007. In contrast, average rates paid on interest bearing liabilities decreased only 121 basis points year over year. The table below illustrates the average balances of interest earning assets and interest bearing liabilities and the resulting annualized yields and costs for the three month periods ended September 30, 2008 and 2007.
September 30, 2008 September 30, 2007 ------------------ ------------------ Average Average Average Average Balance Interest Yield/ Cost Balance Interest Yield/ Cost ------- -------- ----------- ------- -------- ----------- Investments .................................... $ 22,445,451 $ 293,738 5.19% $ 19,259,404 $ 258,234 5.32% Federal Funds Sold ............................. 4,919,769 20,420 1.65% 5,777,407 73,630 5.06% Loans .......................................... 113,879,340 1,957,863 6.82% 102,497,647 2,232,096 8.64% ------------ ---------- ------------ ---------- Total interest earning assets ............... 141,244,560 2,272,021 6.38% 127,534,458 2,563,960 7.98% ============ ---------- ============ ---------- Interest bearing transaction accounts .......... 13,411,247 30,695 .91% 13,110,573 38,159 1.15% Savings and money market ....................... 15,150,258 67,895 1.78% 10,592,280 58,768 2.20% Time deposits .................................. 75,240,191 649,421 3.42% 74,925,482 924,074 4.89% ------------ ---------- ------------ ---------- Total interest bearing deposits ............. 103,801,696 748,011 2.86% 98,628,335 1,021,001 4.11% ------------ Customer repurchase agreements and Federal Funds purchased .................... 5,131,258 35,992 2.78% 5,285,745 58,051 4.36% Borrowings from FHLB Atlanta ................... 7,896,908 64,786 3.25% 2,603,184 26,742 4.08% Broker repurchase agreements ................... 5,000,000 44,518 3.53% - - -% ------------ ---------- ------------ ---------- Total interest bearing liabilities .......... $121,829,862 893,307 2.91% $106,517,264 1,105,794 4.12% ============ ---------- ============ ---------- Net interest income ............................ $1,378,714 $1,458,166 ========== ========== Interest rate spread ........................... 3.47% 3.86% Interest margin ................................ 3.87% 4.54%
The Bank, which accounts for all of the Company's sensitivity to changes in interest rates, measures interest sensitivity using various measures. Using a static GAP measurement, which compares the amount of interest sensitive assets repricing within a one year time period as compared to the amount of interest sensitive liabilities repricing within the same time frame, the Bank's sensitivity to changes in interest rates can be analyzed. This method does not take into account loan prepayments and other non-contractual changes in balances and the applicable interest rates, but it does give some information as to possible changes in net interest income that could be expected simply as a result of changes in interest rates. As of September 30, 2008, the Bank's cumulative Gap ratio was .81 through 12 months. This indicates a slightly liability-sensitive position as of September 30, 2008. Based on a static GAP 11 measurement, in a period of rising interest rates, asset-sensitive balance sheets would be normally expected to experience a widening of the net interest margin, while liability-sensitive balance sheets would normally be expected to experience pressure on the net interest margin. In a period of decreasing interest rates, liability-sensitive balance sheets would normally be expected to experience a widening of the net interest margin and asset-sensitive balance sheets would normally be expected to experience the opposite effect. Various market factors can, however, affect the net interest margin and cause it to react differently to changes in interest rates than would normally be expected under the static GAP model. For example, although the Bank has the contractual right to decrease rates on its liabilities as the Federal Reserve lowers rates, in the past few months, the Bank has experienced increased difficulty in lowering rates on its liabilities because it has been competing for funds with much larger entities that have been facing liquidity needs. This competition for funds has resulted in an increase in rates by many of the sources the Bank ordinarily uses for funding. This illustrates the difficulty in predicting changes in interest income using various analytical tools such as the static GAP measurement. Provision for loan losses For the quarter ended September 30, 2008, the Company expensed $220,000 to the provision for loan losses. The Bank increased its provision in 2008 over 2007 levels in response to an increase in potential problem loans. During the quarter, charge-offs totaled $381,930 and there were no recoveries. Management has sought to provide the amount estimated to be necessary to maintain an allowance for loan losses that is adequate to cover the level of loss that management believed to be inherent in the portfolio as a whole, taking into account the Company's experience, economic conditions and information about borrowers available at the time of the analysis. However, management expects further deterioration of economic conditions in the Company's market areas is likely in the short-term, especially with respect to real estate related activities and real property values. Consequently, management expects that further increases in provisions for loan losses could be needed in the future. See "Balance Sheet Review- Loans" for additional information on the Company's loan portfolio and allowance for loan losses. Noninterest income (loss) The primary recurring drivers of noninterest income for the Company and the Bank are service charges on deposit accounts and mortgage loan origination fees. Other income (loss) for the third quarter of 2008 includes the Other Than Temporary Loss on FNMA preferred stock of $918,264 ($606,054, net of tax). For the three months ended September 30, 2008 the Company earned $152,043 in service charges on deposit accounts compared to $143,586 for the same period in 2007. This increase is attributable to an increase in the number of accounts and the number of services used by our customers. Mortgage loan origination fees have decreased by $42,168 or 44.1% since the third quarter of 2007. The decrease is directly related to turmoil in the national market for mortgages as third party lenders have changed programs and tightened credit standards, notwithstanding any reductions in interest rates. Noninterest expense Noninterest expense totaled $1.1 million for the three months ended September 30, 2008 and 2007. Salaries and employee benefits decreased approximately $33,900 or 5.5% in 2008 compared to 2007 due to retirements. Premises and equipment increased 21.2% as a result of the addition of our operations center, which opened in August 2007. This facility allowed us to move our back office and mortgage operations out of our main office building and utilize the available space in the main office for customer service personnel. Other expense increased $14,804 or 10.0% in 2008 over 2007 levels. Other expense in 2008 includes approximately $22,000 of costs associated with the acquisition of properties in foreclosure, which was partially offset by decreases in various other costs. Results of Operations for the Nine Months Ended September 30, 2008 and 2007 Summary The Company's net income for the nine months ended September 30, 2008 was $97,622 or $.05 per basic and diluted share compared to $1,254,739 or $.64 per basic and $.62 per diluted share for the nine months ended September 30, 2007. The decrease in net income is due to the impairment of the Company's investment in FNMA preferred stock as well as changes in interest rates, the decline in the mortgage brokerage business, and an increase in the provision for loan losses. 12 Net Interest Income Net interest income was $4.1 million for the nine months ended September 30, 2008 compared to $4.4 million for the nine months ended September 30, 2007. The decrease was the result of previously mentioned changes in the Bank's net interest margin. The Bank's interest earning assets increased $15.7 million, but decreases in rates earned on those assets had a greater impact on net interest income than the increases in volume. The average rate earned for the nine months ended September 30, 2008 was 6.65% compared to 8.02% for the nine months ended September 30, 2007, a decrease of 137 basis points. Rates paid on interest bearing liabilities did not decrease by the same margin, dropping only 78 basis points to 3.25% from 4.03%. The table below illustrates the average balances of interest earning assets and interest bearing liabilities and the resulting annualized yields and costs for the nine month periods ended September 30, 2008 and 2007.
September 30, 2008 September 30, 2007 ------------------ ------------------ Average Interest Average Average Interest Average Balance Earned Yield/Cost Balance Earned Yield/Cost ------- ------ ---------- ------- ------ ---------- Investments ................................... $ 23,309,479 $ 910,380 5.22% $ 17,789,562 $ 696,994 5.24% Federal Funds Sold ............................ 5,212,948 82,414 2.11% 5,006,878 192,518 5.14% Loans ......................................... 112,032,843 5,997,307 7.16% 102,059,327 6,596,912 8.64% ------------ ---------- ------------ ---------- Total interest earning assets .............. 140,555,270 6,990,101 6.65% $124,855,767 7,486,424 8.02% ============ ============ Interest bearing transaction accounts ......... 13,621,648 101,887 1.00% 13,887,407 118,748 1.14% Savings and money market accounts ............. 12,876,335 170,028 1.77% 10,126,588 155,435 2.05% Time deposits ................................. 77,346,028 2,226,970 3.85% 71,538,046 2,592,701 4.85% ------------ ---------- ------------ ---------- Total interest bearing deposits ............ 103,844,011 2,498,885 3.22% 95,552,041 2,866,884 4.01% Customer repurchase agreements and Federal Funds Purchased .................... 5,394,802 137,348 3.40% 5,229,966 173,631 4.44% Advances from FHLB ............................ 6,202,787 162,971 3.51% 2,640,353 80,675 4.09% Broker repurchase agreements .................. 4,781,022 126,238 3.53% - - -% ------------ ---------- ------------ ---------- Total interest bearing liabilities ......... $120,222,622 2,925,442 3.25% $103,422,360 3,121,190 4.03% ============ ---------- ============ ---------- Net interest income ........................... $4,064,659 $4,365,234 ========== ========== Interest rate spread .......................... 3.40% 3.99% Interest margin ............................... 3.87% 4.67%
Provision for loan losses The Company's provision for loan losses for the nine months ended September 30, 2008 was $460,000 compared to $136,636 for the nine months ended September 30, 2007. In the first nine months of 2008 the Bank increased the provision for loan losses in response to an increase in potential problem loans. Charge-offs totaled $608,423 for the first nine months of 2008 compared to $96,307 for the first nine months of 2007. Recoveries totaled $275,599 in 2008. The majority of recoveries made during 2008 related to two loans to the same borrower charged off in 2006. See "Balance Sheet Review- Loans" for additional information on the Company's loan portfolio and allowance for loan losses. Noninterest income (loss) Noninterest income (loss) for the nine months ended September 30, 2008 was a loss of $163,946 compared to income of $842,187 for the nine months ended September 30, 2007. Excluding the Other Than Temporary Impairment charge for the Bank's investment in FNMA preferred stock, noninterest income was $754,318, a decrease of $87,869. Service charges on deposit accounts increased due to the opening of new accounts and additional services utilized by customers. The increase in service charges on deposit accounts was offset by a decline in mortgage loan origination fees. Mortgage origination fees decreased to $226,038 in 2008 from $376,831 for the first nine months of 2007 for the same reasons as discussed above for the three month periods. Noninterest expense Noninterest expense totaled $3.3 million for the nine months ended September 30, 2008 compared to $3.2 million for the nine months ended September 30, 2007. Salaries and employee benefits increased less than 1% in 2008 compared to 2007. Premises and equipment increased 11.1% as a result of the addition of our operations center, which opened in August 2007. Other expense increased $75,158 or 19.3% in 2008 over 2007 levels. Other expense in 2008 includes approximately $52,000 of costs associated with the acquisition of properties in foreclosure, 13 additional software costs of approximately $13,000, and higher ATM processing costs of approximately $10,300. Balance Sheet Review Investments At September 30, 2008, the Bank held available for sale securities with a fair value and amortized cost of $19.7 million and other investments with an amortized cost of $1.0 million. Available for sale securities include government sponsored enterprise bonds, mortgage-backed securities, municipal bonds, and preferred stock issued by the Federal National Mortgage Association ("FNMA"), a government sponsored enterprise. The fair values of the Company's available for sale investments, other than municipal bonds, are measured on a recurring basis using quoted market prices in active markets for identical assets and liabilities ("Level 1 inputs" under SFAS 157). Due to the lower level of trading activity in municipal bonds, the fair market values of these investments are measured based on other inputs such as inputs that are observable or can be corroborated by observable market data for similar assets with substantially the same terms ("Level 2 inputs" under SFAS 157). Other investments include stock in the Federal Home Loan Bank of Atlanta and the Federal Reserve Bank. These stocks are held at amortized cost because they have no quoted market value and have historically been redeemed at par value. As of September 30, 2008, investments available for sale had a net unrealized loss of $28,558. As described above, we realized a loss of $918,264 ($606,054, net of tax) on the FNMA Preferred stock held by the Bank as of September 30, 2008. As of September 30, 2008 we held 13 other investments that are in an unrealized loss position. Of those 13, only one had been in an unrealized loss position for more than 12 months. The amount of the total unrealized loss in the portfolio is $350,000, with $5,769 related to the one security in an unrealized loss position for 12 months or more. The Bank has historically had the intent and ability to hold investments until maturity, and expects to be able to continue to do so. Most of the investments with unrealized losses at September 30, 2008 are issued by various municipal governments. We do not currently expect that these losses are other than temporary. Loans The following table summarizes the composition of our loan portfolio.
September 30, 2008 December 31, 2007 ------------------ ----------------- % of % of Amount Loans Amount Loans ------ ----- ------ ----- Commercial and industrial ........................ 20,293,060 17.2% $ 18,753,358 17.3% Real Estate - construction ....................... 51,832,917 44.0 43,332,737 39.9 Real Estate - mortgage 1-4familyresidential ...................... 21,144,938 18.0 18,947,690 17.4 Nonfarm, nonresidential ................... 21,380,814 18.1 24,248,479 22.3 Multifamily residential ................... 1,240,018 1.1 1,621,110 1.5 Consumer installment ............................. 1,896,932 1.6 1,739,958 1.6 ------------ ----- ------------ ----- Total Loans ............................... 117,788,679 100.0% 108,643,332 100.0% ===== ===== Less allowance for loan losses ........... (1,420,306) (1,293,130) ------------ ------------ Net Loans ............................. $116,368,373 $107,350,202 ============ ============
14 Activity in the allowance for loan losses for the first nine months of 2008 and 2007 is presented below.
Nine months ended Nine months ended September 30, September 30, 2008 2007 ---- ---- Allowance for loan losses, beginning of year ..................................... $ 1,293,130 $ 1,199,999 Provision for losses ............................................................. 460,000 136,636 Charge-offs ...................................................................... (608,423) (96,307) Recoveries ....................................................................... 275,599 - ------------- ------------- Allowance for loan losses, end of period ................................... $ 1,420,306 $ 1,240,328 ============= ============= Ratios Nonperforming loans to loans at end of period ............................... 1.10% .01% Net (charge-offs) recoveries to average loans outstanding ................... (.29%) (.09%) Net (charge-offs) recoveries to loans at end of period ...................... (.28%) (.09%) Allowance for loan losses to average loans .................................. 1.26% 1.22% Allowance for loan losses to loans at end of period ......................... 1.21% 1.18% Net (charge-offs) recoveries to allowance for loan losses ................... (23.43%) (7.76%) Net (charge-offs) recoveries to provision for loan losses ................... (72.4%) (70.5%)
Charge-offs totaled $608,423 for the first nine months of 2008 and recoveries totaled $275,599. These charge-offs related to a number of different loans, in multiple collateral categories. The majority of recoveries made during 2008 related to two unsecured loans to the same borrower charged-off in 2006. Loans which management identifies as impaired generally will be nonperforming loans. Nonperforming loans include nonaccrual loans or loans which are 90 days or more delinquent as to principal or interest payments. As of September 30, 2008, the Bank had nonaccrual loans of $1.29 million, representing five loans. Each of these loans is secured by real estate. These loans are currently being carried at management's best estimate of net realizable value, although no assurance can be given that no further losses will be incurred on these loans until the collateral has been acquired and liquidated or other arrangement can be made. Management's estimates of net realizable, or fair value, are obtained (on a nonrecurring basis) using independent appraisals, less estimated selling costs, which the Company considers to be level 2 inputs as defined by SFAS No. 157. Management identifies and maintains a list of potential problem loans. These are loans that are not included in nonaccrual status or loans that are past due 90 days or more and still accruing interest. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank's portfolio. There were loans in the amount of $1.4 million that have been determined by management to be potential problem loans at September 30, 2008. 15 Deposits The following table shows the average balance amounts and the average rates we paid on deposits for the quarters ended September 30, 2008 and 2007.
Average Deposits ---------------- Quarter ended Quarter ended September 30, 2008 September 30, 2007 ------------------ ------------------ Amount Rate Amount Rate ------ ---- ------ ---- Noninterest bearing demand ................................... $ 10,794,010 -% $ 11,685,964 -% Interest bearing transaction accounts ........................ 13,411,247 .91% 13,887,407 1.15% Savings and money market ..................................... 15,150,258 1.78% 10,126,588 2.20% Time deposits ................................................ 75,240,191 3.42% 71,538,046 4.89% ------------ ------------ Total average deposits ................................. $114,595,706 $107,238,005 ============ ============
Borrowings The Bank's outstanding borrowings are described in the following table. The amounts listed as broker repurchase agreements are collateralized borrowings from other institutions. Retail repurchase agreements with the Bank's customers are not included in the table below. Borrowings at or for the quarter ended September 30, 2008
Maximum Weighted Period- Month-end Average Ending Balance End Rate Balance Average Balance Rate Paid -------------- -------- ------- --------------- --------- Federal Home Loan Bank advances ....... $8,431,713 3.31% $8,456,852 $7,896,908 3.25% Broker repurchase agreements .......... $5,000,000 3.53% $5,000,000 $5,000,000 3.53%
Liquidity Liquidity is the ability to meet current and future obligations through liquidation or maturity of existing assets or the acquisition of liabilities. The Company manages both assets and liabilities to achieve appropriate levels of liquidity. Cash and short-term investments are the Company's primary sources of asset liquidity. These funds provide a cushion against short-term fluctuations in cash flow from both deposits and loans. The investment portfolio is the Company's principal source of secondary asset liquidity. However, the availability of this source of funds is influenced by market conditions. Individual and commercial deposits and borrowings are the Company's primary source of funding for credit activities. The Company has lines of credit with unrelated banks and with the FHLB of Atlanta. The bank lines total $5.3 million and are available on a one to fourteen day basis for general corporate purposes of the Bank. The FHLB line is based on the availability of eligible collateral, with a maximum borrowing capacity of 10% of Bank assets. The Bank currently has $8.4 million borrowed under the FHLB line. Approximately $7.0 million is available under the FHLB line, assuming adequate collateral is available for pledging. Although many banks have recently experienced substantial pressure on their liquidity, in some cases requiring government intervention, the demands on the Bank's liquidity have been comfortably manageable. Management believes that the Company's liquidity sources are adequate to meet its operating needs. Off Balance Sheet Risk Through the operations of the Bank, the Company has contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to the Bank's customers at predetermined interest rates for a specified period of time. Commitments are subject to various conditions which are expected to reduce the credit risk to the Company. The Bank's management evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by management upon extension of credit, is based on a credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial or residential real estate. Management manages the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. At September 30, 2008, the Bank had issued commitments to extend credit of $24.9 million through various types of lending arrangements and overdraft protection 16 arrangements. Of that amount, approximately $16.3 million was undisbursed amounts of closed-end loans, $1.2 million was related to unused overdraft protection, and approximately $6.9 million was related to lines of credit. The Bank also had standby letters of credit outstanding of approximately $1.2 million at September 30, 2008. An immaterial amount of fees were collected related to these commitments and letters of credit during the quarter and six months ended September 30, 2008. Historically many of these commitments and letters of credit expire unused, and the total amount committed as of September 30, 2008 is not necessarily expected to be funded. The Bank offers an automatic overdraft protection product to checking account customers. Each qualified account with the automatic overdraft protection feature can have up to $500 of paid overdrafts. Unused overdraft protection was $1.2 million as of September 30, 2008, the majority of which is not expected to be utilized. As of September 30, 2008, accounts in overdraft status totaled $26,299. Capital Resources The capital base for the Company decreased by approximately $652,588 for the first nine months of 2008, due to net income and stock option activity, net of decreases in accumulated other comprehensive income, the cumulative effect of an accounting change for split dollar life insurance plan agreements, and cash dividends. Stock option activity includes the impact of both stock options exercised and stock-based compensation on unexercised options. The Company's equity to asset ratio was 12.3% as of September 30, 2008 and 13.9% as of December 31, 2007. The Company expects to continue to leverage its capital as the Bank grows. The following table details return on average assets (net income divided by average total assets, annualized if necessary), return on average equity (net income divided by average total equity, annualized if necessary) and the ratio of average equity to average assets as of and for the nine months ended September 30, 2008 and as of and for the year ended December 31, 2007. Return on Assets and Return on Equity for the first nine months of 2008 have decreased significantly compared to Return on Assets and Return on Equity for the year ended December 31, 2007 due to the realized loss on FNMA preferred stock, pressure on our net interest margin and the effect of an increased provision for loan losses. See "Results of Operations" for more information. Based on 2007 earnings and first quarter 2008 earnings, on April 8, 2008, our Board of Directors declared the Company's first cash dividend of $.30 per share payable to shareholders of record on May 13, 2008. The dividend was paid May 23, 2008.
Nine- month period ended Year ended September 30, December 31, 2008 2007 ---- ---- (annualized) Return on average assets ............................. .09% 1.18% Return on average equity ............................. .67% 8.73% Ratio of average equity to average assets ............ 12.95% 13.56% Dividend payout ratio ................................ 459% -%
The FDIC has established guidelines for capital requirements for banks. As of September 30, 2008, the Bank is considered well capitalized based on the capital levels that are required to be maintained according to FDIC guidelines as shown in the following table.
Capital Ratios Adequately Well Capitalized Capitalized Actual Requirement Requirement ------ ----------- ----------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- Total capital to risk weighted assets $19,993 15.3% $13,056 10.0% $10,445 8.0% Tier 1 capital to risk weighted assets $18,572 14.2% $7,833 6.0% $5,222 4.0% Tier 1 capital to average assets $18,572 12.2% $7,619 5.0% $6,095 4.0%
The Federal Reserve has also established guidelines for capital requirements for bank holding companies that are similar to the FDIC's guidelines for banks. At September 30, 2008, the Company exceeded all of the minimum requirements of the Federal Reserve guidelines. 17 The Company has two stock-based compensation plans. See "Stock based Compensation" in the Notes to Unaudited Consolidated Financial Statements above for more information. Impact of Inflation Unlike most industrial companies, the assets and liabilities of financial institutions such as the Company are primarily monetary in nature. Therefore, interest rates have a more significant impact on the Company's performance than do the effects of changes in the general rate of inflation and changes in prices. In addition, interest rates do not necessarily move in the same magnitude as the prices of goods and services. As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation. Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk is the risk of loss from adverse changes in market prices and rates which principally arises from liquidity risk and interest rate risk inherent in the Bank's lending, deposit gathering, and borrowing activities. Other types of market risks such as foreign currency exchange risk and commodity price risk do not normally arise in the ordinary course of our business. The Funds Management Committee of our Board of Directors, which meets quarterly, monitors and considers methods of managing exposure to liquidity and interest rate risk. Our Management monitors liquidity and interest rate risk on an on-going basis. Management is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities and managing our liquidity within board-approved limits. Interest rate sensitivity "GAP" analysis measures the timing and magnitude of the repricing of assets compared with the repricing of liabilities and is an important part of asset/liability management. The objective of interest rate sensitivity management is to generate stable growth in net interest income, and to control the risks associated with interest rate movements. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be made in a timely manner. ITEM 4T. Controls and Procedures. Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or 240.15d-15(b) of the Company's disclosure controls and procedures (as defined in 17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company's chief executive officer and chief financial officer concluded that such controls and procedures, as of the end of the period covered by this report, were effective. There has been no change in the Company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 18 Part II - Other Information Item 1A. Risk Factors Set forth below are a number of risks related to our business and our industry that should be considered in light of recent events affecting financial markets and the national economy. 1. There can be no assurance that recent government actions will help stabilize the U.S. financial system. In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, various branches and agencies of the U.S. government have put in place laws, regulations and programs to address capital and liquidity issues in the banking system. There can be no assurance, however, as to the actual impact that such laws, regulations and programs will have on the financial markets, including the extreme levels of volatility, liquidity and confidence issues and limited credit availability currently being experienced. The failure of such laws, regulations and programs to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock. 2. Current levels of market volatility are unprecedented. Although many markets have been experiencing volatility and disruption for months, in the past few weeks, the volatility and disruption of financial and credit markets has reached unprecedented levels for recent times. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers' underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations. 3. The soundness of other financial institutions could adversely affect us. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers, dealers, commercial banks, investment banks, and government sponsored enterprises. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or other obligation due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings. 4. Current market developments may adversely affect our industry, business and results of operations. Dramatic declines in the housing market during the prior year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely, directly or indirectly, affect our business, financial condition and results of operations. ITEM 6. Exhibits Exhibits: 31-1 Rule 13a-14(a)/ 15d-14(a) Certifications of Chief Executive Officer 31-2 Rule 13a-14(a)/Rule 15d-14(a) Certifications of Chief Financial Officer 32 18 U.S.C. Section 1350 Certifications 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Cornerstone Bancorp (Registrant) By: s/J. Rodger Anthony Date: November 7, 2008 --------------------------------------- J. Rodger Anthony Chief Executive Officer By: s/Jennifer M. Champagne Date: November 7, 2008 --------------------------------------- Jennifer M. Champagne Senior Vice President and Chief Financial Officer (Principal Financial Officer) 20 EXHIBIT INDEX 31-1 Rule 13a-14(a)/ 15d-14(a) Certifications of Chief Executive Officer 31-2 Rule 13a-14(a)/Rule 15d-14(a) Certifications of Chief Financial Officer 32 18 U.S.C. Section 1350 Certifications 21 EX-31.1 2 cstn10q3-08ex31_1.txt Exhibit 31-1 CERTIFICATIONS I, J. Rodger Anthony, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Cornerstone Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer 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 control 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 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 registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the 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 over financial reporting. Date: November 7, 2008 /s/J. Rodger Anthony ---------------- ---------------------------------------- J. Rodger Anthony Chief Executive Officer EX-31.2 3 cstn10q3-08ex31_2.txt Exhibit 31-2 CERTIFICATIONS I, Jennifer M. Champagne, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Cornerstone Bancorp; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer 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 control 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 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 registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the 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 over financial reporting. Date: November 7, 2008 /s/ Jennifer M. Champagne ---------------- --------------------------------- Jennifer M. Champagne Chief Financial Officer EX-32 4 cstn10q3-08ex32.txt Exhibit 32 Certifications Pursuant to 18 U.S.C. Section 1350 The undersigned, who are the chief executive officer and the chief financial officer of Cornerstone Bancorp, each hereby certifies that, to the best of his/her knowledge, the accompanying Form 10-Q of the issuer fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and that information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. November 7, 2008 /s/ J. Rodger Anthony -------------------------------- J. Rodger Anthony Chief Executive Officer /s/ Jennifer M. Champagne -------------------------------- Jennifer M. Champagne Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----