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.
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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
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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)
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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