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 March 31, 2009
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 has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months(or for such shorter period that the registrant was required
to submit and post such files). Yes [ ] No [ ] (Not yet applicable to the
Registrant)
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, 2,005,737 shares outstanding on May 1, 2009
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2009 2008
---- ----
Assets (Unaudited)
Cash and due from banks ........................................................................ $ 14,714,615 $ 3,820,227
Federal funds sold ............................................................................. 135,000 140,000
------------ ------------
Cash and cash equivalents ............................................................... 14,849,615 3,960,227
Investment securities
Available-for-sale .......................................................................... 20,680,042 19,676,604
Other investments ........................................................................... 997,650 1,114,150
Loans, net ..................................................................................... 135,235,725 129,483,130
Property and equipment, net .................................................................... 5,482,860 5,551,275
Cash surrender value of life insurance policies ................................................ 1,784,563 1,768,520
Other real estate owned ........................................................................ 219,200 575,000
Other assets ................................................................................... 1,773,163 1,722,161
------------ ------------
Total assets ..................................................................... $181,022,818 $163,851,067
============ ============
Liabilities And Shareholders' Equity
Liabilities
Deposits
Noninterest bearing ....................................................................... $ 11,821,768 $ 10,069,125
Interest bearing .......................................................................... 132,927,830 112,512,449
------------ ------------
Total deposits ............................................................................ 144,749,598 122,581,574
Federal funds purchased ..................................................................... - 1,810,000
Customer repurchase agreements .............................................................. 4,494,080 4,582,619
Borrowings from Federal Home Loan Bank of Atlanta ........................................... 6,856,297 10,394,005
Broker repurchase agreements ................................................................ 5,000,000 5,000,000
Other liabilities ........................................................................... 461,013 345,922
------------ ------------
Total liabilities ......................................................................... 161,560,988 144,714,120
Commitments and contingencies
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, no shares issued ............................. - -
Common stock, no par value, 20,000,000 shares authorized, 2,106,023 and 1,991,565
shares issued at March 31, 2009 and December 31, 2008, respectively ..................... 19,023,640 18,323,333
Retained earnings ........................................................................... 206,081 765,906
Accumulated other comprehensive income ...................................................... 232,109 47,708
------------ ------------
Total shareholders' equity ................................................................ 19,461,830 19,136,947
------------ ------------
Total liabilities and shareholders' equity ................................................ $181,022,818 $163,851,067
============ ============
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
March 31,
---------
2009 2008
---- ----
Interest and Dividend Income
Interest and fees on loans ................................................ $ 1,738,030 $ 2,067,113
Investment securities ..................................................... 251,788 302,707
Federal funds sold and interest bearing
balances ................................................................ 2,556 24,821
----------- -----------
Total interest income ................................................. 1,992,374 2,394,641
----------- -----------
Interest Expense
Deposits .................................................................. 771,498 924,235
Borrowings ................................................................ 127,684 144,436
----------- -----------
Total interest expense ................................................. 899,182 1,068,671
----------- -----------
Net Interest Income ......................................................... 1,093,192 1,325,970
Provision for Loan Losses ................................................... 160,000 120,000
----------- -----------
Net interest income after provision
for loan losses ...................................................... 933,192 1,205,970
----------- -----------
Noninterest Income
Service charges on deposit accounts ....................................... 132,891 141,946
Mortgage loan origination fees ............................................ 54,518 72,813
Gain on sale of security .................................................. 52,300 -
Other ..................................................................... 13,209 29,935
----------- -----------
Total noninterest income ............................................... 252,918 244,694
----------- -----------
Noninterest Expense
Salaries and employee benefits ............................................ 602,041 659,810
Premises and equipment .................................................... 147,990 153,282
Data processing ........................................................... 57,186 49,871
Professional and regulatory fees .......................................... 129,498 74,761
Supplies .................................................................. 14,963 20,742
Advertising ............................................................... 13,600 16,492
Other ..................................................................... 185,606 150,361
----------- -----------
Total noninterest expense .............................................. 1,150,884 1,125,319
----------- -----------
Net income before taxes ................................................ 35,226 325,345
Provision (benefit) for income taxes ........................................ (6,670) 105,451
----------- -----------
Net income ............................................................. $ 41,896 $ 219,894
=========== ===========
Earnings Per Share
Basic ..................................................................... $ .02 $ .11
Diluted ................................................................... $ .02 $ .10
Weighted Average Shares Outstanding
Basic ..................................................................... 2,094,532 2,084,071
Diluted ................................................................... 2,103,140 2,128,674
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 three months ended March 31, 2009 and 2008
(Unaudited)
Accumulated
Common stock other Total
------------ Retained comprehensive shareholders'
Shares Amount earnings income (loss) equity
------ ------ -------- ------------- ------
Balance, December 31, 2007 ...................... 1,983,169 $ 18,185,328 $ 1,177,450 $ 218,052 $ 19,580,830
Net income ...................................... - - 219,894 - 219,894
Other comprehensive income, net
of income taxes
Unrealized loss on investment
securities, net .............................. - - - (58,383) (58,383)
------------
Comprehensive income ............................ - - 161,511
Stock based compensation ........................ - 14,455 - - 14,455
Options exercised ............................... 8,396 81,833 - - 81,833
Cumulative effect of accounting change .......... - - (39,389) - (39,389)
------------ ------------ ------------ ------------ ------------
Balance, March 31, 2008 ......................... 1,991,565 $ 18,281,616 1,357,955 $ 159,669 $ 19,799,240
============ ============ ============ ============ ============
Balance, December 31, 2008 ...................... 1,991,565 $ 18,323,333 $ 765,906 $ 47,708 $ 19,136,947
Net income ...................................... - - 41,896 - 41,896
Other comprehensive income, net
of income taxes
Unrealized gain on investment
securities, net .............................. - - - 184,401 184,401
------------
Comprehensive income ............................ 226,297
Stock based compensation ........................ - 18,586 - - 18,586
Options exercised ............................... 14,172 80,000 - 80,000
Stock dividend declared (5%) .................... 100,286 601,721 (601,721) - -
------------ ------------ ------------ ------------ ------------
Balance, March 31, 2009 ......................... 2,106,023 $ 19,023,640 $ 206,081 $ 232,109 $ 19,461,830
============ ============ ============ ============ ============
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 three months ended
March 31,
---------
2009 2008
---- ----
Operating Activities
Net income .......................................................................... $ 41,896 $ 219,894
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization .................................................... 73,168 77,445
Provision for loan losses ........................................................ 160,000 120,000
Non-cash option expense .......................................................... 18,586 14,455
Gain on sale of property and equipment .............................................. (625) -
Loss on sale of property acquired in foreclosure .................................... 24,753 -
Gain on sale of security available for sale ......................................... (52,300)
Changes in operating assets and liabilities
Change in interest receivable .................................................... 55,380 103,670
Change in other assets ........................................................... (122,425) (72,273)
Change in other liabilities ...................................................... 20,098 (52,368)
------------ ------------
Net cash provided by operating activities ..................................... 218,531 410,823
------------ ------------
Investing Activities
Proceeds from maturities and principal repayments of available for
sale securities .................................................................. 2,375,939 693,721
(Purchase) Redemption of FHLB and Federal Reserve stock ............................. 116,500 (73,900)
Purchase of investment securities available for sale ................................ (3,052,041) (6,085,514)
Purchase of property and equipment .................................................. (395) (17,415)
Proceeds from sale of property acquired in foreclosure .............................. 550,247 -
Proceeds from sale of property and equipment ........................................ 625 -
Net increase in loans to customers .................................................. (6,131,795) (6,935,548)
------------ ------------
Net cash used for investing activities ........................................ (6,140,920) (12,418,656)
------------ ------------
Financing Activities
Net increase in demand, savings and time deposits ................................... 22,168,024 7,321,514
Net decrease in customer repurchase agreements ...................................... (88,539) (775,811)
Net decrease in Federal Funds Purchased ............................................. (1,810,000) -
Repayment of FHLB advances .......................................................... (5,037,708) (337,708)
Borrowings from FHLB ................................................................ 1,500,000 2,300,000
Proceeds from broker repurchase agreements .......................................... - 5,000,000
Proceeds from exercise of stock options ............................................. 80,000 81,833
------------ ------------
Net cash provided by financing activities ..................................... 16,811,777 13,589,828
------------ ------------
Net increase in cash and cash equivalents ..................................... 10,889,388 1,581,995
Cash and Cash Equivalents, Beginning of Period ........................................... 3,960,227 5,233,777
------------ ------------
Cash and Cash Equivalents, End of Period ................................................. $ 14,849,615 $ 6,815,772
============ ============
Supplemental Information
Cash paid for interest ............................................................... $ 896,910 $ 1,019,693
Cash paid for income taxes ........................................................... $ 5,181 $ -
Non-cash Supplemental information
Loans transferred to other real estate owned ......................................... $ 219,200 $ 236,644
Loans charged-off, net ............................................................... $ 157,906 $ 183,993
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") 2008 Annual Report to Shareholders, which also contains
the Company's audited financial statements for 2008 and is also included in the
Form 10-K for the year ended December 31, 2008.
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 2008 Annual Report on Form 10-K.
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 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 per common share for the three month
period ended March 31, 2009 was 2,094,532 shares. The weighted average number of
common shares outstanding for diluted net income per share for the quarter ended
March 31, 2009 was 2,103,140 shares. There were 104,898 outstanding options that
were anti-dilutive as of March 31, 2009. The calculation of earnings per share
includes the effect of the 5% stock dividend declared on April 14, 2009 as if it
had been declared on January 1, 2009.
Stock Based Compensation
As described in Notes 1 and 17 to the financial statements in the Company's
Annual Report on Form 10-K for the year ended December 31, 2008, 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 12, 2009 and January 2, 2008, the Board of Directors
awarded options to purchase 15,600 and 19,200 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 2009 grant
was $10.00 per share. After giving effect to the 5% stock dividend declared
April 14, 2009 and payable on May 29, 2009 to shareholders of record as of May
12, 2009, the number of options granted in 2009 will be adjusted to 16,380 with
an exercise price of $9.52 per share, in accordance with the terms of the 2003
Plan. Refer to the notes to the financial statements in the Company's Annual
Report on Form 10-K for the year ended December 31, 2008 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 2.34% for the 2009 grant and 3.91% for the 2008 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 38.71% for the 2009 grant and
27.5% for the 2008 grant based on a review of stock trades known to management
or quoted on the OTC Bulletin Board during the preceding period. Management is
aware of only limited trades, which may not represent market value as the stock
is not traded on an exchange, though it is quoted on the OTC Bulletin Board. For
the three months ended March 31, 2009, the Company expensed $4,543 related to
options granted in 2009, $4,913 related to options granted in 2008, $5,174
related to options granted in 2007, and $3,956, related to the options granted
6
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 March 31, 2009 there are 104,898 options outstanding under the
2003 Plan, exercisable at a weighted average exercise price of $11.08 per share.
Following the 5% stock dividend declared by the Board of Directors on April 14,
2009 and payable to shareholders of record on May 12, 2009, the adjusted number
of options outstanding will be approximately 110,143 and the weighted average
exercise price will be $10.56 per share, all in accordance with the 2003 Plan.
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, 24,000 of the original
options have been exercised (34,786 after stock dividends) and 4,000 have been
forfeited. As of March 31, 2009, after the effect of stock dividends and
exercises, there are 28,342 Organizers' Options outstanding. Each option is
currently exercisable at a price of $5.64. Following the 5% stock dividend
declared by the Board of Directors on April 14, 2009 and payable to shareholders
of record on May 12, 2009, the adjusted number of Organizers Options outstanding
will be 29,759 and the exercise price will be $5.37 per share, all in accordance
with the terms of the original grant. 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 2008 Form 10-K. 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") and using definitions required by regulatory agencies. The Bank
has loans in two NAIC categories that each represents more than 10% of the
portfolio. The NAIC concentrations are 31.5% in Residential Building
Construction and 16.0% in Real Estate and Rental and Leasing. The portfolio also
has loans representing 20 other NAIC categories.
The Bank has concentrations in loans collateralized by real estate according to
the regulatory definition. Included in this segment of the portfolio is the
category for construction and development loans. While the Bank does have a
concentration of loans in this category, the Bank's business is managed in
specific ways with the intention of helping to reduce the risks normally
associated with construction lending. Management requires lending personnel to
visit job sites, maintain frequent contact with borrowers and perform or
commission inspections of completed work prior to issuing additional
construction loan draws. In addition, management employs additional procedures
for monitoring construction loans, such as engaging an independent appraiser to
perform routine reviews of the percentage complete inspection reports for a
sample of construction projects. Senior management compares the independent
review report to the percentage complete report in the Bank's loan files. Any
discrepancy is investigated immediately to help insure that the Bank's
investment is protected.
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% at the time the loan is made. The Bank does offer loan
products with features that can increase credit risk during periods of declining
7
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 March
31, 2009, the Bank has $1.9 million of loans which exceed the regulatory loan to
value guidelines. This amount is within the maximum allowable exceptions to the
guidelines.
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 No. 157 defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS No. 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 No. 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.
Adoption of SFAS No. 157 did not have a significant impact on the Company's
financial position, results of operations, or cash flows.
In May, 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles." SFAS No. 162 identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with GAAP. SFAS NO. 162 was effective November 15, 2008.
The FASB has stated that it does not expect SFAS No. 162 will result in a change
in current practice. The application of SFAS No. 162 had no effect on the
Company's financial position, results of operations or cash flows.
FSP EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No.
99-20," ("FSP EITF 99-20-1") was issued in January 2009. Prior to the Staff
Position, other-than-temporary impairment was determined by using either EITF
Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased
Beneficial Interests and Beneficial Interests that Continue to be Held by a
Transferor in Securitized Financial Assets," ("EITF 99-20") or SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," depending on
the type of security. EITF 99-20 required the use of market participant
assumptions regarding future cash flows regarding the probability of collecting
all cash flows previously projected. SFAS 115 determined impairment to be other
than temporary if it was probable that the holder would be unable to collect all
amounts due according to the contractual terms. To achieve a more consistent
8
determination of other-than-temporary impairment, the Staff Position amends EITF
99-20 to determine any other-than-temporary impairment based on the guidance in
SFAS No. 115, allowing management to use more judgment in determining any
other-than-temporary impairment. The Staff Position was effective for the
Company as of December 31, 2008. Management has reviewed and evaluated the
Company's security portfolio for any other-than-temporary impairments.
The SEC's Office of the Chief Accountant and the staff of the FASB issued press
release 2008-234 on September 30, 2008 ("Press Release") to provide
clarifications on fair value accounting. The Press Release includes guidance on
the use of management's internal assumptions and the use of "market" quotes. It
also reiterates the factors in SEC Staff Accounting Bulletin ("SAB") Topic 5M
that should be considered when determining other-than-temporary impairment: the
length of time and extent to which the market value has been less than cost;
financial condition and near-term prospects of the issuer; and the intent and
ability of the holder to retain its investment for a period of time sufficient
to allow for any anticipated recovery in market value.
On October 10, 2008, the FASB issued FSP SFAS 157-3, "Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active" ("FSP SFAS
157-3"). This Staff Position clarifies the application of SFAS No. 157 in a
market that is not active, and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that asset is not active. The FSP is effective upon issuance,
including prior periods for which financial statements have not been issued. For
the Company, this FSP was effective for the quarter ended September 30, 2008.
The Company considered the guidance in the Press Release and in FSP SFAS 157-3
when conducting its review for other-than-temporary impairment as of March 31,
2009.
On April 9, 2009, the FASB issued three staff positions related to fair value
which are discussed below.
FSP SFAS 115-2 and SFAS 124-2, "Recognition and Presentation of
Other-Than-Temporary Impairments," ("FSP SFAS 115-2 and SFAS 124-2") categorizes
losses on debt securities available-for-sale or held-to-maturity determined by
management to be other-than-temporarily impaired into losses due to credit
issues and losses related to all other factors. Other-than-temporary impairment
(OTTI) exists when it is more likely than not that the security will mature or
be sold before its amortized cost basis can be recovered. An OTTI related to
credit losses should be recognized through earnings. An OTTI related to other
factors should be recognized in other comprehensive income. The FSP does not
amend existing recognition and measurement guidance related to
other-than-temporary impairments of equity securities. Annual disclosures
required in SFAS 115 and FSP SFAS 115-1 and SFAS 124-1 are also required for
interim periods (including the aging of securities with unrealized losses).
FSP SFAS 157-4, "Determining Fair Value When the Volume and Level of Activity
for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That are Not Orderly" recognizes that quoted prices may not be
determinative of fair value when the volume and level of trading activity has
significantly decreased. The evaluation of certain factors may necessitate that
fair value be determined using a different valuation technique. Fair value
should be the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction, not a forced liquidation or distressed
sale. If a transaction is considered to not be orderly, little, if any, weight
should be placed on the transaction price. If there is not sufficient
information to conclude as to whether or not the transaction is orderly, the
transaction price should be considered when estimating fair value. An entity's
intention to hold an asset or liability is not relevant in determining fair
value. Quoted prices provided by pricing services may still be used when
estimating fair value in accordance with SFAS 157; however, the entity should
evaluate whether the quoted prices are based on current information and orderly
transactions. Inputs and valuation techniques are required to be disclosed in
addition to any changes in valuation techniques.
FSP SFAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial
Instruments" requires disclosures about the fair value of financial instruments
for interim reporting periods of publicly traded companies as well as in annual
financial statements and also requires those disclosures in summarized financial
information at interim reporting periods A publicly traded company includes any
company whose securities trade in a public market on either a stock exchange or
in the over-the-counter market, or any company that is a conduit bond obligor.
Additionally, when a company makes a filing with a regulatory agency in
preparation for sale of its securities in a public market it is considered a
publicly traded company for this purpose.
The three staff positions are effective for periods ending after June 15, 2009,
with early adoption permitted for periods ending after March 15, 2009, in which
case all three must be adopted. The Company will adopt the staff positions for
its second quarter 10-Q but does not expect the staff positions to have a
material impact on the consolidated financial statements.
9
Also on April 1, 2009, the FASB issued FSP SFAS 141(R)-1, "Accounting for Assets
Acquired and Liabilities Assumed in a Business Combination That Arise from
Contingencies." The FSP requires that assets acquired and liabilities assumed in
a business combination that arise from a contingency be recognized at fair
value. If fair value cannot be determined during the measurement period as
determined in SFAS 141 (R), the asset or liability can still be recognized if it
can be determined that it is probable that the asset existed or the liability
had been incurred as of the measurement date and if the amount of the asset or
liability can be reasonably estimated. If it is not determined to be probable
that the asset/liability existed/was incurred or no reasonable amount can be
determined, no asset or liability is recognized. The entity should determine a
rational basis for subsequently measuring the acquired assets and assumed
liabilities. Contingent consideration agreements should be recognized initially
at fair value and subsequently reevaluated in accordance with guidance found in
paragraph 65 of SFAS 141 (R). The FSP is effective for business combinations
with an acquisition date on or after the beginning of the Company's first annual
reporting period beginning on or after December 15, 2008. The Company will
assess the impact of the FSP if and when a future acquisition occurs.
The Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin
("SAB") No. 111 on April 9, 2009 to amend Topic 5.M., "Other Than Temporary
Impairment of Certain Investments in Debt and Equity Securities" and to
supplement FSP SFAS 115-2 and SFAS 124-2. SAB 111 maintains the staff's previous
views related to equity securities; however debt securities are excluded from
its scope. The SAB provides that "other-than-temporary" impairment is not
necessarily the same as "permanent" impairment and unless evidence exists to
support a value equal to or greater than the carrying value of the equity
security investment, a write-down to fair value should be recorded and accounted
for as a realized loss. The SAB was effective upon issuance and had no impact on
the Company's financial position.
Accounting standards that have been issued or proposed by the FASB that do not
require adoption until a future date are not expected to have a material impact
on the consolidated financial statements upon adoption.
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," "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 future economic and business conditions;
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, costs and
composition of deposits, loan demand, and the values of our loan
collateral, securities, and interest sensitive assets and liabilities;
10
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 and government programs;
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 higher than anticipated levels of defaults on loans;
o perceptions by depositors about the safety of deposits;
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 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;
o loss of consumer confidence and economic disruptions resulting from
terrorist activities;
o ability to weather the current economic downturn;
o loss of consumer or investor confidence; and
o other factors and information described in this report and in any of
the other reports we file with the Securities and Exchange Commission
under the Securities Act of 1934.
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.
11
Effect of Economic Trends
During the fourth quarter of 2008 and continuing into the first quarter of 2009,
the FDIC, the Federal Reserve, the Department of the Treasury and Congress took
a number of actions designed to alleviate or correct mounting problems in the
financial services industry. A number of these initiatives were directly
applicable to community banks.
Congress enacted the Emergency Economic Stabilization Act of 2008 which, among
other things, temporarily increased the maximum amount of FDIC deposit insurance
from $100,000 to $250,000 and created a Troubled Assets Relief Program ("TARP")
administered by Treasury. In October, 2008, Treasury announced a Capital
Purchase Program ("CPP") under TARP to increase the capital of healthy banks.
Under the CPP, Treasury would purchase preferred stock with warrants from
qualified banks and bank holding companies in an amount up to 3% of the seller's
risk-weighted assets as of September 30, 2008. Institutions wishing to
participate in the CPP were required to file an application with their principal
federal regulators. The Company filed such an application and received
preliminary approval to sell preferred stock to the Treasury, but ultimately
elected not to participate in the CPP because of (i) the cost of the preferred
stock, (ii) the open-ended administrative burdens associated with the preferred
stock, including having to agree to allow Treasury to amend unilaterally the
stock purchase agreement to comply with subsequent changes in applicable federal
statutes, (iii) the fact that the Company and the Bank were already well
capitalized under regulatory guidelines and expected to continue to be so, and
(iv) management's belief that other sources of capital were, and would continue
to be, available should additional capital be needed.
The FDIC also implemented in October, 2008, a Temporary Liquidity Guarantee
Program consisting of a deposit insurance component pursuant to which it
undertook to provide deposit insurance in an unlimited amount for non-interest
bearing transaction accounts, and a debt guarantee component pursuant to which
it undertook to fully guarantee senior, unsecured debt issued by banks or bank
holding companies. Coverage of both components was automatic until December 5,
2008, at which time covered institutions could opt out of one or both of the
components. Institutions not opting out would be charged fees for their
participation in the components. The Bank did not opt out of either component.
An unfortunate consequence of the difficulties that have beset the banking
industry in the last year has been a large increase in bank failures, which has
led to substantial claims being made against the FDIC's Deposit Insurance Fund.
In order to increase the amount in the Deposit Insurance Fund to reflect the
increased risk of additional bank failures and insurance claims, the FDIC has
raised its assessments on banks for 2009, and has also proposed a special
one-time assessment of 20 cents per $100 of assessable deposits, to be paid in
September, 2009, based on deposits at June 30, 2009. There appears, however, to
be a possibility that the assessment will be reduced if Congress authorizes the
FDIC to borrow sufficient funds. Assuming that the special assessment is imposed
as proposed and without reduction, the additional cost to the Bank in 2009 would
be approximately $289,000.
Additional governmental efforts to ameliorate the problems afflicting the
banking industry have been adopted or proposed, or are being considered by
Congress and various governmental entities. The Company is presently unable to
predict the impact of any such changes, although it appears that they are likely
to increase operating expenses in the near term without creating completely
offsetting benefits.
The current outlook for the national economy in the United States remains
negative. Management expects that unfavorable economic conditions will persist
through 2009. We will continue to monitor both the local and national economic
conditions in an effort to minimize any negative impact on the Company.
Throughout 2008 and into the first quarter of 2009, the Federal Reserve has held
its target short-term interest rates at very low levels by historical standards.
The Federal Reserve has done this as part of its response to the economic
turmoil currently dominating the U.S. economy. 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 remained very low.
However, interest rates on the Bank's interest bearing liabilities have not
decreased by the same magnitude, tightening the Bank's net interest margin. In
addition, the turmoil in the national mortgage market over the last fifteen
months 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 low level of
income earned from mortgage brokerage fees. Both of these trends negatively
impacted the Company's profitability in 2008 and have continued to create
challenges into 2009. 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
12
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 March 31, 2009 and 2008
Summary
The Company earned $41,896 during the first quarter of 2009 or $.02 per basic
and diluted share compared to income of $219,894 during the first quarter of
2008 or $.11 per basic and $.10 per diluted share, after giving effect to the
five percent stock dividend declared in 2009. 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.
These were partially offset by a gain on the sale of an available-for-sale
security in 2009. 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 related to 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 and continuing into 2009, 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 62% 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 maintenance of very low target interest rates by the
Federal Open Market Committee of the Federal Reserve from September 2007 through
March of 2009, earning rates on over half of the Bank's loan portfolio adjusted
downward and remain low. While the average balance of loans outstanding grew
18.2% in the first quarter of 2009 as compared to the first quarter of 2008,
decreases in rates earned on the portfolio had a greater impact on interest
income than the increases in volume. Average rates earned decreased 219 basis
points in the first quarter of 2009 compared to the first quarter of 2008. In
contrast, average rates paid on interest bearing liabilities decreased only 123
basis points year over year.
13
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 March 31, 2009 and 2008.
March 31, 2009 March 31, 2008
-------------- --------------
Average Average Average Average
Balance Interest Yield/ Cost Balance Interest Yield/ Cost
------- -------- ----------- ------- -------- -----------
Investments ................................ $ 21,157,694 $ 251,788 4.83% $ 23,155,707 $ 302,707 5.30%
Federal Funds Sold ......................... 342,700 165 .20% 3,026,868 21,490 2.88%
Loans ...................................... 130,580,290 1,738,030 5.40% 110,492,096 2,067,113 7.59%
Other ...................................... 8,791,938 2,391 .11% 328,556 3,331 4.11%
------------ ---------- ------------ ----------
Total interest earning assets ........... 160,872,622 1,992,374 5.02% 137,003,227 2,394,641 7.09%
============ ---------- ============ ----------
Interest bearing transaction accounts ...... 12,797,308 21,330 .68% 13,367,584 36,931 1.12%
Savings and money market ................... 24,633,537 118,960 1.96% 10,862,065 53,722 2.01%
Time deposits .............................. 89,204,351 631,209 2.87% 77,113,830 833,582 4.38%
------------ ---------- ------------ ----------
Total interest bearing deposits ......... 126,635,196 771,499 2.47% 101,343,479 924,235 3.70%
Customer repurchase agreements and
Federal Funds purchased ................ 4,474,792 27,388 2.48% 5,827,419 57,690 4.01%
Borrowings from FHLB Atlanta ............... 8,098,112 56,745 2.84% 5,203,892 48,575 3.79%
Broker repurchase agreements ............... 5,000,000 43,550 3.53% 4,340,659 38,171 3.57%
------------ ---------- ------------ ----------
Total interest bearing liabilities ...... $144,208,100 899,182 2.53% $116,715,449 1,068,671 3.71%
============ ---------- ============ ----------
Net interest income ........................ $1,093,192 $1,325,970
========== ==========
Interest rate spread ....................... 2.49% 3.38%
Interest margin ............................ 2.76% 3.93%
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 March 31, 2009, the Bank's cumulative
Gap ratio was .80 through 12 months. This indicates a liability-sensitive
position as of March 31, 2009. Based on a static GAP 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 twelve months, the Bank has
experienced difficulty in lowering rates on its liabilities because it has been
competing for funds with many other entities, some of which have faced
significant liquidity needs. This competition for funds has resulted in an
increase in rates or a lack of decreases 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 March 31, 2009, the Company expensed $160,000 to the
provision for loan losses. The Bank sets allowance for loan loss levels in
response to trends in the portfolio and the level of potential problem loans.
During the quarter, charge-offs totaled $157,906 and recoveries totaled $500.
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
14
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
The primary recurring drivers of noninterest income for the Company and the Bank
are service charges on deposit accounts and mortgage loan origination fees. For
the three months ended March 31, 2009, the Company earned $132,891 in service
charges on deposit accounts compared to $141,946 for the same period in 2008.
The decrease is attributable to a decrease in charges for insufficient funds.
Mortgage loan origination fees in the first quarter of 2009 have decreased by
$18,295 or 25% compared to the first quarter of 2008. The decrease is directly
related to problems that borrowers are facing as they try to purchase or
refinance homes. National mortgage lenders have changed or deleted programs and
tightened credit standards. Some credit worthy borrowers are not making
refinancing or purchase decisions until they can determine that interest rates
have probably reached their lowest level for this economic cycle.
Noninterest expense
Noninterest expense totaled $1.15 million for the three months ended March 31,
2009 and $1.13 million for the three months ended March 31, 2008. Salaries and
employee benefits decreased approximately $57,769 or 8.8% in 2009 compared to
2008 due to retirements. Data processing increased 14.7% in 2009 over 2008,
mainly due to price increases at our core processor. Professional and regulatory
fees increased 73.2%. This dramatic increase relates to premiums for FDIC
insurance. The FDIC released a statement on February 27, 2009, stating that the
FDIC Board adopted an interim rule imposing a 20 basis point emergency special
assessment on the industry on June 30, 2009. The assessment is to be collected
on September 30, 2009. The interim rule would also permit the Board to impose an
emergency special assessment after June 30, 2009, of up to 10 basis points if
necessary to maintain public confidence in federal deposit insurance. The
banking industry has strongly opposed the amount of this assessment on the basis
that the industry will be further weakened by this assessment in its current
form. The FDIC has stated in the month since the special assessment was
announced that it will not impose the assessment in its current form if workable
alternatives can be found. At this time, there can be no assurance that the
assessment will be reduced. As a result, the Company accrued a portion of the
special assessment during the first quarter of 2009. Total FDIC insurance
premium expense for the quarter ended March 31, 2009 was $65,375 compared to
$17,144 for the quarter ended March 31, 2008. Other expense increased $35,245 or
23.4% in 2009 over 2008 levels. Other expense in 2009 includes approximately
$22,700 of additional software licensing costs and loan-related expenses of
$25,397 which are primarily associated with the foreclosure process and
re-appraisals of properties collateralizing loans.
Balance Sheet Review
Investments
At March 31, 2009, the Bank held available for sale securities with a fair value
and amortized cost of $20.7 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.
However, there can be no assurance that these stocks will, in fact, be redeemed
at cost in the future.
As of March 31, 2009, investments available for sale had a net unrealized gain
of $351,680. As of March 31, 2009 we held nine investments that are in an
unrealized loss position. Of those nine, only two had been in an unrealized loss
position for more than 12 months. The amount of the total unrealized loss in the
portfolio is $214,958, with $61,132 related to the two securities 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. One of the two investments in a net unrealized loss
position at March 31, 2009 is our investment in FNMA Preferred stock. In
September 2008 the U.S. Treasury placed FNMA in conservatorship. At that time
the Company recognized an other-than-temporary-impairment charge. However, there
can be no certainty that we will not incur further losses on the FNMA preferred
stock. The amortized cost of our investment in FNMA preferred stock is $87,200
and the fair value is $31,600 at March 31, 2009. The majority of the remaining
investments with unrealized losses at March 31, 2009 are issued by various
15
municipal governments. Based on our review of these securities, we do not
currently expect that these losses are other than temporary.
Loans
The following table summarizes the composition of our loan portfolio.
March 31, 2009 March 31, 2008
-------------- --------------
% of % of
Amount Loans Amount Loans
------ ----- ------ -----
Commercial and industrial ....................... $ 16,378,633 12.0% $ 18,748,902 16.3%
Real Estate - construction ...................... 54,778,470 40.0 48,773,907 42.3
Real Estate - mortgage
1-4 family residential ................... 26,335,962 19.2 20,290,520 17.6
Nonfarm, nonresidential .................. 36,537,853 26.7 23,468,989 20.4
Multifamily residential .................. 1,220,996 0.9 1,598,772 1.4
Consumer installment ............................ 1,684,968 1.2 2,277,153 2.0
------------ ----- ------------ -----
Total Loans .......................... 136,936,882 100.0% 115,158,243 100.0%
===== =====
Less allowance for loan losses .......... (1,701,157) (1,229,137)
------------ ------------
Net Loans ............................ $135,235,725 $113,929,106
============ ============
Activity in the allowance for loan losses for the first three months of 2009 and
2008 is presented below.
Three months ended Three months ended
March 31, 2009 March 31, 2008
-------------- --------------
Allowance for loan losses, beginning of year ................................... $ 1,698,563 $ 1,293,130
Provision for losses ........................................................... 160,000 120,000
Charge-offs .................................................................... (157,906) (183,993)
Recoveries ..................................................................... 500 -
------------- -------------
Allowance for loan losses, end of period ................................. $ 1,701,157 $ 1,229,137
============= =============
Ratios
Nonperforming loans to loans at end of period ............................. 3.44% .61%
Net (charge-offs) recoveries to average loans
outstanding ......................................................... (.12%) (.17%)
Net (charge-offs) recoveries to loans at end of period .................... (.11%) (.16%)
Allowance for loan losses to average loans ................................ 1.27% 1.11%
Allowance for loan losses to loans at end of period ....................... 1.24% 1.07%
Net (charge-offs) recoveries to allowance for loan losses ................. (9.25%) (14.97%)
Net (charge-offs) recoveries to provision for loan losses ................. (98.4%) (153.3%)
Charge-offs totaled $157,906 for the first three months of 2009 and recoveries
totaled $500. These charge-offs related to a number of different loans, in
multiple collateral categories.
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 March 31, 2009,
the Bank had nonaccrual loans of $4.7 million, representing 31 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 arrangements 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. In
addition to loans on nonaccrual, as of March 31, 2009, Management considers
another $933,315 of loans impaired. Management is currently assessing the
collateral associated with these impaired loans in an effort to determine the
amount of potential impairment.
16
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 $3.6 million that have
been determined by management to be potential problem loans at March 31, 2009.
These loans are generally secured by real estate, and in many cases have been
reappraised. Should potential problem loans become impaired, Management will
charge-off any impairment amount as soon as the amount can be determined.
Deposits
The following table shows the average balance amounts and the average rates we
paid on deposits for the quarters ended March 31, 2009 and 2008.
Average Deposits
----------------
Quarter ended Quarter ended
March 31, 2009 March 31, 2008
-------------- --------------
Amount Rate Amount Rate
------ ---- ------ ----
Noninterest bearing demand ................................... $ 9,964,060 -% $ 10,829,693 -%
Interest bearing transaction accounts ........................ 12,797,308 .68% 13,367,584 1.12%
Savings and money market ..................................... 24,633,537 1.96% 10,862,065 2.01%
Time deposits ................................................ 89,204,351 2.87% 77,113,830 4.38%
------------ ------------
Total average deposits ................................. $136,599,256 2.47% $112,173,172 3.70%
============ ============
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 March 31, 2009
-----------------------------------------------------
Maximum Weighted
Period- Month-end Average
Ending Balance End Rate Balance Average Balance Rate Paid
-------------- -------- ------- --------------- ---------
Federal Home Loan Bank advances ..................... $6,856,297 3.23% $8,381,435 $8,098,112 2.84%
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 $3.0 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
$6.9 million borrowed under the FHLB line. Approximately $11.2 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.
17
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 March 31, 2009, the Bank had issued commitments to extend credit of $22.7
million through various types of lending arrangements and overdraft protection
arrangements. Of that amount, approximately $15.0 million was undisbursed
amounts of closed-end loans, $1.3 million was related to unused overdraft
protection, and approximately $6.4 million was related to lines of credit. The
Bank also had standby letters of credit outstanding of approximately $1.0
million at March 31, 2009. An immaterial amount of fees were collected related
to these commitments and letters of credit during the quarter ended March 31,
2009. Historically many of these commitments and letters of credit expire
unused, and the total amount committed as of March 31, 2009 is not necessarily
expected to be funded. Subsequent to March 31, 2009, one of these letters of
credit was funded in the amount of $427,902.
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
$1.3 million as of March 31, 2009, the majority of which is not expected to be
utilized. As March 31, 2009, accounts in overdraft status totaled $19,492.
Capital Resources
The capital base for the Company increased by approximately $324,900 for the
first three months of 2009, due to net income, stock option activity, and
increases in accumulated other comprehensive income. 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 10.8% as of
March 31, 2009. 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),the ratio of
average equity to average assets and the Dividend Payout Ratio (dividends paid
divided by net income) as of and for the three months ended March 31, 2009 and
as of and for the year ended December 31, 2008. Return on Assets and Return on
Equity for the first three months of 2009 have decreased compared to Return on
Assets and Return on Equity for the year ended December 31, 2008 due to pressure
on our net interest margin and the effect of an increased provision for loan
losses.
Three- month
period ended Year ended
March 31, 2009 December 31, 2008
-------------- -----------------
(annualized)
Return on average assets ............. .10% .15%
Return on average equity ............. .87% 1.16%
Ratio of average equity
to average assets ................... 11.19% 12.68%
Dividend payout ratio* -% 265%
* In May 2008 the Company declared a cash dividend which was less than the
Company's reported net income for the first two quarters of 2008. Following the
placement of FNMA in conservatorship in September 2008, the Company recognized
an Other-than-temporary-impairment charge of $918,264, which reduced the
Company's net income for 2008 to an amount less than the amount of the dividend
declared in May 2008.
18
The FDIC has established guidelines for capital requirements for banks. As of
March 31, 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 ................. $20,444 13.64% $14,986 10.0% $11,989 8.0%
Tier 1 capital to risk weighted assets ................ $18,743 12.51% $ 8,991 6.0% $ 5,994 4.0%
Tier 1 capital to average assets ...................... $18,743 10.77% $ 8,700 5.0% $ 6,960 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
March 31, 2009 the Company exceeded all of the minimum requirements of the
Federal Reserve guidelines.
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 2. Unregistered Sales of Equity Securities and Use of Proceeds.
During the quarter ended March 31, 2009, the Company issued shares of
common stock to one director/employee and one director upon the exercise of
options as follows:
Date of Issuance Number of Shares Issued Aggregate Exercise Price
---------------- ----------------------- ------------------------
March 11, 2009 7,086 $ 40,000
March 12, 2009 7,086 $ 40,000
Issuance of such shares was not registered under the Securities Act of
1933 in reliance upon the exemption provided by Section 4(2) thereunder based on
the fact that no public offering was involved.
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
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: May 8, 2009
-------------------------------------------------------
J. Rodger Anthony
Chief Executive Officer
By: s/Jennifer M. Champagne Date: May 8, 2009
-------------------------------------------------------
Jennifer M. Champagne
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
20