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, 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, 2,105,738 shares outstanding on November 1, 2009
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2009 2008
---- ----
Assets (Unaudited)
Cash and due from banks ....................................................................... $ 10,987,229 $ 3,820,227
Federal funds sold ............................................................................ 1,680,000 140,000
------------- -------------
Cash and cash equivalents .............................................................. 12,667,229 3,960,227
Investment securities
Available-for-sale ......................................................................... 24,496,910 19,676,604
Other investments .......................................................................... 1,142,050 1,114,150
Loans, net .................................................................................... 138,446,382 129,483,130
Property and equipment, net ................................................................... 5,353,323 5,551,275
Cash surrender value of life insurance policies ............................................... 1,820,963 1,768,520
Other real estate owned ....................................................................... 4,848,984 575,000
Other assets .................................................................................. 3,029,330 1,722,161
------------- -------------
Total assets .................................................................... $ 191,805,171 $ 163,851,067
============= =============
Liabilities And Shareholders' Equity
Liabilities
Deposits
Noninterest bearing ...................................................................... $ 12,180,011 $ 10,069,125
Interest bearing ......................................................................... 141,862,370 112,512,449
------------- -------------
Total deposits ........................................................................... 154,042,381 122,581,574
Federal funds purchased .................................................................... - 1,810,000
Customer repurchase agreements ............................................................. 3,549,610 4,582,619
Borrowings from Federal Home Loan Bank of Atlanta .......................................... 9,780,880 10,394,005
Broker repurchase agreements ............................................................... 5,000,000 5,000,000
Other liabilities .......................................................................... 666,165 345,922
------------- -------------
Total liabilities ........................................................................ 173,039,036 144,714,120
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, 2,105,738 and 1,991,565
shares issued at September 30, 2009 and December 31, 2008, respectively ................ 18,781,612 18,323,333
Retained earnings (deficit) ................................................................ (545,965) 765,906
Accumulated other comprehensive income ..................................................... 530,488 47,708
------------- -------------
Total shareholders' equity ............................................................... 18,766,135 19,136,947
------------- -------------
Total liabilities and shareholders' equity ............................................... $ 191,805,171 $ 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 For the nine months ended
September 30, September 30,
------------- -------------
2009 2008 2009 2008
---- ---- ---- ----
Interest and Dividend Income
Interest and fees on loans ........................... $ 1,722,059 $ 1,957,863 $ 5,230,366 $ 5,997,307
Investment securities ................................ 267,048 293,738 757,071 910,380
Federal funds sold and interest bearing
balances ........................................... 3,546 20,420 10,880 82,414
----------- ----------- ----------- -----------
Total interest income ............................ 1,992,653 2,272,021 5,998,317 6,990,101
----------- ----------- ----------- -----------
Interest Expense
Deposits ............................................. 709,667 748,011 2,225,544 2,498,885
Borrowings ........................................... 123,354 145,296 369,139 426,557
----------- ----------- ----------- -----------
Total interest expense ............................ 833,021 893,307 2,594,683 2,925,442
----------- ----------- ----------- -----------
Net Interest Income .................................... 1,159,632 1,378,714 3,403,634 4,064,659
Provision for Loan Losses .............................. 945,000 220,000 2,025,000 460,000
----------- ----------- ----------- -----------
Net interest income after provision
for loan losses ................................. 214,632 1,158,714 1,378,634 3,604,659
----------- ----------- ----------- -----------
Noninterest Income
Service charges on deposit accounts .................. 154,258 152,043 424,982 439,587
Mortgage loan origination fees ....................... 25,781 53,408 136,843 226,038
Gain on sale of security ............................. - - 52,300 -
Other than temporary impairment loss
on investment securities available
for sale ........................................ - (918,264) - (918,264)
Other ................................................ 49,375 29,500 98,309 88,693
----------- ----------- ----------- -----------
Total noninterest income (loss) ................... 229,414 (683,313) 712,434 (163,946)
----------- ----------- ----------- -----------
Noninterest Expense
Salaries and employee benefits ....................... 601,564 579,378 1,811,201 1,847,901
Premises and equipment ............................... 140,164 152,863 438,701 452,702
Data processing ...................................... 53,882 57,944 164,757 172,382
Professional and regulatory fees ..................... 120,146 97,626 442,483 245,437
Supplies ............................................. 16,335 19,637 51,691 60,856
Advertising .......................................... 6,105 16,625 25,002 52,255
Other ................................................ 353,723 163,312 733,599 463,967
----------- ----------- ----------- -----------
Total noninterest expense ......................... 1,291,919 1,087,385 3,667,434 3,295,500
----------- ----------- ----------- -----------
Net income (loss) before taxes .................... (847,873) (611,984) (1,576,366) 145,213
Provision (benefit) for income taxes ................... (301,908) (206,510) (590,141) 47,591
----------- ----------- ----------- -----------
Net income (loss) ................................. $ (545,965) $ (405,474) $ (986,225) $ 97,622
=========== =========== =========== ===========
Earnings (Loss) Per Share
Basic ................................................ $ (.26) $ (.19) $ (.46) $ .05
Diluted .............................................. $ (.26) $ (.19) $ (.46) $ .05
Weighted Average Shares Outstanding
Basic ................................................ 2,105,738 2,091,143 2,102,130 2,088,794
Diluted .............................................. 2,105,738 2,091,143 2,102,130 2,122,339
Earnings per share in 2008 reflect the effect of the 5% stock dividend in 2009.
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, 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 ..................................... - - 97,622 - 97,622
Other comprehensive income, net
of income taxes
Unrealized loss on investment
securities, net ............................. - - - (236,900) (236,900)
------------
Comprehensive income ........................... (139,278)
Stock based compensation ....................... - 41,717 - - 41,717
Options exercised .............................. 8,396 81,833 - - 81,833
Cumulative effect of accounting change ......... - - (39,389) - (39,389)
Dividends paid ................................. - - (597,471) - (597,471)
--------- ------------ ------------ ------------ ------------
Balance, September 30, 2008 .................... 1,991,565 $ 18,308,878 $ 638,212 $ (18,848) $ 18,928,242
========= ============ ============ ============ ============
Balance, December 31, 2008 ..................... 1,991,565 $ 18,323,333 $ 765,906 $ 47,708 $ 19,136,947
Net loss ....................................... - - (986,225) - (986,225)
Other comprehensive income, net
of income taxes
Unrealized gain on investment
securities, net ............................. - - - 482,780 482,780
------------
Comprehensive loss ............................. (503,445)
Stock based compensation ....................... - 54,348 - - 54,348
5% stock dividend, net of cash paid in
lieu of fractional shares .................... 100,001 323,931 (325,646) - (1,715)
Options exercised .............................. 14,172 80,000 - - 80,000
--------- ------------ ------------ ------------ ------------
Balance, September 30, 2009 .................... 2,105,738 $ 18,781,612 $ (545,965) $ 530,488 $ 18,766,135
========= ============ ============ ============ ============
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,
---------------------------------------
2009 2008
---- ----
Operating Activities
Net income (loss) ................................................................. $ (986,225) $ 97,622
Adjustments to reconcile net income (loss) to net cash provided by
operating activities
Depreciation and amortization .................................................. 247,539 220,770
Provision for loan losses ...................................................... 2,025,000 460,000
Non-cash option expense ........................................................ 54,348 41,717
Gain on sale of property and equipment ............................................ (625) -
Other than temporary impairment loss on investment securities ..................... - 918,264
available for sale
(Gain) loss on sale of property acquired in foreclosure ........................... 35,369 (481)
Gain on sale of security available for sale ....................................... (3,828)
Changes in operating assets and liabilities
Change in interest receivable .................................................. 93,693 137,434
Change in other assets ......................................................... (1,453,305) (482,500)
Change in other liabilities .................................................... 71,539 (184,126)
------------ ------------
Net cash provided by operating activities ................................... 87,333 1,204,872
------------ ------------
Investing Activities
Proceeds from maturities and principal repayments of available for sale
securities .................................................................. 6,065,417 4,140,996
Purchase of FHLB and Federal Reserve stock ........................................ (27,900) (210,750)
Purchase of investment securities available for sale .............................. (10,198,378) (7,085,514)
Purchase of property and equipment ................................................ (5,448) (22,763)
Proceeds from sale of property acquired in foreclosure ............................ 2,198,474 343,852
Proceeds from sale of property and equipment ...................................... 625 7,495
Net increase in loans to customers ................................................ (17,496,079) (10,399,915)
------------ ------------
Net cash used for investing activities ...................................... (19,463,289) (13,226,599)
------------ ------------
Financing Activities
Net increase in demand, savings and time deposits ................................. 31,460,807 5,460,067
Net decrease in customer repurchase agreements .................................... (1,033,009) (1,152,611)
Dividends paid .................................................................... - (597,471)
Cash paid in lieu of fractional shares ............................................ (1,715) -
Decrease in federal funds purchased ............................................... (1,810,000) -
Repayment of FHLB advances ........................................................ (5,113,125) (3,413,125)
Borrowings from FHLB .............................................................. 4,500,000 8,300,000
Proceeds from broker repurchase agreements ........................................ - 5,000,000
Proceeds from exercise of stock options ........................................... 80,000 81,833
------------ ------------
Net cash provided by financing activities ................................... 28,082,958 13,678,693
------------ ------------
Net increase in cash and cash equivalents ................................... 8,707,002 1,656,966
Cash and Cash Equivalents, Beginning of Period ......................................... 3,960,227 5,233,777
------------ ------------
Cash and Cash Equivalents, End of Period ............................................... $ 12,667,229 $ 6,890,743
============ ============
Supplemental Information
Cash paid for interest ............................................................. $ 2,621,816 $ 2,937,257
Cash paid for income taxes ......................................................... $ 60,127 $ 438,048
Non-cash Supplemental information
Loans transferred to other real estate owned ....................................... $ 4,479,462 $ 921,744
Loans (charged-off) recovered, net ................................................. $ 1,680,936 $ 332,824
The accompanying notes are an integral part of these consolidated financial
statements.
5
CORNERSTONE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. Nature of Business and Basis of Presentation
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
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.
Note 2. Earnings per Share
FASB ASC 260, "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 and diluted net loss per
common share for the three month period ended September 30, 2009 was 2,105,738
shares. Outstanding options were excluded from the loss per share calculation as
they are anti-dilutive as of September 30, 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. The weighted average number of
common shares outstanding for net loss per common share for the nine month
period ended September 30, 2009 was 2,102,130 shares.
Note 3. 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 FASB
ASC 718, "Compensation- Stock Compensation." 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
was 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
6
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 nine months ended September 30, 2009, the Company expensed $12,219 related
to options granted in 2009, $14,739 related to options granted in 2008, $15,522
related to options granted in 2007, and $11,868, 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 FASB ASC 718 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. Following
the 5% stock dividend declared by the Board of Directors on April 14, 2009 and
distributable to shareholders of record on May 12, 2009, the adjusted number of
options outstanding was approximately 110,143 and the weighted average exercise
price was $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, 20,000 of the original
options have been exercised and 4,000 have been forfeited. As of September 30,
2009, after the effect of stock dividends and exercises, there are 29,759
Organizers' Options outstanding. Each option is currently exercisable at a price
of $5.38, following the 5% stock dividend declared by the Board of Directors on
April 14, 2009 and distributable to shareholders of record on May 12, 2009 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. These options expire
in December, 2009.
Note 4. 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.
Note 5. 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 25.3% in Residential Building
Construction and 21.7% in Real Estate and Rental and Leasing. The portfolio also
has loans representing 21 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
7
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, 2009, the Bank has $3.7 million of loans which exceed the
regulatory loan to value guidelines. This amount is within the maximum allowable
exceptions to the guidelines. Of the $3.7 million of loans with exceptions to
the regulatory loan to value guidelines, $2.5 million were not exceptions at the
time the loan was made, but became exceptions upon reappraisal. Management
routinely reappraises real estate collateral based on specific criteria and
circumstances. If additional collateral is available, the Bank may require the
borrower to commit additional collateral to the loan.
Note 6. Income taxes
The Company accounts for income taxes under SFAS No. 109 FASB Accounting
Standards Codification TM ("FASB ASC") 740, "Accounting for Income Taxes."
Certain items of income and expense (principally provision for loan losses,
depreciation, and prepaid expenses) are included in one reporting period for
financial accounting purposes and another for income tax purposes. Refer to the
notes to the Company's consolidated financial statements for the year ended
December 31, 2008 for more information. To date in 2009, the Company recorded an
income tax benefit of $590,141 compared to tax expense of $47,591 in 2008. The
primary reasons for the benefit in 2009 are the exclusion of nontaxable
municipal bond income in 2009 and the net tax effect of loan charge-offs. In
2008, taxable income was affected by the exclusion of nontaxable municipal bond
income and the tax effect of the other-than temporary-impairment charge on the
FNMA preferred stock. In the fourth quarter of 2008, legislation was passed by
Congress making the OTTI charge includable in ordinary income for holders of
FNMA and Federal Home Loan Mortgage Corporation ("FHLMC") preferred stocks. The
Company, therefore, recorded a deferred tax asset in 2008 of $312,210 related to
the other-than-temporary impairment of the FNMA preferred stock. As of September
30, 2009 management has evaluated its deferred tax items and does not believe
that any require reserves as of September 30, 2009. The Company also believes
that its income tax filing positions taken or expected to be taken in its tax
returns will more likely than not be sustained upon audit by the taxing
authorities, and does not anticipate any adjustments that will result in a
material adverse impact on the Company's financial condition, results of
operations, or cash flows. Therefore, no reserves for uncertain income tax
positions have been recorded pursuant to FIN 48.
Note 7. Fair Value Accounting
Effective January 1, 2008, the Company adopted FASB ASC 820, "Fair Value
Measurements," which defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements. FASB ASC 820 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. FASB ASC 820 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
8
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.
Note 8. Evaluation of subsequent events
In accordance with FASB ASC 855, "Subsequent Events," issued in May 2009 and
effective for periods ending after June 15, 2009, management performed an
evaluation to determine whether or not there have been any subsequent events
since the balance sheet date. The evaluation was performed through November 13,
2009, the date on which the Company's 10-Q was issued as filed with the
Securities and Exchange Commission.
Note 9. 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:
In June 2009, the FASB issued SFAS 168 "The FASB Accounting Standards
Codification TM and the Hierarchy of Generally Accepted Accounting Principles -
a replacement of FASB Statement No. 162," ("SFAS 168") . SFAS 168 establishes
the FASB Accounting Standards Codification TM ("ASC") as the source of
authoritative generally accepted accounting principles for nongovernmental
entities. SFAS 168 (ASC 105-10-5) is effective for interim and annual periods
ending after September 15, 2009 and is not expected to have any impact on the
Company's financial position. In conjunction with the issuance of SFAS 168, the
FASB also issued its first Accounting Standards Update No. 2009-1, "Topic 105
- -Generally Accepted Accounting Principles" ("ASU 2009-1") which includes SFAS
168 in its entirety as a transition to the ASC. ASU 2009-1 is effective for
interim and annual periods ending after September 15, 2009 and will not have an
impact on the Company's financial position or results of operations but will
change the referencing system for accounting standards. Certain of the
pronouncements were issued prior to the issuance of the ASC and adoption of the
ASUs. For such pronouncements, citations to the applicable Codification by
Topic, Subtopic and Section are provided where applicable in addition to the
original standard type and number.
FSP EITF 99-20-1 (ASC 325-40-65), "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 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 the balance
sheet date.
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 (ASC 320-10-65), "Recognition and Presentation of
Other-Than-Temporary Impairments," ("FSP SFAS 115-2 and SFAS 124-2") categorizes
9
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 (ASC 820-10-65), "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 (ASC 825-10-65), "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.
Also on April 1, 2009, the FASB issued FSP SFAS 141(R)-1 (ASC 805-20-25),
"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. (ASC 320-10-S99), "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.
SFAS 165 "Subsequent Events," ("SFAS 165") (ASC 855-10-05) was issued in May
2009 and provides guidance on when a subsequent event should be recognized in
the financial statements. Subsequent events that provide additional evidence
10
about conditions that existed at the date of the balance sheet should be
recognized at the balance sheet date. Subsequent events that provide evidence
about conditions that arose after the balance sheet date but before financial
statements are issued, or are available to be issued, are not required to be
recognized. The date through which subsequent events have been evaluated must be
disclosed as well as whether it is the date the financial statements were issued
or the date the financial statements were available to be issued. For
non-recognized subsequent events which should be disclosed to keep the financial
statements from being misleading, the nature of the event and an estimate of its
financial effect, or a statement that such an estimate cannot be made, should be
disclosed. The standard is effective for interim or annual periods ending after
June 15, 2009. See Note 1 for Management's evaluation of subsequent events.
The FASB issued ASU 2009-05, "Fair Value Measurements and Disclosures (Topic
820) - Measuring Liabilities at Fair Value" in August, 2009 to provide guidance
when estimating the fair value of a liability. When a quoted price in an active
market for the identical liability is not available, fair value should be
measured using (a) the quoted price of an identical liability when traded as an
asset; (b) quoted prices for similar liabilities or similar liabilities when
traded as assets; or (c) another valuation technique consistent with the
principles of Topic 820 such as an income approach or a market approach. If a
restriction exists that prevents the transfer of the liability, a separate
adjustment related to the restriction is not required when estimating fair
value. The ASU was effective October 1, 2009 for the Company and will have no
impact on financial position or operations.
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;
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;
11
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.
Effect of Economic Trends
During the fourth quarter of 2008 and continuing throughout 2009, the Federal
Deposit Insurance Corporation ("FDIC"), the Federal Reserve, the Department of
the Treasury and Congress have taken 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.
12
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 also leveled a special one-time
assessment of five cents per $100 of a bank's assessable base, which was defined
as total assets less Tier one capital as of June 30, 2009. The Bank paid $80,894
on September 30, 2009 related to the special assessment. The assessment was paid
in addition to $163,481 expensed for recurring FDIC insurance premiums during
the first nine months of 2009. The FDIC has also voted to require FDIC insured
institutions to prepay their quarterly assessments for the years 2010, 2011, and
2012. Increases in deposit levels and assessments will both be incorporated into
the calculation of the prepaid assessments, which are required to be paid to the
FDIC on December 30, 2009. The prepayments will be booked at the end of each
quarter during the three year period, and therefore, will not immediately affect
earnings. Further, there can be no assurance that additional payments in the
form of special assessments or higher premiums will not be required in the
future as the FDIC's Deposit Insurance Fund absorbs losses resulting from failed
institutions.
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. On June 17, 2009, the Obama
Administration unveiled its plans for reorganizing the regulatory system for
financial institutions. The proposal raises many issues for banks and savings
associations. 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 and into 2010. Specifically, unemployment is expected to remain
high in the near term. 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 2009, the Federal Open Market Committee of the Federal
Reserve ("FOMC") has held its target short-term interest rates at very low
levels by historical standards. The FOMC 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 short-term interest rates, 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 ability of many borrowers to obtain mortgage financing has
decreased, impacting one source of non-interest income for the Bank. Both of
these trends have negatively impacted the Company's profitability in 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 some other parts
of the country, these factors have had a significant effect on the local
markets, as evidenced by the increases in our potential problem loans,
charge-offs, and nonaccrual loans, particularly with respect to new residential
real estate.
Results of Operations for the Three Months Ended September 30, 2009 and 2008
Summary
The Company recorded a loss of $545,965 during the third quarter of 2009 or $.26
per share compared to a loss of $405,474 during the third quarter of 2008 or
$.19 per 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 and increases in FDIC insurance premiums and
foreclosure-related costs. These were partially offset by a gain on the sale of
an available-for-sale security in 2009. The third quarter of 2008 included an
Other-than-temporary-loss on FNMA Preferred Stock that occurred when the US
Government put FNMA and the Federal Home Loan Mortgage Corporation ("FHLMC")
into conservatorship in September 2008. 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
13
for mortgage loan products. The increase in the provision for loan losses is a
result of an increase in 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 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 60% of
the Bank's loans are tied to the Prime Rate, which responds immediately to
changes in market interest rates. Some of these loans include provisions for
interest rate floors, but due to competitive pressures at the time the loans
were made, many do not. 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. In addition, the current
economic climate is requiring banks to keep more liquidity on their balance
sheets. Liquid assets are generally lower-earning assets than loans, further
impacting our net interest margin.
As mentioned above, a result of maintenance of very low target interest rates by
the FOMC from September 2007 through September of 2009 is that earning rates on
over half of the Bank's loan portfolio adjusted downward and remain low. While
the average balance of loans outstanding grew 15.2% in the third quarter of 2009
as compared to the third 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 on the loan portfolio decreased 161 basis points in the
third quarter of 2009 compared to the third quarter of 2008, exclusive of
nonaccrual loans. In contrast, average rates paid on interest bearing
liabilities decreased only 80 basis points year over year. Management continues
to seek improvements to the net interest margin without taking on undue risk.
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, 2009 and 2008.
September 30, 2009 September 30, 2008
------------------ ------------------
Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost
------- -------- ---------- ------- -------- ----------
Investments ................................ $ 25,147,390 $ 267,048 4.21% $ 22,445,451 $ 293,738 5.19%
Federal Funds Sold ......................... 9,583,410 3,546 .15% 4,919,769 20,420 1.65%
Loans, excluding nonaccruals ............... 131,176,743 1,722,059 5.21% 113,879,340 1,957,863 6.82%
------------ ---------- ------------ ----------
Total interest earning assets ........... 165,907,543 1,992,653 4.77% 141,244,560 2,272,021 6.38%
============ ---------- ============ ----------
Interest bearing transaction accounts ...... 13,280,845 15,817 .47% 13,411,247 30,695 .91%
Savings and money market ................... 37,792,204 178,750 1.88% 15,150,258 67,895 1.78%
Time deposits .............................. 85,524,789 515,100 2.39% 75,240,191 649,421 3.42%
------------ ---------- ------------ ----------
Total interest bearing deposits ......... 136,597,838 709,667 2.06% 103,801,696 748,011 2.86%
Customer repurchase agreements and
Federal Funds purchased ................ 3,672,218 16,089 1.74% 5,131,258 35,992 2.78%
Borrowings from FHLB Atlanta ............... 9,507,173 62,747 2.62% 7,896,908 64,786 3.25%
Broker repurchase agreements ............... 5,000,000 44,518 3.53% 5,000,000 44,518 3.53%
------------ ---------- ------------ ----------
Total interest bearing liabilities ...... $154,777,229 833,021 2.14% $121,829,862 893,307 2.91%
============ ---------- ============ ----------
Net interest income ........................ $1,159,632 $1,378,714
========== ==========
Interest rate spread ....................... 2.63% 3.47%
Interest margin ............................ 2.77% 3.87%
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, 2009, the Bank's
cumulative Gap ratio was 1.70 through 12 months. This indicates an
asset-sensitive position as of September 30, 2009. However, this measurement is
14
based on assumptions about the repricing of various accounts, which may not
occur as they have been modeled.
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 September 30, 2009, the Company expensed $945,000 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 $1,090,881 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 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
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 September 30, 2009, the Company earned $154,258 in
service charges on deposit accounts compared to $152,043 for the same period in
2008. Mortgage loan origination fees in the third quarter of 2009 have decreased
by $27,627 or 51.7% compared to the third 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, and the appraisal process has become
time-consuming and difficult. 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. Other
noninterest income increased to $49,375 in the third quarter of 2009 from
$29,500 for the third quarter of 2008 due to an increase in brokerage fee
income. The increase in brokerage income partially offset the decreases in
mortgage origination income.
Noninterest expense
Noninterest expense totaled $1.3 million for the three months ended September
30, 2009 and $1.1 million for the three months ended September 30, 2008.
Professional and regulatory fees increased 23.1% for the quarter over the same
quarter of 2008. This increase primarily relates to premiums for FDIC insurance.
Other expense increased $190,411 or 116.6% in 2009 over 2008 levels due to
increases in loan-related expenses. These expenses are primarily associated with
the foreclosure process.
Results of Operations for the Nine Months Ended September 30, 2009 and 2008
Summary
The Company's net loss for the nine months ended September 30, 2009 was $986,225
or $.46 per share, compared to income of $97,622 or $.05 per basic and diluted
share for the nine months ended September 30, 2008 (including the effect of the
five percent stock dividend declared in 2009). The decrease in net income is due
to changes in interest rates and the mortgage brokerage business and an increase
in the provision for loan losses.
15
Net Interest Income
Net interest income was $3.4 million in the first nine months of 2009 compared
to $4.1 million for the nine months ended September 30, 2008. The decrease was
the result of previously mentioned changes in the Bank's net interest margin.
The Bank's interest earning assets increased $22.7 million over September 30,
2008 levels, 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, 2009 was 4.91% compared to 6.65% for the
nine months ended September 30, 2008. Rates paid on interest bearing liabilities
did not decrease by the same margin, dropping 92 basis points to 2.33% from
3.25%.
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, 2009 and 2008.
September 30, 2009 September 30, 2008
------------------ ------------------
Average Interest Average Average Interest Average
Balance Earned Yield/Cost Balance Earned Yield/Cost
------- ------ ---------- ------- ------ ----------
Investments .................................. $ 22,434,970 $ 757,071 4.51% $ 23,309,479 $ 910,380 5.22%
Federal Funds Sold and other
interest-bearing cash balances ........... 9,648,247 10,880 .15% 5,212,948 82,414 2.11%
Loans, excluding nonaccruals ................. 131,215,566 5,230,366 5.33% 112,032,843 5,997,307 7.16%
------------ ---------- ------------ ----------
Total interest earning assets ............. 163,298,783 5,998,317 4.91% 140,555,270 6,990,101 6.65%
============ ---------- ============ ----------
Interest bearing transaction accounts ........ 13,116,268 58,784 .60% 13,621,648 101,887 1.00%
Savings and money market accounts ............ 30,792,513 435,538 1.89% 12,876,335 170,028 1.77%
Time deposits ................................ 87,898,317 1,731,222 2.63% 77,346,028 2,226,970 3.85%
------------ ---------- ------------ ----------
Total interest bearing deposits ........... 131,807,098 2,225,544 2.26% 103,844,011 2,498,885 3.22%
Customer repurchase agreements and
Federal Funds Purchased .................. 3,959,807 62,257 2.10% 5,394,802 137,348 3.40%
Advances from FHLB ........................... 8,153,049 174,780 2.87% 6,202,787 162,971 3.51%
Broker repurchase agreements ................. 5,000,000 132,102 3.53% 4,781,022 126,238 3.53%
------------ ---------- ------------ ----------
Total interest bearing liabilities ........ $148,919,954 2,594,683 2.33% $120,222,622 2,925,442 3.25%
============ ---------- ============ ----------
Net interest income .......................... $3,403,634 $4,064,659
========== ==========
Interest rate spread ......................... 2.58% 3.40%
Interest margin .............................. 2.79% 3.87%
Provision for loan losses
The amount of the Company's provision for loan losses for the nine months ended
September 30, 2009 was $2,025,000 compared to $460,000 for the nine months ended
September 30, 2008. In each period, 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. Charge-offs totaled $1,680,936 during the nine months of 2009 compared
to $608,423 for the first nine months of 2008. Recoveries totaled $500 in 2009
and $275,599 in 2008. See "Balance Sheet Review- Loans" for additional
information on the Company's loan portfolio and allowance for loan losses.
Noninterest income
Noninterest income for the nine months ended September 30, 2009 was $712,434
compared to a loss of $163,946 for the nine months ended September 30, 2008. The
loss in 2008 included an impairment charge of $918,264 for our investment in
FNMA preferred stock. Service charges on deposit accounts decreased primarily
due to lower charges for insufficient funds. Mortgage loan origination fees
decreased to $136,843 in 2009 from $226,038 in 2008 for the same reasons as
discussed above for the three month period. The decreases in noninterest income
in 2009 compared to 2008 were partially offset by a gain on the sale of an
available for sale security in the amount of $52,300 in the first quarter of
2009.
Noninterest expense
Total noninterest expense for the nine months ended September 30, 2009 was $3.7
million versus $3.3 million for the nine months ended September 30, 2008.
16
Salaries decreased $36,700 or 2.0% in 2009 over 2008 levels. The decrease
reflects the decrease in commissions paid to mortgage loan officers as well as
retirements, partially offset by annual salary increases and increases in the
cost of providing benefits, including stock option expenses. Professional and
regulatory fees increased $197,046 or 80.0% due to significant increases in FDIC
insurance premiums. Other expenses included costs of foreclosure of real estate
of approximately $295,000, which contributed heavily to the 58.1% increase in
other expense.
Balance Sheet Review
Investments
At September 30, 2009, the Bank held available for sale securities with a fair
value cost of $24.5 million and other investments with an amortized cost of $1.1
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 FASB ASC 820). 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 FASB ASC 820). We obtain our fair value information via
our bond accounting vendor. This vendor obtains municipal bond market pricing
from Interactive Data, a provider of third-party financial market data. The
Company does not adjust market pricing received from this vendor, but we do
request that a qualified analyst review each municipal bond in the portfolio to
determine if any other information is available that would call into question
the market values used.
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 September 30, 2009, investments available for sale had a net unrealized
gain of $803,770. As of September 30, 2009 we held three investments that are in
an unrealized loss position. Of those three, 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 $23,843, with $18,806 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 investments in a net unrealized loss
position at September 30, 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 a charge for other-than-temporary-impairment. 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 $72,800 at September 30, 2009. The remaining
investments with unrealized losses at September 30, 2009 are a bond issued by a
US government-sponsored agency and an agency mortgage-backed security. 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.
September 30, 2009 September 30, 2008
------------------ ------------------
% of % of
Amount Loans Amount Loans
------ ----- ------ -----
Commercial and industrial* .................... $ 14,733,609 10.4% $ 20,293,060 17.2%
Real Estate - construction .................... 53,347,137 38.0 51,832,917 44.0
Real Estate - mortgage
1-4familyresidential ................... 25,656,222 18.3 21,144,938 18.0
Nonfarm, nonresidential ................ 43,113,773 30.7 21,380,814 18.1
Multifamily residential ................ 2,270,357 1.6 1,240,018 1.1
Consumer installment .......................... 1,367,911 1.0 1,896,932 1.6
------------ ----- ------------ -----
Total Loans ............................ 140,489,009 100.0% 117,788,679 100.0%
===== =====
Less allowance for loan losses ........ (2,042,627) (1,420,306)
------------ ------------
Net Loans .......................... $138,446,382 $116,368,373
============ ============
* Note that certain loans have been reclassified in 2009 since the 2008
presentation.
17
Activity in the allowance for loan losses for the first nine months of 2009 and
2008 is presented below.
Nine months ended Nine months ended
September 30, 2009 September 30, 2008
------------------ ------------------
Allowance for loan losses, beginning of year ....................... $ 1,698,563 $ 1,293,130
Provision for losses ............................................... 2,025,000 460,000
Charge-offs ........................................................ (1,681,436) (608,423)
Recoveries ......................................................... 500 275,599
----------- -----------
Allowance for loan losses, end of period ..................... $ 2,042,627 $ 1,420,306
=========== ===========
Ratios As of or for the nine As of or for the nine
months ended months ended
September 30, 2009 September 30, 2008
------------------ ------------------
Nonperforming loans to loans at end of period ...................... 5.71% 1.10%
Net (charge-offs) recoveries to average loans outstanding .......... (1.22%) (.29%)
Net (charge-offs) recoveries to loans at end of period ............. (1.20%) (.28%)
Allowance for loan losses to average loans ......................... 1.48% 1.26%
Allowance for loan losses to loans at end of period ................ 1.45% 1.21%
Net (charge-offs) recoveries to allowance for loan losses .......... (82.29%) (23.43%)
Net (charge-offs) recoveries to provision for loan losses .......... (83.00%) (72.4%)
Charge-offs totaled $1,680,936 for the first nine months of 2009. Of the total
net charge-offs in 2009, 47.2% related to construction loans, 36.4% related to
commercial and industrial loans, 10.2% related to loans secured by residential
real estate, and 6.2% related to nonfarm, nonresidential real estate loans.
Loans which management identifies as impaired generally will be nonperforming
loans or restructured 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, 2009, the Bank had nonaccrual loans of $8.0 million
representing 31 loans. With the exception of one loan, these loans are secured
by real estate. In addition to loans on nonaccrual, as of September 30, 2009,
management considers another $8.5 million of loans impaired. Of that amount,
$6.4 million have been restructured and are now current. The remaining $2.1
million are currently past due more than 30 days, but less than 90 days.
Management is currently assessing the collateral associated with these
additional impaired loans in an effort to determine the amount of potential
impairment. 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. The foreclosure
process is lengthy (generally a minimum of six months), so loans may be on
nonaccrual status for a significant time period prior to moving to other real
estate owned and sold. As soon as the amount of impairment is estimable, the
amount of impairment is generally charged against the allowance for loan losses.
However, until losses can be estimated via appraisal or other means, a portion
of the allowance may be allocated to specific impaired loans. The timing of the
appraisal varies from loan to loan depending on the Bank's ability to access the
property. As of September 30, 2009 the allowance for loan losses included
$44,000 of reserves specifically related to impaired loans.
Management's estimates of net realizable, or fair value, of real estate
collateral 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 FASB ASC 820. Estimates of net realizable value for equipment and
other types of collateral are estimated based on input from equipment dealers
and other professionals (also level 2 inputs). If an appraisal is not available
or management determines that fair value of the collateral is further impaired
below the appraised value and there is not observable market price, the Company
records the impaired loan as determined by Level 3 inputs as defined by FASB ASC
820.
18
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 $1.06 million that have
been determined by management to be potential problem loans at September 30,
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 of impairment can be
determined.
Other real estate owned
As of September 30, 2009 the Company had an investment in other real estate
owned as a result of foreclosures totaling $4.8 million representing 28
properties. Of the total recorded amount, $1.7 million relates to five
commercial properties or commercial lots. The remainder represents 23
residential properties or lots. If at the time of foreclosure the fair value is
determined to be lower than the Company's recorded investment, a charge-off is
recorded at that time. If an appraisal is available, the appraisal will be used
to estimate fair value. If an appraisal is not available or management
determines that fair value of the collateral is further impaired below the
appraised value and there is not an observable market price, the Company records
the impaired loan as determined by Level 3 inputs as defined by FASB ASC 820.
Other assets
As of September 30, 2009 other assets included accrued interest receivable on
loans and investment securities available for sale, receivables related to
income taxes, non-real estate collateral acquired in settlement of loans, and
several miscellaneous items. The increase over December 31, 2008 levels is
mainly related to the repossessed collateral and various income tax related
items. See Note 6 to the unaudited consolidated financial statements above for
additional information related to income taxes.
Deposits
The following table shows the average balance amounts and the average rates we
paid on deposits for the nine months ended September 30, 2009 and 2008.
Average Deposits
----------------
Nine months ended Nine months ended
September 30, 2009 September 30, 2008
------------------ ------------------
Amount Rate Amount Rate
------ ---- ------ ----
Noninterest bearing demand .................................. $ 10,897,772 -% $ 10,794,010 -%
Interest bearing transaction accounts ....................... 13,116,268 .60% 13,411,247 .91%
Savings and money market .................................... 30,792,513 1.89% 15,150,258 1.78%
Time deposits ............................................... 87,898,317 2.63% 75,240,191 3.42%
------------ ------------
Total average deposits ................................ $142,704,870 $114,595,706
============ ============
Included in total deposit as of September 30, 2009 were $43.7 million of
deposits considered to be brokered deposits based on regulatory definitions.
These deposits come from a variety of sources, and are generally fully insured
by FDIC. The Company uses brokered deposits to fund various maturities that may
not be attractive to customers in the local market area or to supplement local
time deposits when interest rates offered locally are higher than interest rates
on similar products in other markets.
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.
19
Borrowings at or for the nine months ended September 30, 2009
-------------------------------------------------------------
Maximum Weighted
Period- Month-end Average
Ending Balance End Rate Balance Average Balance Rate Paid
-------------- -------- ------- --------------- ---------
Federal Home Loan Bank advances ......... $9,780,888 2.56% $9,806,019 $8,153,049 2.87%
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 $4.1 million
and are available on a one to fourteen day basis for general corporate purposes
of the Bank. Of these lines, $2.1 will only be available if eligible collateral
is pledged. Currently no collateral is pledged, nor are there any borrowings
under the line. 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 $9.8 million borrowed under the FHLB line. Approximately $9.4
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.
Estimated Fair Value of Financial Instruments
The Company adopted FASB ASC 820 on January 1, 2008. Refer to Note 1 for more
information regarding FASB ASC 820 and the levels of inputs used in determining
fair value of the Company's available for sale securities. The table below
presents the balances of assets measured at fair value on a recurring basis by
level within the hierarchy of inputs that may be used to measure fair value.
September 30, 2009
------------------
Carrying Fair
Amount Value
------ -----
Financial Assets
Cash and due from banks ......................................... $ 10,987,229 $ 10,987,229
Federal funds sold .............................................. 1,680,000 1,680,000
Investment securities ........................................... 25,638,960 25,638,960
Loans, gross .................................................... 140,489,009 141,820,684
Cash surrender value of life insurance policies ................. 1,820,963 1,820,963
Financial Liabilities
Deposits ........................................................ $154,042,381 $152,876,387
Customer repurchase agreements .................................. 3,549,610 3,650,570
Borrowings from FHLB ............................................ 9,780,880 9,944,737
Broker repurchase agreements .................................... 5,000,000 5,189,152
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
20
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, 2009, the Bank had issued commitments to extend credit of $20.3
million through various types of lending arrangements and overdraft protection
arrangements. Of that amount, approximately $13.3 million was undisbursed
amounts of closed-end loans, $1.2 million was related to unused overdraft
protection, and approximately $5.8 million was related to lines of credit. The
Bank also had standby letters of credit outstanding of approximately $752,000 at
September 30, 2009. An immaterial amount of fees were collected related to these
commitments and letters of credit during the nine-month period ended September
30, 2009. Historically many of these commitments and letters of credit expire
unused, and the total amount committed as of September 30, 2009 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, 2009, the majority of which is not expected to
be utilized. As of September 30, 2009, accounts in overdraft status totaled
$22,507.
Capital Resources
The capital base for the Company decreased by $370,812 for the first nine months
of 2009, due to net losses, offset by stock option activity and increases in
accumulated other comprehensive income. Stock option activity includes the
impact of both stock options exercised and accounting requirements for
stock-based compensation on unexercised options. The Company's equity to asset
ratio was 9.8% as of September 30, 2009.
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 nine months ended September 30, 2009
and as of and for the year ended December 31, 2008. Return on Assets and Return
on Equity for the first nine 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.
Nine-month period
ended Year ended
September 30, 2009 December 31, 2008
------------------ -----------------
(annualized)
Return on average assets ............................. (.73%) .15%
Return on average equity ............................. (6.89%) 1.16%
Ratio of average equity to average assets ............ 10.65% 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. The Company may or may not decide to pay cash dividends in
the future.
21
The FDIC has established guidelines for capital requirements for banks. As of
September 30, 2009, 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 ................. $20,038 13.07% $15,329 10.0% $12,264 8.0%
Tier 1 capital to risk weighted assets ................ $18,120 11.82% $ 9,198 6.0% $ 6,132 4.0%
Tier 1 capital to average assets ...................... $18,120 9.75% $ 9,290 5.0% $ 7,432 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, 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.
22
Part II - Other Information
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: November 12, 2009
-----------------------------------------------
J. Rodger Anthony
Chief Executive Officer
By: s/Jennifer M. Champagne Date: November 12, 2009
-------------------------------------------------
Jennifer M. Champagne
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)