UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 2010
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 May 1, 2010
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2010 2009
---- ----
Assets (Unaudited)
Cash and due from banks .................................................................... $ 9,602,478 $ 4,369,596
Federal funds sold ......................................................................... 3,640,000 1,670,000
------------- -------------
Cash and cash equivalents ........................................................... 13,242,478 6,039,596
Investment securities
Available-for-sale ...................................................................... 26,169,183 28,902,143
Other investments ....................................................................... 1,142,050 1,142,050
Loans, net ................................................................................. 130,622,834 135,067,914
Property and equipment, net ................................................................ 5,253,817 5,291,203
Cash surrender value of life insurance policies ............................................ 1,855,663 1,838,663
Other real estate owned .................................................................... 7,254,388 6,712,948
Other assets ............................................................................... 3,535,501 3,975,813
------------- -------------
Total assets ................................................................. $ 189,075,914 $ 188,970,330
============= =============
Liabilities And Shareholders' Equity
Liabilities
Deposits
Noninterest bearing ................................................................... $ 11,700,310 $ 11,234,486
Interest bearing ...................................................................... 142,605,825 141,146,788
------------- -------------
Total deposits ........................................................................ 154,306,135 152,381,274
Customer repurchase agreements .......................................................... 3,184,245 3,257,002
Borrowings from Federal Home Loan Bank of Atlanta ....................................... 8,205,463 9,743,172
Broker repurchase agreements ............................................................ 5,000,000 5,000,000
Other liabilities ....................................................................... 458,427 549,477
------------- -------------
Total liabilities ..................................................................... 171,154,270 170,930,925
Shareholders' equity
Preferred stock, 10,000,000 shares authorized, no shares issued ......................... - -
Common stock, no par value, 20,000,000 shares authorized, 2,211,025 shares at
March 31, 2010 and 2,105,738 at December 31, 2009 ................................... 18,815,503 18,799,728
Retained earnings (deficit) ............................................................. (1,161,589) (921,014)
Accumulated other comprehensive income .................................................. 267,730 160,691
------------- -------------
Total shareholders' equity ............................................................ 17,921,644 18,039,405
------------- -------------
Total liabilities and shareholders' equity ............................................ $ 189,075,914 $ 188,970,330
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
2
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the three months ended
March 31,
---------
2010 2009
---- ----
Interest and Dividend Income
Interest and fees on loans ............................................... $ 1,769,282 $ 1,738,030
Investment securities .................................................... 268,242 251,788
Federal funds sold and interest bearing
balances ............................................................... 2,380 2,556
----------- -----------
Total interest income ................................................ 2,039,904 1,992,374
----------- -----------
Interest Expense
Deposits ................................................................. 652,005 771,498
Borrowings ............................................................... 116,374 127,684
----------- -----------
Total interest expense ................................................ 768,379 899,182
----------- -----------
Net Interest Income ........................................................ 1,271,525 1,093,192
Provision for Loan Losses .................................................. 620,000 160,000
----------- -----------
Net interest income after provision
for loan losses ..................................................... 651,525 933,192
----------- -----------
Noninterest Income
Service charges on deposit accounts ...................................... 126,404 132,891
Mortgage loan origination fees ........................................... - 54,518
Gain on sale of security ................................................. - 52,300
Loss on sale of repossessed collateral ................................... (4,187) (24,753)
Other .................................................................... 45,799 37,962
----------- -----------
Total noninterest income .............................................. 168,016 252,918
----------- -----------
Noninterest Expense
Salaries and employee benefits ........................................... 565,109 602,041
Premises and equipment ................................................... 145,921 147,990
Data processing .......................................................... 54,845 57,186
Professional and regulatory fees ......................................... 128,058 129,498
Supplies ................................................................. 17,178 14,963
Advertising .............................................................. 5,738 13,600
Other .................................................................... 301,666 185,606
----------- -----------
Total noninterest expense ............................................. 1,218,515 1,150,884
----------- -----------
Net income (loss) before taxes ........................................ (398,974) 35,226
Income tax benefit ......................................................... (158,399) (6,670)
----------- -----------
Net income (loss) ..................................................... $ (240,575) $ 41,896
=========== ===========
Earnings (Loss) Per Share
Basic .................................................................... $ (.11) $ .02
Diluted .................................................................. $ (.11) $ .02
Weighted Average Shares Outstanding
Basic .................................................................... 2,211,025 2,199,259
Diluted .................................................................. 2,211,025 2,208,297
The accompanying notes are an integral part of these consolidated financial
statements.
3
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
For the three months ended March 31, 2010 and 2009
(Unaudited)
Accumulated
Common stock Retained other Total
------------ earnings comprehensive shareholders'
Shares Amount (deficit) income (loss) equity
------ ------ --------- ------------- ------
Balance, December 31, 2008 ................. 1,991,565 $ 18,323,333 $ 765,906 $ 47,708 $ 19,136,947
Net income ................................. - - 41,896 - 41,896
Other comprehensive income, net
of income taxes
Unrealized gain on investment
securities, net ......................... - - - 184,401 184,401
------------
Comprehensive income ....................... 226,297
Stock based compensation ................... - 18,586 - - 18,586
Options exercised .......................... 14,172 80,000 - 80,000
Stock dividend declared (5%) ............... 100,286 601,721 (601,721) - -
------------ ------------ ------------ ------------ ------------
Balance, March 31, 2009 .................... 2,106,023 $ 19,023,640 $ 206,081 $ 232,109 $ 19,461,830
============ ============ ============ ============ ============
Balance, December 31, 2009 ................. 2,105,738 $ 18,799,728 $ (921,014) $ 160,691 $ 18,039,405
Net loss ................................... - - (240,575) - (240,575)
Other comprehensive loss, net of
income taxes
Unrealized gain on investment
securities, net ......................... - - - 107,039 107,039
------------
Comprehensive loss ......................... (133,536)
Stock based compensation ................... - 15,775 - - 15,775
Stock dividend declared (5%),
recorded as a stock split ................ 105,287 - - - -
------------ ------------ ------------ ------------ ------------
Balance, March 31, 2010 .................... 2,211,025 $ 18,815,503 $ (1,161,589) $ 267,730 $ 17,921,644
============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
4
CORNERSTONE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the three months ended March 31,
------------------------------------
2010 2009
---- ----
Operating Activities
Net income (loss) ..................................................................... $ (240,575) $ 41,896
Adjustments to reconcile net income (loss) to net cash provided by
operating activities
Depreciation and amortization ...................................................... 112,598 73,168
Provision for loan losses .......................................................... 620,000 160,000
Non-cash option expense ............................................................ 15,775 18,586
Gain on sale of property and equipment ................................................ - (625)
Loss on sale of property acquired in foreclosure ...................................... 4,187 24,753
Gain on sale of security available for sale ........................................... - (52,300)
Changes in operating assets and liabilities
Change in interest receivable ...................................................... (16,632) 55,380
Change in other assets ............................................................. 439,944 (122,425)
Change in other liabilities ........................................................ (146,191) 20,098
------------ ------------
Net cash provided by operating activities ....................................... 789,106 218,531
------------ ------------
Investing Activities
Proceeds from maturities and principal repayments of available for sale
securities ...................................................................... 2,844,144 2,375,939
Redemption of FHLB and Federal Reserve stock .......................................... - 116,500
Purchase of investment securities available for sale .................................. - (3,052,041)
Purchase of property and equipment .................................................... (24,216) (395)
Proceeds from sale of property acquired in foreclosure ................................ 1,897,985 550,247
Capitalization of improvements to foreclosed property ................................. (50,116) -
Proceeds from sale of property and equipment .......................................... - 625
Net (increase) decrease in loans to customers ......................................... 1,431,584 (6,131,795)
------------ ------------
Net cash provided by (used for) investing activities ............................ 6,099,381 (6,140,920)
------------ ------------
Financing Activities
Net increase in demand, savings and time deposits ..................................... 1,924,861 22,168,024
Net decrease in customer repurchase agreements ........................................ (72,757) (88,539)
Decrease in federal funds purchased ................................................... - (1,810,000)
Repayment of FHLB advances ............................................................ (1,537,709) (5,037,708)
Borrowings from FHLB .................................................................. - 1,500,000
Proceeds from exercise of stock options ............................................... - 80,000
------------ ------------
Net cash provided by financing activities ....................................... 314,395 16,811,777
------------ ------------
Net increase in cash and cash equivalents ....................................... 7,202,882 10,889,388
Cash and Cash Equivalents, Beginning of Period ............................................. 6,039,596 3,960,227
------------ ------------
Cash and Cash Equivalents, End of Period ................................................... $ 13,242,478 $ 14,849,615
============ ============
Supplemental Information
Cash paid for interest ................................................................. $ 776,271 $ 896,910
Cash paid for income taxes ............................................................. $ - $ 5,181
Non-cash Supplemental information
Loans transferred to other real estate owned ........................................... $ 2,393,496 $ 219,200
Loans charged-off, net ................................................................. $ 269,969 $ 157,406
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") 2009 Annual Report to Shareholders, which also contains
the Company's audited financial statements for 2009 and is also included in the
Form 10-K for the year ended December 31, 2009.
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 consolidated 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 financial 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 2009 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 March 31, 2010 was 2,213,274
shares. Outstanding options were excluded from the loss per share calculation as
they are anti-dilutive as of March 31, 2010. The calculation of earnings per
share includes the effect of the 5% stock dividend declared on April 13, 2010 as
if it had been declared on January 1, 2010.
Note 3. Stock Based Compensation
As described in Notes 1 and 18 to the financial statements in the Company's
Annual Report on Form 10-K for the year ended December 31, 2009, the Company has
a stock-based employee and director compensation plan, which was approved by
shareholders in 2003 (the "2003 Plan").
There have been no options granted in 2010 under 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, 2009 for further information.
For the three months ended March 31, 2010, the Company expensed $4,543 related
to options granted in 2009, $4,297 related to options granted in 2008, $4,297
related to options granted in 2007, and $2,638, related to 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. Following the 5% stock dividend declared on April 13, 2010, the adjusted
total number of options outstanding was approximately 111,565 and the weighted
average exercise price was $9.99 per share, all in accordance with the 2003
Plan.
6
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 2009 Form 10-K. The
provision for income taxes and the valuation of other real estate owned are also
considered significant estimates.
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
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 20.5% in
Residential Building Construction and 22.4% in Real Estate 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. Under current policy, loans are limited to 80% of cost
of construction projects, and borrowers are required to meet minimum net worth
requirements and debt service coverage ratios. Projects for construction of
single family homes are generally limited to those projects with contracts for
sale where the ultimate owner has a significant investment in the contract.
These policies may be considered stricter than policies in place when some of
the Bank's currently outstanding loans were originated. However, as loans mature
or as new loans are made, the current guidelines described above would be used
to underwrite construction loans.
The Bank does not make long term (more than 15 years) mortgage loans to be held
in its portfolio, does not offer loans with negative amortization features or
long-term interest only features, or loans with loan to collateral value ratios
in excess of 100% at the time the loan is made. The Bank does offer loan
products with features that can increase credit risk during periods of declining
economic conditions, such as adjustable rate loans, short-term interest-only
loans, and loans with amortization periods that differ from the maturity date
(i.e., balloon payment loans). However, the Bank evaluates each customer's
creditworthiness based on the customer's individual circumstances, and current
and expected economic conditions, and underwrites and monitors each loan for
associated risks. Loans made with exceptions to internal loan guidelines and
those with loan-to-value ratios in excess of regulatory loan-to-value guidelines
are monitored and reported to the Board of Directors on a monthly basis. The
regulatory loan-to-value guidelines permit exceptions to the guidelines up to a
maximum of 30% of total capital for commercial loans and exceptions for all
types of real estate loans up to a maximum of 100% of total capital. As of March
31, 2010, the Bank has $7.5 million of loans which exceed the regulatory loan to
value guidelines. This amount is within the maximum allowable exceptions to the
guidelines. Of the $7.5 million of loans with exceptions to the regulatory loan
to value guidelines, $5.8 million were not exceptions at the time the loans were
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 or take other actions to mitigate the Bank's
risk.
Note 6. Income taxes
The Company accounts for income taxes using a method whereby 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, 2009
for more information. To date in 2010, the Company recorded an income tax
benefit of $158,399 compared to tax benefit of $6,670 in 2009. The primary
reasons for the benefit in 2010 are the exclusion of nontaxable municipal bond
7
income and the net tax effect of loan charge-offs. In 2009, taxable income was
primarily affected by the exclusion of nontaxable municipal bond income. As of
March 31, 2010 management has evaluated its deferred tax items and does not
believe that any require reserves as of March 31, 2010. 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 ASC 740, "Income Taxes".
Note 7. Fair Value Accounting
Effective January 1, 2008, the Company adopted an accounting standard which
expands disclosures about fair value measurements used in the financial
statements. The standard 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. The standard
also establishes a fair value hierarchy which requires an entity to maximize the
use of observable inputs and minimize the use of unobservable inputs when
measuring fair value. The standard describes three levels of inputs that may be
used to measure fair value:
Level 1-Quoted prices in active markets for identical assets or
liabilities. Level 1 assets and liabilities include debt and equity
securities and derivative contracts that are traded in an active exchange
market, as well as U.S. Treasuries and money market funds.
Level 2-Observable inputs other than Level 1 prices such as quoted prices
for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by
observable market data for substantially the full term of the assets or
liabilities. Level 2 assets and liabilities include debt with quoted prices
that are traded less frequently than exchange-traded instruments,
mortgage-backed securities, municipal bonds, corporate debt securities, and
derivative contracts whose value is determined using a pricing model with
inputs that are observable in the market or can be derived principally from
or corroborated by observable market data. This category generally includes
certain derivative contracts and impaired loans.
Level 3-Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities. Level 3 assets and liabilities include financial instruments
whose value is determined using pricing models, discounted cash flow
methodologies, or similar techniques, as well as instruments for which the
determination of fair value requires significant management judgment or
estimation. For example, this category generally includes certain private
equity investments, retained residual interests in securitizations,
residential mortgage servicing rights, and highly-structured or long-term
derivative contracts.
During the quarter ended March 31, 2010, there were no significant transfers of
assets between categories.
Note 8. Evaluation of subsequent events
In accordance with the accounting standard regarding subsequent events,
management performed an evaluation to determine whether or not there have been
any subsequent events since the balance sheet date.
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:
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 had no impact
on financial position or operations.
In January 2010, fair value guidance was amended to require disclosures for
significant amounts transferred in and out of Levels 1 and 2 and the reasons for
8
such transfers and to require that gross amounts of purchases, sales, issuances
and settlements be provided in the Level 3 reconciliation. The new disclosures
are effective for the Company for the current quarter and have been reflected in
the Note 7 above.
Guidance related to subsequent events was amended in February 2010 to remove the
requirement for an SEC filer to disclose the date through which subsequent
events were evaluated. The amendments were effective upon issuance and had no
significant impact on the Company's financial statements.
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 actions taken by regulatory authorities;
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;
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;
9
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 2008 and 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 problems in the financial services
industry. A number of these initiatives were directly applicable to community
banks.
Congress enacted the Emergency Economic Stabilization Act of 2008 which, among
other things, temporarily increased the maximum amount of FDIC deposit insurance
from $100,000 to $250,000 and created a Troubled Assets Relief Program ("TARP")
administered by Treasury. In October, 2008, Treasury announced a Capital
Purchase Program ("CPP") under TARP to increase the capital of healthy banks.
Under the CPP, Treasury would purchase preferred stock with warrants from
qualified banks and bank holding companies in an amount up to 3% of the seller's
risk-weighted assets as of September 30, 2008. Institutions wishing to
participate in the CPP were required to file an application with their principal
federal regulators. The Company filed such an application and received
preliminary approval to sell preferred stock to the Treasury, but ultimately
elected not to participate in the CPP because of (i) the cost of the preferred
stock, (ii) the open-ended administrative burdens associated with the preferred
stock, including having to agree to allow Treasury to amend unilaterally the
stock purchase agreement to comply with subsequent changes in applicable federal
statutes, (iii) the fact that the Company and the Bank were already well
capitalized under regulatory guidelines and expected to continue to be so, and
(iv) management's belief that other sources of capital were, and would continue
to be, available should additional capital be needed.
The FDIC also implemented in October, 2008, a Temporary Liquidity Guarantee
Program consisting of a deposit insurance component pursuant to which it
undertook to provide deposit insurance in an unlimited amount for non-interest
bearing transaction accounts, and a debt guarantee component pursuant to which
it undertook to fully guarantee senior, unsecured debt issued by banks or bank
holding companies. Coverage of both components was automatic until December 5,
2008, at which time covered institutions could opt out of one or both of the
components. Institutions not opting out would be charged fees for their
10
participation in the components. The Bank did not opt out of either component.
The deposit insurance component expires June 30, 2010.
An unfortunate consequence of the difficulties that have beset the banking
industry in the last two years 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. The FDIC also voted to require FDIC insured
institutions to prepay the premiums for the years 2010, 2011, and 2012 on
December 30, 2009. 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. The Bank expensed $62,917 of the prepaid premium during the
first quarter of 2010.
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 and Congressional action is pending. 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 for community banks.
Throughout 2008, 2009 and 2010, 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 levels of short-term interest rates, the Bank's net interest margin has been
adversely impacted. Nevertheless, management expects that the net interest
margin will improve over the remainder of 2010. However, the Company and the
Bank may be exposed to interest rate risk if market interest rates move
significantly in a short period of time. Management monitors interest rate risk,
but if one or more of its assumptions regarding the timing or magnitude of
changes in balances or interest rates proves to be incorrect, the Company's
interest margin, and its profitability could be impacted. Additionally, if the
real estate markets and unemployment levels in South Carolina do not improve in
the near future, the Company could face additional nonperforming assets.
The current outlook for the national economy in the United States remains
cautiously positive. Even so, management expects that economic conditions will
continue to affect financial companies throughout the remainder of 2010.
Specifically, unemployment is expected to remain high in the near term, and the
real estate markets will only improve slowly. We will continue to monitor both
the local and national economic conditions in an effort to minimize any negative
impact on the Company.
Results of Operations for the Three Months Ended March 31, 2010 and 2009
Summary
The Company recorded a loss of $240,575 during the first quarter of 2010 or $
(.11) per share compared to income of $41,896 during the first quarter of 2009
or $.02 per share, after giving effect to the five percent stock dividend
declared in 2010. The primary reason for the decline in earnings is an increase
in the provision for loan losses. Due to the closure of the Bank's mortgage loan
origination department, the Company also experienced a decrease in mortgage loan
origination fees in 2010 compared to the first quarter of 2009. However, the
closure of the mortgage department also decreased general and administrative
costs, offsetting the loss of income. The increase in the net interest margin
partially offset the increased provision for loan losses in 2010. The Bank also
experienced an increase in other expense in 2010 compared to 2009, primarily due
to foreclosure costs and carrying costs for real estate acquired in foreclosure.
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. The Company's net interest margin increased to 3.13% in the first
quarter of 2010 from 2.76% in the first quarter of 2009. The primary reason for
the increase was a decrease in the average rate paid on interest bearing
liabilities. For the quarter ended March 31, 2010 the Bank paid an average of
1.95% on interest bearing liabilities, compared with an average of 2.53% on
interest bearing liabilities in the 2009 quarter.
11
The table below illustrates the average balances of interest earning assets and
interest bearing liabilities and the resulting annualized yields and costs for
the three month periods ended March 31, 2010 and 2009.
March 31, 2010 March 31, 2009
-------------- --------------
Average Average Average Average
Balance Interest Yield/ Cost Balance Interest Yield/ Cost
------- -------- ----------- ------- -------- -----------
Investments ............................ $ 28,789,515 $ 268,242 3.78% $ 21,157,694 $ 251,788 4.83%
Federal Funds Sold ..................... 2,239,000 315 .06% 342,700 165 .20%
Loans, excluding nonaccruals ........... 127,442,354 1,769,282 5.63% 130,580,290 1,738,030 5.40%
Other interest earning assets .......... 6,459,977 2,065 .13% 8,791,938 2,391 .11%
------------ ---------- ------------ ----------
Total interest earning assets ....... 164,930,846 2,039,904 5.02% 160,872,622 1,992,374 5.02%
============ ---------- ============ ----------
Interest bearing transaction accounts .. 12,823,905 15,092 .48% 12,797,308 21,330 .68%
Savings and money market ............... 49,075,728 214,027 1.77% 24,633,537 118,960 1.96%
Time deposits .......................... 80,464,063 422,886 2.13% 89,204,351 631,209 2.87%
------------ ---------- ------------ ----------
Total interest bearing deposits ..... 142,363,696 652,005 1.86% 126,635,196 771,499 2.47%
Customer repurchase agreements and
Federal Funds purchased ............ 3,081,333 12,662 1.67% 4,474,792 27,388 2.48%
Borrowings from FHLB Atlanta ........... 9,459,051 59,678 2.56% 8,098,112 56,745 2.84%
Broker repurchase agreements ........... 5,000,000 44,034 3.57% 5,000,000 43,550 3.53%
------------ ---------- ------------ ----------
Total interest bearing liabilities .. $159,904,080 768,379 1.95% $144,208,100 899,182 2.53%
============ ---------- ============ ----------
Net interest income .................... $1,271,525 $1,093,192
========== ==========
Interest rate spread ................... 3.07% 2.49%
Interest margin ........................ 3.13% 2.76%
The Bank, which accounts for all of the Company's sensitivity to changes in
interest rates, measures interest sensitivity using various methods. Using a
static GAP measurement, which compares the amount of interest sensitive assets
repricing within a one year time period as compared to the amount of interest
sensitive liabilities repricing within the same time frame, the Bank's
sensitivity to changes in interest rates can be analyzed. This method does not
take into account loan prepayments and other non-contractual changes in balances
and the applicable interest rates, but it does give some information as to
possible changes in net interest income that could be expected simply as a
result of changes in interest rates. As of March 31, 2010, the Bank's cumulative
static GAP ratio was .68 through 12 months assuming all non-maturing deposits
reprice immediately. This indicates a liability-sensitive position as of March
31, 2010. However, this measurement is 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 normally be 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 2008 and 2009, the Bank experienced difficulty in
lowering rates on its liabilities because it was competing for funds with many
other entities, some of which faced significant liquidity needs. This
competition for funds 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.
12
Provision for loan losses
For the quarter ended March 31, 2010, the Company expensed $620,000 to the
provision for loan losses. The Bank sets the 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 $269,969 and there were no recoveries.
During the quarter three loans became past due which were dependent on sales of
real estate for repayment. For various reasons the sales did not occur during
the quarter, and additional allowance for loan losses was provided for these
loans in the event that the expected transactions do not occur in a timely
manner.
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 is possible, 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. Prior to the third quarter of 2009,
mortgage loan origination fees also played an important role. For the three
months ended March 31, 2010, the Company earned $126,404 in service charges on
deposit accounts compared to $132,891 for the same period in 2009. During the
turmoil in the residential mortgage markets over the last 18 months when
national mortgage lenders changed or deleted programs and tightened credit
standards and when the appraisal process became time-consuming and difficult,
mortgage origination fees declined. The Company temporarily suspended its
conventional mortgage origination department in the fourth quarter of 2009. When
the market for conventional mortgages returns, management plans to reevaluate
the possibility of offering long-term mortgage loans to its customers. Mortgage
loan origination fees in the first quarter of 2009 were $54,518. Other
noninterest income increased to $45,799 in the first quarter of 2010 from
$37,962 for the first quarter of 2009 due to an increase in brokerage fee
income. The increase in brokerage income partially offset the decreases in
mortgage origination income. In 2009 the Bank recorded a gain on the sale of a
security in the amount of $52,300. There were no such sales of securities in
2010.
Noninterest expense
Noninterest expense totaled $1.2 million for the three months ended March 31,
2010 and $1.15 million for the three months ended March 31, 2009. Other expense
increased $116,060 or 62.5% in 2010 over 2009 levels primarily due to increases
in expenses related to other real estate owned. As other real estate is sold
these expenses are expected to decline. The increase was partially offset by the
$36,932 decrease in salaries and employee benefits resulting primarily from the
suspension of the conventional mortgage origination department.
Balance Sheet Review
Investments
At March 31, 2010, the Bank held available for sale securities with a fair value
of $26.2 million and other investments with an amortized cost of $1.14 million.
Available for sale securities include government sponsored enterprise bonds,
mortgage-backed securities, and municipal bonds. 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.
13
Other investments include stock in the Federal Home Loan Bank of Atlanta and the
Federal Reserve Bank. These stocks are held at amortized cost because they have
no quoted market value and have historically been redeemed at par value.
However, there can be no assurance that these stocks will, in fact, be redeemed
at cost in the future.
As of March 31, 2010, investments available for sale had a net unrealized gain
of $405,530. As of March 31, 2010, we held seven investments that are in an
unrealized loss position. None had been in an unrealized loss position for more
than 12 months. The amount of the total unrealized loss in the portfolio is
$60,449. Four of the seven securities are government sponsored agency bonds and
three are government-sponsored mortgage backed securities. The Bank has
historically had the intent and ability to hold investments until maturity, and
expects to be able to continue to do so. Based on our review of these
securities, we do not currently expect that these losses are other than
temporary.
Loans
The following table summarizes the composition of our loan portfolio.
March 31, 2010 December 31, 2009
-------------- -----------------
% of % of
Amount Loans Amount Loans
------ ----- ------ -----
Commercial and industrial ...................... $ 12,778,871 9.6% $ 13,418,581 9.8%
Real Estate - construction ..................... 50,981,978 38.1 53,827,245 39.1
Real Estate - mortgage
1-4 family residential .................. 21,623,663 16.2 23,284,692 16.9
Nonfarm, nonresidential ................. 43,106,752 32.2 41,810,020 30.3
Multifamily residential ................. 2,386,054 1.8 2,520,201 1.8
Consumer installment ........................... 1,192,649 .9 1,346,807 1.0
Other Loans .................................... 1,598,235 1.2 1,555,705 1.1
------------ ----- ------------ -----
Total Loans ............................. 133,668,202 100.0% 137,763,251 100.0%
===== =====
Less allowance for loan losses ......... (3,045,368) (2,695,337)
------------ ------------
Net Loans ........................... $130,622,834 $135,067,914
============ ============
Activity in the allowance for loan losses for the first three months of 2010 and
2009 is presented below.
Three months ended Three months ended
March 31, 2010 March 31, 2009
-------------- --------------
Allowance for loan losses, beginning of year ................................. $ 2,695,337 $ 1,698,563
Provision for losses ......................................................... 620,000 160,000
Charge-offs .................................................................. (269,969) (157,906)
Recoveries ................................................................... - 500
----------- -----------
Allowance for loan losses, end of period ............................... $ 3,045,368 $ 1,701,157
=========== ===========
Ratios As of or for the As of or for the three
three months ended months ended
March 31, 2010 March 31, 2009
-------------- --------------
Nonperforming loans to loans at end of period .................................. 5.98% 3.44%
Net charge-offs to average loans outstanding ................................... (.20%) (.12%)
Net charge-offs to loans at end of period ...................................... (.20%) (.11%)
Allowance for loan losses to average loans ..................................... 2.24% 1.27%
Allowance for loan losses to loans at end of period ............................ 2.28% 1.24%
Net charge-offs to allowance for loan losses ................................... (8.87%) (9.25%)
Net charge-offs to provision for loan losses ................................... (43.5%) (98.4%)
14
Charge-offs totaled $269,969 for the first three months of 2010. Of the total
net charge-offs in 2010, 65.9% related to construction loans, and 34.1% related
to loans secured by residential real estate.
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 March 31, 2010, the Bank had nonaccrual loans of $8.0 million representing
21 loans, a decrease of $1.7 million or 17.5% from December 31, 2009. With the
exception of one loan, these loans are secured by real estate. In addition to
loans on nonaccrual, as of March 31, 2010, management considers another $5.5
million of loans impaired. Of that amount, $3.7 million have been restructured
and are in compliance with restructured terms. The remaining $1.8 million are
currently past due, but not on nonaccrual. Management is currently assessing the
collateral and other circumstances 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 and often much longer), 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 March 31, 2010 the allowance for loan losses included
approximately $331,000 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. Estimates of net realizable value for equipment
and other types of collateral are estimated based on input from equipment
dealers and other professionals. 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,
"Fair Value Measurements and Disclosures".
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 $1.1 million that have
been determined by management to be potential problem loans at March 31, 2010.
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 March 31, 2010 the Company held other real estate owned as a result of
foreclosures totaling $7.3 million representing 38 properties. Of the total
recorded amount, $1.7 million relates to five commercial properties or
commercial lots. The remainder represents 33 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 March 31, 2010 other assets included accrued interest receivable on loans
and investment securities available for sale totaling over $700,000, receivables
related to income taxes over $800,000, deferred tax assets over $800,000 prepaid
expenses over $1.1 million and several miscellaneous items. Prepaid expenses
include $856,000 of FDIC premiums for 2010 through 2012 that were required to be
prepaid to the FDIC in December 2009. See Note 6 to the unaudited consolidated
financial statements above for additional information related to income taxes.
15
Deposits
The following table shows the average balance amounts and the average rates we
paid on deposits for the three months ended March 31, 2010 and 2009.
Average Deposits
----------------
Three months ended Three months ended
March 31, 2010 March 31, 2009
-------------- --------------
Amount Rate Amount Rate
------ ---- ------ ----
Noninterest bearing demand ................................... $ 11,226,243 -% $ 9,964,060 -%
Interest bearing transaction accounts ........................ 12,823,905 .48% 12,797,308 .68%
Savings and money market ..................................... 49,075,728 1.77% 24,633,537 1.96%
Time deposits ................................................ 80,464,063 2.13% 89,204,351 2.87%
------------- -------------
Total average deposits ................................. $ 153,589,939 $ 136,599,256
============= =============
Included in total deposits as of March 31, 2010 were $35.8 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.
Borrowings at or for the three months ended March 31, 2010
Maximum Weighted
Period- Month-end Average
Ending Balance End Rate Balance Average Balance Rate Paid
-------------- -------- ------- --------------- ---------
Federal Home Loan Bank advances ........ $ 8,205,463 2.51% $9,730,602 $ 9,459,051 2.56%
Broker repurchase agreements ........... $ 5,000,000 3.48% $ 5,000,000 $ 5,000,000 3.57%
Estimated Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments were as
follows:
March 31, 2010
--------------
Carrying Fair
Amount Value
------ -----
Financial Assets
Cash and due from banks ........................................ $ 9,602,478 $ 9,602,478
Federal funds sold ............................................. 3,640,000 3,640,000
Investment securities .......................................... 27,311,233 27,311,233
Loans, gross ................................................... 133,668,202 135,173,390
Cash surrender value of life insurance policies ................. 1,855,663 1,855,663
Financial Liabilities
Deposits ....................................................... 154,306,135 152,594,211
Customer repurchase agreements ................................. 3,184,245 3,184,245
Borrowings from FHLB ........................................... 8,205,463 8,270,471
Broker repurchase agreements ................................... 5,000,000 5,263,387
16
The Company adopted a new accounting standard on January 1, 2008 which requires
disclosure of the levels of inputs used in determining fair value of the
Company's assets measured at fair value, including available for sale securities
and other real estate owned. The table below presents the balances of assets
measured at fair value on a recurring or nonrecurring basis by level within the
hierarchy of inputs that may be used to measure fair value.
March 31, 2010
--------------
Total Level 1 Level 2 Level 3
----- ------- ------- -------
Investment securities, recurring .................... $27,311,233 $19,833,370 $6,335,813 $ 1,142,050
Other real estate owned, nonrecurring ............... $ 7,254,388 $ - $ - $ 7,254,388
Impaired loans, nonrecurring ........................ $13,487,442 $ - $ - $13,487,442
March 31, 2009
--------------
Total Level 1 Level 2 Level 3
----- ------- ------- -------
Investment securities, recurring .................... $28,902,143 $21,336,460 $6,423,633 $1,142,050
Other real estate owned, nonrecurring ............... $ 6,712,948 $ - $ - $6,712,948
Impaired loans, nonrecurring ........................ $ 5,619,604 $ - $ - $5,619,604
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 million 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 $8.2 million borrowed under the FHLB line. Approximately
$10.7 million is available under the FHLB line, assuming adequate collateral is
available for pledging. Management believes that the Company's liquidity sources
are adequate to meet its operating needs.
Off Balance Sheet Risk
Through the operations of the Bank, the Company has contractual commitments to
extend credit in the ordinary course of its business activities. These
commitments are legally binding agreements to lend money to the Bank's customers
at predetermined interest rates for a specified period of time. Commitments are
subject to various conditions which are expected to reduce the credit risk to
the Company. The Bank's management evaluates each customer's creditworthiness on
a case-by-case basis. The amount of collateral obtained, if deemed necessary by
management upon extension of credit, is based on a credit evaluation of the
borrower. Collateral varies but may include accounts receivable, inventory,
property, plant and equipment, and commercial or residential real estate.
Management manages the credit risk on these commitments by subjecting them to
normal underwriting and risk management processes.
At March 31, 2010, the Bank had issued commitments to extend credit of $16.5
million through various types of lending arrangements and overdraft protection
arrangements. Of that amount, approximately $9.4 million was undisbursed amounts
of closed-end loans, $1.2 million was related to unused overdraft protection,
and approximately $5.9 million was related to lines of credit. The Bank also had
standby letters of credit outstanding of approximately $658,186 at March 31,
2010. An immaterial amount of fees were collected related to these commitments
and letters of credit during the three-month period ended March 31, 2010.
Historically many of these commitments and letters of credit expire unused, and
the total amount committed as of March 31, 2010 is not necessarily expected to
be funded.
17
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 March 31, 2010, the majority of which is not expected to be
utilized. As of March 31, 2010, accounts in overdraft status totaled $13,711.
Capital Resources
The capital base for the Company decreased by $117,761 for the first three
months of 2010, due to net losses, offset by stock based compensation activity
and increases in accumulated other comprehensive income. Stock based
compensation activity includes the impact of accounting requirements on
unexercised options. The Company's ending equity to asset ratio was 9.48% as of
March 31, 2010. The Company average equity to assets ratio was 9.51% for the
quarter ended March 31, 2010.
The following table details return on average assets (net income divided by
average total assets, annualized in 2010), return on average equity (net income
divided by average total equity, annualized if necessary), the ratio of average
equity to average assets and the Dividend Payout Ratio (dividends paid divided
by net income) as of and for the three months ended March 31, 2010 and as of and
for the year ended December 31, 2009. The annualized return on assets and return
on equity for the first three months of 2010 have increased compared to return
on assets and return on equity for the year ended December 31, 2009 due to
improvements in our net interest margin. However, annualized results for the
first quarter of 2010 may not be indicative of actual annual results for 2010.
Three- month period
ended Year ended
March 31, 2010 December 31, 2009
-------------- -----------------
(annualized)
Return on average assets .......................... (.51%) (.75%)
Return on average equity .......................... (5.35%) (7.21%)
Ratio of average equity to average assets ......... 9.51% 10.42%
Dividend payout ratio ............................. -% -%
The FDIC has established guidelines for capital requirements for banks. As of
March 31, 2010, the Bank is considered well capitalized based on the capital
levels that are required to be maintained according to FDIC guidelines as shown
in the following table.
Capital Ratios Adequately
Well Capitalized Capitalized
Actual Requirement Requirement
------ ----------- -----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total capital to risk weighted assets ................... $19,479 12.99% $14,993 10.0% $11,994 8.0%
Tier 1 capital to risk weighted assets .................. $17,581 11.73% $ 8,996 6.0% $ 5,997 4.0%
Tier 1 capital to average assets ........................ $17,581 9.27% $ 9,480 5.0% $ 7,584 4.0%
The Federal Reserve has also established guidelines for capital requirements for
bank holding companies that are similar to the FDIC's guidelines for banks. At
March 31, 2010 the Company exceeded all of the minimum requirements of the
Federal Reserve guidelines.
Because the Bank had a relatively high level of nonperforming assets at March
31, 2010 and recorded a loss for the year ended December 31, 2009 and for the
first quarter of 2010, the Bank expects the OCC to require the Bank to maintain
capital ratios in excess of those required to be well capitalized as shown in
the table above, but less than the Bank's actual ratios as of March 31, 2010.
The Bank also expects to enter into an agreement with the OCC to take other
specified actions intended to reduce the risks faced by the Bank. The OCC will
have the authority to enforce such an agreement with various regulatory actions.
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Impact of Inflation
Unlike most industrial companies, the assets and liabilities of financial
institutions such as the Company are primarily monetary in nature. Therefore,
interest rates have a more significant impact on the Company's performance than
do the effects of changes in the general rate of inflation and changes in
prices. In addition, interest rates do not necessarily move in the same
magnitude as the prices of goods and services. As discussed previously,
management seeks to manage the relationships between interest sensitive assets
and liabilities in order to protect against wide rate fluctuations, including
those resulting from inflation.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates,
which principally arises from liquidity risk and interest rate risk inherent in
the Bank's lending, deposit gathering, and borrowing activities. Other types of
market risks such as foreign currency exchange risk and commodity price risk do
not normally arise in the ordinary course of our business. The Funds Management
Committee of our Board of Directors, which meets quarterly, monitors and
considers methods of managing exposure to liquidity and interest rate risk. Our
Management monitors liquidity and interest rate risk on an on-going basis.
Management is responsible for maintaining the level of interest rate sensitivity
of our interest sensitive assets and liabilities and managing our liquidity
within board-approved limits.
Interest rate sensitivity "GAP" analysis measures the timing and magnitude of
the repricing of assets compared with the repricing of liabilities and is an
important part of asset/liability management. The objective of interest rate
sensitivity management is to generate stable growth in net interest income, and
to control the risks associated with interest rate movements. Management
constantly reviews interest rate risk exposure and the expected interest rate
environment so that adjustments in interest rate sensitivity can be made in a
timely manner.
ITEM 4T. Controls and Procedures.
Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company's chief
executive officer and chief financial officer concluded that such controls and
procedures, as of the end of the period covered by this report, were effective.
There has been no change in the Company's internal control over
financial reporting during the most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
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Part II - Other Information
ITEM 6. Exhibits
Exhibits:
31-1 Rule 13a-14(a)/ 15d-14(a) Certifications of Chief
Executive Officer
31-2 Rule 13a-14(a)/Rule 15d-14(a) Certifications of
Chief Financial Officer
32 18 U.S.C. Section 1350 Certifications
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Cornerstone Bancorp
(Registrant)
By: s/J. Rodger Anthony Date: May 11, 2010
-------------------------------------------------------
J. Rodger Anthony
Chief Executive Officer
By: s/Jennifer M. Champagne Date: May 11, 2010
-------------------------------------------------------
Jennifer M. Champagne
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
20